Understanding the Difference Between Private Money Loans and Hard Money Loans
Hard money loans and private money loans are two different types of alternative financing. When a business has capital needs that traditional lenders such as banks can’t meet, alternative financing can provide a practical solution.
It’s fairly common for modern businesses to run into this situation due to the strict and often exaggerated requirements many banks have for loan approval. In those cases, having an outside lender available can keep business operations running smoothly and allow owners to boost company growth.
Choosing the right type of alternative financing matters. The more you understand the pros and cons, the better equipped you are to make a great decision and save money. What are the differences between hard money loans and private loans? When are they a good choice for your business?
What Are Hard Money Loans?
Hard money loans are also known as asset-based lending. Sometimes, they’re called bridge loans. This type of financing relies on a business asset to act as collateral for the loan. Many business assets can be collateral: property, inventory, heavy machinery, construction equipment, vehicles and (sometimes) jewelry. Real estate is the most common type of collateral used for ABL financing.
How Does Asset-Based Financing Work?
With a hard money loan, the main factor that affects your ability to get a loan is the asset you choose and its value. This collateral needs to be able to cover the cost of the loan as well as any insurance, closing costs or other fees. It’s also important for assets to be something valuable that is relatively easy to sell.
Next, the lending company has the asset appraised. The loan offered is based on a percentage of the item’s as-is value. You decide if the amount covers your needs, and sign the necessary paperwork if you agree. Funds are transferred to your bank account quickly and you can spend them as you see fit.
What Are Private Loans?
Private lenders make up a large category of non-traditional financing. Angel investors, venture capitalists, friends, family members, businesses and other sources are types of private lenders. They’re different from conventional loan sources such as banks both in loan types and loan requirements.
A private loan can have virtually any kind of terms imaginable. Some family members may give you a smaller loan with no interest whatsoever. VCs and angel investors may want some type of equity in your business in exchange for money. Other private lenders offer short- and long-term financing but with a range of interest rates.
What Terms Do Private Loans Carry?
Private loans don’t have any specific definitions or guidelines to follow, aside from following U.S. laws regarding lending. There is a huge range of repayment terms, fees, and interest rates with this type of loan, and the specifics mainly come down to who you decide to work with.
What Are the Advantages of Hard Money Loans?
Many businesses use hard money lending because of the benefits it provides. You can evaluate the same factors for your business.
Fast Financing for Business Emergencies
Sometimes, a business needs working capital right away. For example, a piece of equipment may break down and need repairs. If this is one of your primary sources of revenue, you can’t afford to wait weeks or months to get money for it. The same situation can happen if you have a slow month and you need some help covering payroll or taxes.
Hard money loans can get approved in about 5–7 days max, and sometimes in just a few days. That’s much faster than traditional loans that require weeks for underwriting, credit checks and meetings. You can get working capital to cover business emergencies without problems.
Fast approval is also important when you need a bridge loan for real estate. If you come across a great property from a bank auction, you need financing quickly to close on the real estate before other buyers can get their hands on it. Many house flippers rely on bridge loans to make solid profits from house sales.
Simple Application Process and Qualifications
Another advantage of ABL financing is that you don’t need to dig up tons of financial records. Often, the documents you mainly need are related to the business asset you’re choosing as collateral. There’s no credit check to worry about.
Compare that to traditional loans (and many private loans) and you can see why this option is so popular with small business owners. Most banks want to see years of profit-and-loss forms, tax returns and other financial documents, in addition to hard credit pulls. It takes time to gather all those records, and filling out the application can be a major headache.
Low Credit Score Requirements
One of the biggest differences between hard money loans and traditional loans are the credit rating requirements. With a bridge loan, your credit score doesn’t matter. Alternative lenders don’t even run a credit check with this type of loan. It’s not necessary because collateral reduces the risk of lending.
This is very different than the credit history requirements of most banks. They often require a nearly spotless credit history and a high credit rating. Sure, businesses can get excellent interest rates if they have excellent credit, but if not, banks won’t even consider the application.
Flexible Loan Terms
Compared to traditional loans, hard money financing is amazingly flexible. With conventional lenders, it’s your company that has to adapt to the terms of the loan you’re offered. You don’t get much of a say in interest rates, repayment terms, down payments or additional fees. You either have to accept the loan agreement or find another lender.
With ABL financing, the opposite is true: Hard money lenders are happy to adjust the terms of the loan so it’s more comfortable for your particular business operations. Seasonal businesses can get repayment terms that fit the ups and downs of their schedules. You can negotiate for things such as a longer loan length, no prepayment penalties or lower monthly payments.
No Rules for Spending
When you use business assets to get a loan, you don’t have to worry about rules from banks telling you how to use the money. You simply receive a lump sum right away that you can spend however you want. There are many things you can take care of with extra working capital:
- Inventory purchases
- Operating costs
- Website development
- Digital advertising
- Real estate purchases
- Remodeling costs
- New computer systems or equipment
This is different from bank mortgages or small business loans. Those financing options come with very specific limits you have to follow, sometimes requiring you to submit receipts showing how you spend the funds.
Pros and Cons of Private Loans
How do private loans stack up against hard money financing and traditional loans? Let’s start with the advantages:
- Funding for investments that are too risky for banks
- Flexibility for loan terms and monthly payments
- Low credit score requirements
- Ability to spend money the way you want
- Possibility of very low interest rates
The truth is that there is a huge range of possibilities with private lending. If you get a loan from a friend or family member, you may not pay much in interest, which can save you a lot of money in the long run. At the same time, private lenders often don’t have a huge pool of funds to draw from, so your loan may be on the small side.
Risks of Private Lending
A large downside of private money is the issue of trust. It’s wise to be careful when approaching any loan, but you need to be especially cautious with private lenders. Otherwise, you may end up with a loan that looks good at first but has hidden penalties in the fine print that leave you with huge debts. If you decide to go this route with friends or family, make sure to put everything in writing to avoid any disagreements in the future.
What Are the Terms for Hard Money Loans?
The specific terms depend on the asset you choose, its value and the repayment schedule that works for you. There are many options for repayment terms, generally lasting from six months to a year. ABL financing is designed as a short-term funding solution. As for the total loan amount, or LTV ratio, this is usually around 60%–80% of the asset’s as-is value, though this range can vary with the market.
Hard money loans have a higher interest rate than long-term loans, but they’re also much easier to qualify for. Businesses that have trouble getting approved for traditional loans can often get ABL financing without issues. Many large and small businesses in Florida like this type of alternative financing because of its incredible flexibility.
How Can You Decide If Hard Money Loans Are Right for Your Business Needs?
Like any type of financing, asset-based loans have pros and cons. A trustworthy hard money lender should take the time to answer your questions and explain the terms clearly. At HML Solutions, our financing professionals have been helping Florida businesses for a long time. That’s why we have a great reputation. Contact us today to learn more about this flexible financing solution.