How Hard-Money Loans Work

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Hard money loans are formally non-credit based collateralized loans. According to the Federal Deposit Insurance Corporation (FDIC), hard money loans are subprime loans, a term that many identify with high interest real estate financing for borrowers with bad credit. In addition to being non-credit based loans, hard money loans are an alternative form of financing that do not necessarily require real estate as collateral for bridge loans, distressed property funding and cash-flow financing. Moreover, in the case of mezzanine capital loans, hard money lenders offer financing with the option to convert debt from business loans into an equity stake in a company instead of collateral. 

The reason hard money lenders are not only subprime lenders is because they also specialize in facilitating financing with unique financial services that may not be available through traditional financial institutions. For example, Vital Funds Inc. is a hard money lender that offers a range of financial services such as proof of funds, bank guarantees and standby letters of credit. In a sense these are financial documentation services that allow investors or businesses to gain another source of financing elsewhere.  

As with all financial transactions, hard money loans are regulated. Federal statutory law and individual state laws still determine the underlying legality of if and how hard money loans takes place. However, this does not mean hard money loans have to use the same lending policy and procedures as banks. Generally, hard money loans are easier to qualify for because of a simplified application process. A draw back of hard money loans is that they typically have double digit interest rates that are higher than some credit based loans.  

Just as a car title loan assists with providing quick short-term financing, hard money lenders help facilitate short-term financing solutions; a difference between the two loan types being considerably higher amounts of capital. The specific amount of hard money loans can be quite high and range from hundreds of thousands to billions of dollars. Hard money lenders specify lending range, term, collateral requirements and interest rates prior to the loan. For example, the hard money lender Western Capital Partners, LLC offers loans between $1-7 million up to 75 percent of the value of real estate collateral for a term of no more then two years and no less than six months.   

The use of hard money loans can be substantiated in a number of ways. First, hard money loans can bypass lengthy application procedures for larger amounts of money. For example, hard money loans assist borrowers with time sensitive financial circumstances such as pending foreclosure or short-term financing for a real estate development. A second reason to use hard money loans is based on the notion hard money lenders are not obligated to operate based on credit. In other words, hard money lenders can help individuals and businesses that would otherwise experience difficulty obtaining loans using more conventional resources such as federally insured mortgages.