Hard money commercial loans offer terms that seem too good to be true: quick funding, minimal restrictions on lending, and nominal documentation requirements. These benefits come with a cost: high interest and default interest rates, expensive fees, personal guarantees and fast collections in the event of default.
What are hard money commercial loans?
Hard money commercial loans are often made by private lenders to higher risk borrowers, and to hedge against that risk, the terms of the loans are much less favorable to borrowers than conventional commercial loans. Conventional commercial loans from banks require a minimum credit score, collateral requirements, and a stringent underwriting process, whereas hard money loans often do not have these requirements. Hard money commercial loans are often short-term, and have much higher interest and fees. For example, a conventional commercial loan may have a 10-year term and an interest rate between 5-9%. In contrast, a hard money loan may have a 6-month term and an interest rate of 12%. Also, the lender’s remedies if the borrower defaults are often much more severe in a hard money loan. Whereas a conventional commercial loan may provide default interest of 12%, a hard money often is the maximum allowed by law, which in Maryland is 24.99%. This means that interest is almost ¼ of the loan principal amount of the loan. Hard money commercial lenders will also charge more for loan origination fees and other fees versus conventional commercial loans.
Hard money construction loans
Hard money commercial loans are often used to fund property flips: a borrower buys a house with the intention of fixing it up quickly, and hopes to earn a profit from selling the house after the renovations are complete. In order to fund the construction, the borrower takes a quick hard money loan so it can hire contractors to renovate the property and market and sell it quickly. Often in this scenario, the lender requires a lien on the home and personal guarantees by the owners of the borrower’s business.
Because these loans are made so quickly, there can be confusion between the lender and borrower about the actual terms of the hard money commercial loans. For example, if a lender and borrower agree to construction draws at specific intervals in the lifetime of the project, these terms should be very detailed in the loan documents to avoid confusion should the loan go into default.
Because these loans are high risk for hard money lenders, many times the lender hopes that the project will not complete so that it can foreclose on the property and flip it themselves, while collecting significant fees from the borrower and guarantors. Also, hard money commercial lenders tend to act much more quickly to collect on their loans. Unlike banks, hard money commercial lenders do not have as much capital, and wish to quickly realize gains on their investments.
Hard money construction lenders are motivated to collect quickly through various means. As a result, lenders may be much less willing to work with borrowers on forbearance agreements, loan modifications, short-sales, or other options that could be helpful for borrowers which are standard in conventional commercial loans. Forbearance agreements are agreements in which the borrower agrees to certain terms, and in consideration, the lender agrees to forbear from enforcing its rights under the loan documents. Loan modifications change the terms of the loan, such as the duration, interest rate, and remaining principal balance, and short sales allow a borrower to sell a property for less than what is owed on the property and require the consent of the lender.
Confessed judgment clauses in hard money commercial loans
In Maryland, hard money commercial loans often have confessed judgment clauses, so that if the borrower cannot get the project finished quickly, the lender can easily obtain judgment against the business and the guarantors, and also concurrently foreclose on the property. Confessed judgment clauses are difficult to circumvent, and the borrower does not typically have the right to a trial. Because of this, judgment can be obtained in as little as 30 days, resulting in much quicker collections than a traditional lawsuit.
How Steiner Law Group can help
Steiner Law Group helps borrowers negotiate hard money commercial loans at inception, and also assists borrowers faced with hard money commercial loans in default. We have successfully litigated complex confessed judgment legal issues which resulted in significant benefit to our clients, and have negotiated short-sales with stubborn lenders. We have also protected various assets of businesses that are in collections due to confessed judgments so that our clients can continue operating their businesses while facing collections.
If you have questions about the risks of hard money commercial loans, please call us at (410) 670-7060 to schedule a consultation and subscribe to our newsletter Fresh Chapter.