Hard Money Loan Maturity: 2 Things to Think About Before Borrowing

Private lending offered as a hard money loan is an attractive tool for financing commercial property acquisitions. To an investor getting into hard money for the first time, the hard money model can seem too good to be true. It is not. Hard money is a reality for real estate investors across the country. But it’s not all sunshine and roses.

Hard money’s advantages outweigh its disadvantages for most real estate acquisitions. But anyone new to hard money should learn as much as possible before borrowing. To that end, borrowers should fully understand the implications of loan maturity. There are two big things to think about in this regard: the balloon payment and the exit plan.

Interest-Only Loans

Although there are exceptions to the rule, Salt Lake City, Utah-based Actium Lending says that most hard money loans are structured as interest-only loans. For purposes of explanation, consider a loan with a 24-month term.

The borrower would make only interest payments for the first 23 months. The final payment, due in the 24th month, would also include the entire principal. This is what is known as the balloon payment. Let us talk about that payment.

The Balloon Payment

The payment’s name comes from the fact that the previous interest-only payments were relatively small. But in the final month, the borrower’s payment balloons thanks to the combination of interest and the entire principal. Think of it as a balloon with very little air suddenly being inflated quickly.

A hard money loan’s interest-only structure can make it an attractive financing option when borrowers are trying to manage cash flow. But there is a trap: reaching maturity and not having the funds to make the final payment.

It doesn’t take a rocket scientist to figure out what happens if the final payment cannot be made. Whatever collateral the investor offered to back the loan is now in jeopardy. And because hard money loans also tend to be structured under a trust deed arrangement, it is a lot easier for lenders to take the necessary actions when borrowers default.

How does a borrower plan for this balloon payment? Through something known as an exit strategy.

A Plan for Repayment

An exit strategy is a reasonable plan for satisfying a hard money loan on its maturity date. There is no black-and-white exit plan suitable for every scenario. As such, lenders are typically open to a variety of possibilities. Here are just two examples:

• Traditional Funding – A lot of Actium Lending’s clients go on to refinance the properties they’ve acquired via traditional funding. The traditional loan offers enough money to pay off the hard money note and provide additional funding for renovations, improvements, etc.
• Property Sale – It’s not unusual for Actium to write bridge loans for real estate investors simultaneously looking to obtain new properties and sell others. The sale of a property in an investors portfolio provides the funds to pay off a hard money loan.

Lenders are less concerned about the details of an exit plan and more concerned about whether the plan is actually viable. Regardless, one thing is certain: applying for a hard money loan without a reasonable exit strategy virtually guarantees denial. It’s true that hard money loans are easier to get. But it’s also true that lenders will not budge without an exit plan they can believe in.

If you are new to hard money as a tool for completing real estate transactions, you’re on the right track. But learn as much as you can before you borrow, paying special attention to the implications of loan maturity.