Business hard money loans are becoming more prevalent as borrowers feel the pinch of the credit crunch and find that traditional sources like their local banks won’t approve their loan application. Some borrowers are often surprised, perhaps shocked, to receive notice that their loan has been “repossessed” due to banks’ desire to lighten their exposure. As of April 2008, it is estimated that the rejection rate of traditional banks is as high as 90%… The gap is being filled, to some extent, with commercial hard money loans.
The positives are that borrowers enjoy less red tape, closing often takes as little as 2-3 weeks, and a more “common sense” underwriting mentality generally prevails. Despite the positive aspects, borrowers still typically rely on this type of financing only as an option when they cannot obtain conventional financing; And for good reason. The increase in speed and flexibility with underwriting comes at a price for the borrower with interest rates in the 12-16% range and starting points of 3-6%. Also, the loan will normally not extend beyond 24 to 36 months.
Why would anyone agree to such terms?
1. They have no other options or
2. Despite the high rate and points, the blanket deal makes sense for your situation.
Here are two examples where it made sense for the borrower to go ahead with a hard money business loan.
Denver, Colorado. Small commercial premises that belonged to the same owner for 30 years where he had his business. In short, despite the borrower’s lack of development and real estate management experience, he wanted to move his business and convert the property into a 4-unit rental property. To accomplish this, he needed to completely dismantle the property, alter the façade, and make changes to the parking lot. And, of course, he needed a lot of money to do it.
His problems were many: Firstly, he had no development experience, his credit was in the low 500s, he had almost no liquidity AND his business had been losing money for the last 2 years… In short, he had no chance of obtain conventional funds.
What he did have was a solid building just outside the center of town that he owned free and clean. The loan we arranged was a 50% loan to value with an 18 month payment reserve. Meaning that the first 18 months “were “prepaid” taken from the loan proceeds and placed in a third party escrow account. This was the only way the lender would agree to the deal that made sense because the borrower wouldn’t he had cash to make the monthly payments!It also gave him enough time to renovate and lease the property.The payment reserve was also a great relief for the borrower, because he knew his cash flow situation very well.
Subway Detroit. A local company that owned a large light industrial building with a retail component was impacted by their existing bank. Despite the borrower’s 15-year loyalty to their banks and never falling behind on a payment, their loan was “called,” meaning forced balloon (yes, banks can do this; there’s a call provision in almost every commercial bank mortgages). The reason behind this was that the bank did not like the industry the business was in (tier 3 automotive supplier) and did not like the type of building. Industrial properties in the Detroit metro area continue to take a hit as the market slides with the auto industry.
As the company began looking at options, they discovered that
1. no conventional source wanted your loan and
2. that the few that showed any interest had to have a loan with full recourse, that is, full personal guarantee.
Although the CEO had a 2% stake, the remainder was controlled by a family trust. The CEO was unwilling to say goodbye and neither was any of the family. Many private money lenders want full recourse, but this is a negotiable item. And as long as the loan to securities is below 60 – 50%, you can often find a source. So the borrower decided to go the hard money route with a 3 year interest only loan. They refinanced the mortgage and took out an additional $700,000 to consolidate the date, which greatly improved their cash flow situation.
These are typical scenarios, others include foreclosures, distressed properties, recent bankruptcies, lack of existing cash flow, corporate buyouts, land contract refinances, “need for speed” etc. Simply put, hard money business loans are expensive but can be a viable option.
