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Real Estate Investing – Hard Money Loans Versus Traditional Lending

If you are going to keep your property long term, then get a traditional bank loan. If you are going to rehap, flip, and sell, then a short term lender is the answer. Follow this rule, and you will always know when to use a hard money and when to obtain traditional bank financing.

Why Some People Fear Hard Money and Others Swear By Them.

Many people will shy away from hard money like the plague. They are afraid of paying a high interest rate for a short term. The trade off is money lenders are giving you the money quickly at a short term and without caring about your credit and other underwriting guidelines so you will pay a little more interest for the luxury of getting the money fast. Most of the time, people do not understand the purpose of when to use hard money loans. If they did, they would use them more often. Others who are knowledgeable swear by hard money loans for buying their investment properties quickly and flipping them.

Buy a Short Sale or Foreclosure Property Using Private Lending

It seems absolutely ridiculous to pass up a good foreclosure or short sale opportunity in today’s market place because you do not have the money, when all you had to do was line up your money with a list of one of your hard money or private lenders. By planning and preparing ahead, you will save time and money and be able to act quickly when an opportunity comes along. You should constantly be putting out the word that you have good investments and are looking for financing. Once you accumulate enough hard money or private lenders, you want to keep a list of their names and contact information handy.

Hard Money Lender(s) vs. Traditional Lenders

There are less factors that the hard money lender weighs when deciding to loan you the money. Usually only the collateral is considered by hard money lenders as opposed to the four factors that traditional lenders look for -collateral, credit worthiness, capacity and commitment. Hard money lenders will typically lend you less than 80% of the appraisal value. The reason is they have to recover on the property if you, the borrower default, they need to recover enough to cover the outstanding principal and the legal fees and costs. Conventional lenders such as banks will only lend you 80% of the market value or purchase price, whichever is lower because they want you to feel that you have a vested interest in the deal and that you have some of your own money in the transaction. This idea tends to make conventional lenders feel more secure about loaning to you.

Bridge Loans: Getting You There From Here

This type of business financing is very aptly described by its name, Bridge loans or Bridging loans. This type loan is not a permanent or even long term loan. It is exactly as stated, a bridge between now and when the long term financing is in place.

Many times this type of financing is associated with real estate purchases, (office buildings, homes, raw land): the types of assets that a money lender can use without regard to the type of business that you have. A bridge loan Is considered to be somewhat riskier than either long term financing or Purchase Order loans so be aware that the interest rate may be higher than you would normally expect.

Sources for bridge loans come from many different places. There are many commercial sources for this type of loan. Do not overlook people in your industry who may be willing to help on a short term basis. They can make a nice profit on their money and you may find a new ally within your business community.

You do need to be aware that the contracts for bridge loans that are typically used for short term loans are very tight and heavily weighted in the lender’s favor. They are sometimes called hard money loans. The interest rates are very high on these loans. We have used a bridge loan when our money was tied up just as we were making the purchase of a home. It turned out to be a very good deal for us as the lender became interested in some of the financial contacts that we had at the time. He reduced the interest rate and actually arranged for bank financing for us. We were new in town and our old bankers wanted to keep us as customers but did not loan money outside their ‘area’. (Do not count on something like that happening; it is very rare.) Make sure that you understand the terms of the loan. Even if you arrange financing after the fact, you may be on the ‘hook’ for the interest for a certain number of months. (Say, you use the money for two months, but your contract said minimum interest of six months, so you will owe six months of interest, no matter what!)

If you are in need of such a loan, bridge loans are great and often necessary. Remember, you will be under a contract where the default penalty will be painful; so be sure that the benefit significantly outweighs the risk of failure to repay the loan in a timely basis.

What Kind of Financing is Right for Your Business?

Most businesses need financing. Unless you won the lottery or inherited a fortune most people start a business with either their own funds or a combination of their funds and financing. Even an established business needs financing at one time or another.

Cash flow is different than profits and profits do not guarantee money in the bank. Entrepreneurs need financing for inventory, payroll, expansion, develop and market new products, to enter new markets, marketing, or moving to a new location.

Defining and selecting the right financing for your business can be a complicated and daunting task. Making the wrong deal can lead to a host of problems. Understand that the path to getting financed is neither clear nor predictable. The financing strategy should be driven by corporate and personal goals, by financial needs, and ultimately by the available alternatives. However, it is the entrepreneur’s relative bargaining power with investors and skills in managing and orchestrating the finance drill process that actually governs the final outcome. So be prepared to negotiate with a financing strategy and complete financials.

Here’s a brief rundown on selected types of financing for commercial ventures.

Asset-Based Lending

Loans secured by inventory or accounts receivable and sometimes by hard assets such as property, plant and equipment.

Bank Loans

A loan that is repaid with interest over time. The business will need strong cash flow, solid management, and an absence of things that could throw the loan into default.

Bridge Financing

A short-term loan to get a company over a financial hump such as reaching a next round of venture financing or filling out other financing to complete an acquisition.

Equipment Leasing

Financing to lease equipment instead of buying. It is provided by banks, subsidiaries of equipment manufacturers and leasing companies. In some cases, investment bankers and brokers will bring the parties of a lease together.

Factoring

This is when a company sells its accounts receivable a a discount. The buyer then assumes the risk of collecting on those debts.

Mezzanine Debt

Debt with equity-based options, such as warrants, which entitle the holders to buy specified amounts of securities at a selected price over a period of time. Mezzanine debt generally is either unsecured or has a lower priority, meaning the lender stands further back in the line in the event of bankruptcy. This debt fills the gap between senior lenders, like banks, and equity investors.

Real Estate Loans

Loans on new properties-which are short term construction loans-or on existing, improved properties. The latter typically involves buildings, retail and multi-family complexes that are at least 2 years old and 85% leased.

Sales/Leaseback Financing

Selling an asset, such as a building, and leasing it back for a specific period of time. The asset is generally sold at market value.

Start-Up Financing

Loans for businesses at their earliest stage of development.

Working Capital Loan

A short-term loan for buying assets that provides income. Working capital is used to run day-to-day operations, and is defined as current assets minus current liabilities.

It’s always better to get by without taking on debt. But on the other hand, most businesses need to acquire financing at one point or another. A home office is less likely to require financing than a business location that you rent. A one person operation is less likely to need financing than one with employees.

When you do need the financing, remember to examine all avenues of financing open to you and scrutinize the terms of all the proposals.