It takes money to make money, and if you’re ready to grow your business, you might be considering taking out a loan to help fund that growth. You’ve got several options to consider when it comes to financing, and it’s important that you’re well-informed about all the choices you have.
Traditional vs. Alternative Loans
The type of business loan you’re probably most familiar with is a bank loan, or an SBA loan (which is simply one backed by the Small Business Administration). These are considered traditional loans, and are good options for many business owners, as they offer low interest rates and favorable payback periods.
However, if you filed bankruptcy in the past seven years or don’t have great credit, a bank might not approve you for this type of loan. And in general, these types of loans aren’t always great for startups, making it difficult for you to fund your startup. Does that mean you’re out on the street when it comes to finding financing? Not necessarily.
Another category of business financing that has sprung up in recent years involves alternative lenders. These are private companies willing to loan your business money on less stringent criteria than banks. Be aware: the fees and interest rates with alternative loans tend to be higher than with traditional loans, so it’s best to pay these back as soon as possible to avoid paying too much in interest.
A Third Option
While this category technically falls under the alternative loans mentioned above, the hard money loan is a little bit different.
Rather than basing the decision to lend money to you and your business on your business earnings and ability to repay a loan, hard money lenders (which may be individuals or private companies) use your assets (personal or business) to secure the loan. If you’re unable to pay the loan back, they can take that asset against what you owe.
That asset could be your home, your business equipment, or other real estate. Some hard money lenders even use future equity in your business as that asset.
When and Why to Consider a Hard Money Loan
Hard money loans aren’t for the faint of heart. Ideally, if you’re borrowing money, you want the loan with the lowest interest rate and fees. But if you don’t qualify for traditional lending, a hard money loan could be the solution.
If you don’t have a lot in the way of credit history or sales history (such as being a startup), getting a hard money loan may be easier and less stressful than trying to convince a bank to invest in your business.
A business owner in any field can qualify for a hard money loan, though they are particularly popular for real estate investors who may not have the upfront capital to take out a traditional mortgage.
How a Hard Money Loan Works
Typically your application will be reviewed and approved quickly, helping you get your hands on cash sooner than with traditional loans, typically within a few days to weeks. Usually you can be approved for anywhere from a few thousand dollars up to several million, depending on the value of the assets you put up.
There may be requirements to qualify for a hard money loan, such as a FICO score of 400 or greater, and there may be stipulations on what kind of assets and value you can put up as security against the hard money loan.
Fees range for these types of loans. Many charge at least $500, since they need to appraise your asset to determine its value. Interest rates fluctuate from 8% up to as much as 15%, which can add significantly more to what you pay back, so make sure the investment is used to actually generate more money in your company so you can pay it back on time.
Many hard money lenders will actually charge you a penalty fee if you pay off the loan early, but this fee is far less than what you would continue to pay in interest, so it’s worth doing if you are able.
Before you take out any kind of business loan, have a plan for what you will do with the money. Simply covering payroll or your own expenses with the funds won’t help you grow your business, nor generate additional revenue to help cover the cost of the loan.
If you’ve explored other routes to get financing and are getting the door shut in your face, a hard money loan could be the solution. Just find out up front all the involved fees and interest rates so you go into the loan aware of what you’ll end up paying in the long run.