A hard money loan is a short-term, high-interest rate loan. This type of loan is typically extended to businesses whose financial situations are poor, and so cannot qualify for lower-cost forms of debt. This type of financing tends to be the last available choice for such an entity. A hard money loan typically has the following characteristics:
- High interest rate. The rate may be several multiples of the prime rate, and is intended to cover the much higher risk that the lender takes on in this type of arrangement.
- Short term. The intent of the loan is to keep the borrower solvent for a short period of time. In essence, this is a bridge loan.
- Collateral. The lender typically bases repayment on the assets of the borrower, rather than the borrower's cash flow. This means the lender is willing to shut down the borrower's organization and liquidate its assets in order to obtain repayment of the loan and any outstanding interest.
Banks do not engage in hard money lending, since these loan characteristics go well beyond the normal borrowing rules of a bank. Instead, this type of loan is more likely to be offered by wealthy individuals or smaller firms that are willing to accept a high degree of risk. Given their high fee structures, these lenders are more likely to compete based on the rapid turnaround of loan applications than to offer lower interest rates.
A borrower must have substantial assets in order to take on a hard money loan. Otherwise, a prospective lender will see no obvious way to be repaid. Consequently, this type of financing arrangement is rare in the services industries, which are traditionally light on assets. These loans are more commonly found in the real estate industry, which is asset intensive.