Private lending is evolving to meet the needs of emerging sectors and trends in commercial real estate investments. With this evolution comes a shift in how industry leaders meet the needs of borrowers. And part of this shift is in the application of hard money — the reasons why it’s beneficial and for which borrowers it’s best.
As mortgage lenders, brokers and borrowers alike navigate this change in the private lending space, it’s important to understand that private money is an umbrella term that refers to a variety of lending practices. Hard money is one of these practices. Not every private lending option is the same, nor are they all appropriate for every type of commercial mortgage borrower.
“When borrowers think of the term ‘hard money,’ they imagine hard-to-place deals that aren’t serviced by traditional bank products or even by many private lenders.”
This is particularly true when it comes to hard money, which serves as a lifeline for many borrowers who need funding fast. In this light, it’s smart to underscore the distinctions between hard money and private money to illustrate how these terms ultimately mean different things for borrowers.
Defining private money
Referring to private money when a borrower may actually mean a hard money loan is like asking to rent a vehicle when what you really need is an SUV. The term “vehicle” could refer to any type of model, from a two-door convertible to an 18-wheeler or something else altogether. Sure, they’re all vehicles, but if you need a cargo truck, a sedan simply won’t do.
The same metaphor applies to private money and hard money. While these terms are sometimes used interchangeably when discussing commercial real estate, there are important nuances that affect when each type of loan might be required. These nuances can affect a borrower’s eligibility and repayment terms, among other factors relevant to their deal.
Private lending (or private money) refers to an individual, office or institution that offers loans not available through a bank or credit union. This type of loan may not always be secured by collateral such as real estate or other property. Underneath this umbrella, there’s a diverse array of lending options. Borrowers can find secured or unsecured loans, varying deal sizes, term lengths and interest rate fluctuations, just to name some examples. All of these factors influence which option is best for the borrower.
Additionally, private money can originate from accredited investors, angel investors, or even a circle of friends, family or acquaintances. These sources can structure their loan as an equity stake in the opportunity in question. Terms and conditions also vary widely between private lenders.
Hard money option
Hard money is indeed a type of private loan as it’s not tied to a bank or credit union. But hard money is defined by some key factors that differentiate it from private lending. Namely, hard money is always secured, so collateral is a must.
What a hard money lender chooses to accept as collateral varies. For example, real estate is commonly used as collateral, but only a select few hard money lenders accept raw land as collateral. Notably, hard money is often the best choice for high-risk scenarios as these lenders are experienced in navigating tricky deals and have the expertise to successfully close them.
Due to the high-risk nature of these deals, however, hard money lenders may charge higher interest rates, origination fees and closing costs. They also may require a larger downpayment.
When borrowers think of the term “hard money,” they imagine hard-to-place deals that aren’t serviced by traditional bank products or even by many private lenders. These lenders specialize in funding challenging, high-risk deals that involve hard assets as collateral — hence the term “hard money.”
An example of a situation in which hard money is a better fit includes a land loan. Traditional lenders and many private lenders won’t do deals involving raw land as they view it as too risky. If a borrower defaults, raw land as collateral can be quite difficult for a lender to leverage as repayment for their loan. Hard money lenders (and in particular, lenders with experience funding deals involving raw land) are sorely needed in these instances.
Another example is when a borrower needs to close a deal quickly. Closing a loan can take months, but hard money can shorten this timeline to as little as a few days. That’s because hard money focuses on the essentials for a sound deal. A clean title, a clean environmental report and an up-to-date appraisal are among the few items needed to move forward. This cuts out extensive paperwork, financial analysis and a deep review of the borrower’s history — elements that take weeks to complete and don’t focus on the true merits of the deal at hand.
In a similar vein, borrowers often turn to hard money because of a less-than-stellar credit rating. It’s important to keep in mind that credit ratings can be affected by a number of factors, such as a deal gone sour or a shady former business partner. These numbers do not always speak to a borrower’s ability to follow through on their commitments.
Unfortunately, there’s no room for this nuance when working with traditional lenders and many private lenders. Hard money is a vital option and, in some cases, is the only option for these scenarios.
One of the main reasons for using hard money is flexibility. There are often conditions attached to traditional and private loans, from how the money can be spent to a strict repayment schedule.
Hard money is often free from these restrictions. Borrowers can apply the funds to a wide range of needs, including refinancing to pay off debt, working capital or use as a bridge loan. This kind of versatility is more difficult to come by with other loan types.
This type of loan is also used in international deals. Traditional lenders and the typical private lender won’t touch an opportunity outside the U.S. For borrowers with unique, viable and profitable opportunities on the table, this fact can sink an entire deal. Hard money lenders — and specifically the lenders with a record of successful loan closings abroad — tend to be the only ones that can come through for these kinds of borrowers.
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Hard money holds unique importance within the wider world of private lending. The distinction between hard money and the commercial private lending sector as a whole is important for borrowers with specific needs.
Whether that need is a fast closing, land as collateral, an opportunity abroad or simply more flexibility, there will always be borrowers with circumstances that make hard money the right fit for their deals. By making this distinction clear from the start, borrowers and hard money lenders are more easily matched with options that will help everyone close faster. ●