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.

The eifference between debt and equity financing

Companies use debt and equity financing to leverage capital expenditures, project development and operational expansion. Without leveraging company's financial growth is limited to retained earnings. For this reason debt and equity financing are often times considered vital to business expansion. Both debt and equity financing have advantages and disadvantages associated with them. This article will illustrate both forms of financing then come to a reasoned conclusion as to when and why each form of financing can be valuable.

Debt sources of financing

Debt financing includes collateralized bonds, debentures, business loans from banks, and lines of credit. Generally debt financing comes with an interest rate somewhere between 3-8% depending on the type. For this reason debt financing can be less expensive than equity finance depending on the expectations of the equity financiers. Debt financing may not always generate enough capital to perform intended business projects and goals as this type of financing tends to be more conservative in its lending requirements.

Equity sources of financing

When using equity as a source of financing a company is seeking capital from investors through the issuance of shares. These shares can be common or preferred i.e. having voting rights or priority in the case of company liquidation. Equity financing can also take the form of employee stock options which replace direct pay in the form of a corporate benefit. In the case of common and preferred shares, equity financing can be variable based on stockholder expectations and type meaning the higher the expectations, the higher the cost of financing.

Advantages and disadvantages of debt and equity financing

In business, both debt and equity financing have their advantages. Debt financing from financial institutions is subject to formal approval from lenders and monitored by organizations that rank the quality and credibility of corporate bonds. For this reason, debt financing can not only be a source of cheaper leveraging, but also an indicator of how viable a projects and goals actually are in terms of how convinced lenders and analysts are about the quality of the debt.

On the other hand, in a competitive market place, venture capital and equity financing can mean the difference between innovation, market share and a competitive edge. Often, such ventures can have more risk and therefore demand more return on investment making the financing more expensive. Nevertheless, if a business can garner a return on capital greater than the cost of goods and services including equity costs, then those projects become profitable.

Depending on the type of business, competitive ventures requiring excessive equity financing may simply be unnecessary, impractical or not in accordance with the goals of the business owners. In other words, not all businesses are designed to rapidly expand and yield growing profits on an annual basis. Businesses that simply intend on yielding a steady profit on an annual basis may benefit more from debt financing because of its structured and cost effective nature.

In the case of Equity financing, businesses that lack credibility, start ups and rapidly expanding businesses however may make positive use out of equity financing not only because it may be the only source of capital around but because it can provide the leverage necessary to accomplish the corporate vision.

Summary

Financing is a form of leverage not uncommon to most businesses in one form or another. Smaller businesses tend to use less, fixed or no equity financing due to corporate goals, cost of financing and business size. Contrarily, large high-powered industry leaders and high growth firms may find it essential to raise capital through equity financing to accomplish annual forecasts, corporate goals and owner objectives. Each form of financing has its advantages and disadvantages as this article has illustrated, but in the end financial leveraging is something that may be required for business survival and profitability regardless of cost.