There are basically two types of real estate loans available to purchasers of commercial and investment purpose real estate: traditional loans from sources like banks and life insurance companies, and the alternative — hard money loans — typically provided by private capital funders. While both options provide the financing needed to acquire property, they operate very differently, and it is essential for a savvy real estate investor to understand these differences.

Montegra Capital is a Denver-based hard money lender with over 50 years of experience in funding more than $750,000,000 of hard money loans in Colorado for the purchase or refinance of commercial real estate.

What Is a Hard Money Loan vs a Traditional Loan?

A “hard money” loan is a real estate-secured loan where the capital to fund the loan comes from a non-bank source. These loans have become more and more popular in recent years, and they are replacing many traditional real estate loan sources.

One significant difference is the way hard money loans are underwritten compared to bank loans. A hard money loan relies almost entirely on the value of the property. Another name for them is “asset-based” loans. A bank (or life company) loan instead relies more heavily on the credit history of the property owner and the cash flow that the real estate produces. Another name for them is credit-based loans.

Banks usually have a credit score cut-off where they lend only to borrowers who have a relatively high credit score. Hard money lenders will look at credit scores but place greater reliance on the ratio of the loan to the value of the property (loan-to-value or LTV).

Consumer Loans vs. Business Purpose Loans

Most hard money lenders do not offer loans for the purchase or refinance of owner-occupied single-family homes, where the borrower lives in the property used as collateral. The federal government and most state governments strictly regulate loans where the borrower lives in the property. This kind of loan is called a “consumer loan,” and banks or other lending groups specifically set up to fund consumer loans are usually the primary source for this type of loan.

In contrast to a consumer loan, the technical term for the alternative is a “business purpose loan.” These loans can be funded by non-bank hard money lenders, such as Montegra.

Example: Bank Loan vs. Hard Money Loan in Action

Let’s create an example of a buyer wishing to purchase a warehouse, looking at it as a bank transaction and as a hard money loan transaction.

Mr. Real Estate Investor finds a warehouse leased to a company that stores widgets in it. The warehouse is offered for sale by a real estate brokerage firm for $1,000,000. With a triple net lease generating $10,000 per month, an all-cash buyer would earn a 10% annual return on their investment.

Most investors can’t buy a property with all cash, so they need to find a lender to allow them to leverage their purchase. Mr. Investor goes to the bank and meets with the loan officer. The bank agrees to consider making a loan for $750,000 and asks for numerous forms to be filled out, including a statement of their net worth, a credit report, an appraisal, and a full understanding of their total financial picture, including any other real estate they own, any other assets, all liabilities, etc.

Their loan officer tells them that it will take around 8 to 10 weeks for the bank to fully approve this loan. Mr. Investor makes an offer to buy the property for the full $1,000,000 asking price, but the offer is strictly contingent upon the investor getting approved for their bank loan and requires 65 days to get the approval and remove this contingency.

The owner of the warehouse looks at this contingency in their offer and lets Mr. Investor know they are not willing to tie their property up for 65 days.

Mr. Investor then goes to a hard money lender like Montegra, who reviews the loan application and tells them that within 24 hours, they can close a loan for $650,000 in two weeks. The only contingency is that the property appraises for the $1,000,000 purchase price. The appraisal takes a week, and the rest of the paperwork is simple and completed in less than a week.

The seller still gets his full sale price. Mr. Investor must put up slightly more cash and pay a slightly higher interest rate, but at the end of the day, they do complete the purchase.

Pros and Cons of Using a Hard Money Lender

The disadvantage of using a hard money lender is the requirement for a slightly larger down payment and payment of slightly higher interest. The advantage of using a hard money lender is that the buyer completes their purchase, and because the hard money lender requires interest-only payments instead of interest plus a significant principal amount each month, there is little difference between the monthly payment to the bank and the monthly payment to the hard money lender.

At the end of the initial 12-month loan period with the hard money lender, the investor then takes their time and refinances the building (which they now own) with a life insurance company at a more favorable rate. They never would have gotten the title to the building without the hard money acquisition loan.

Montegra Can Help Colorado Real Estate Investors

If you have a potential purchase (or refinance), email Bob Amter at bob@montegra.com or Kim Skari at kim@montegra.com, or contact us online.

Montegra offers interest rates at the lowest end of the private capital lending spectrum. The fact that we have been funding these hard money (bridge) loans for over 50 years testifies to our reputation for reliability. We can give you a decision on your loan with just a phone call, offer flexible terms to meet your specific requirements, and close extremely quickly.