Hard money loans and mezzanine funding aren't the same. They are separate kinds of business borrowing. Borrowers should keep their differences in mind.
Because so many traditional banks have left the small commercial loan market ($1 million or less), alternative lenders have entered this space. As a result, new terms have also joined the business financing lexicon, such as a hard money loan and mezzanine funding. Understanding what they mean and how they differ can help you determine which one might be right for you.
A hard money loan is a type of loan that is structured against the property and used as collateral. Mezzanine financing is a hybrid of debt and equity financing that lets the lender retain the rights to own the company or take an equity interest in it in case of default, once any venture capital firms or other lenders have been paid.
Here's what you need to know about how hard money loans and mezzanine financing differ:
A hard money loan is secured solely against a piece of real estate, but a mezzanine loan can be secured by an assignment of the property's ownership to the new lender. A mezzanine lien is often not secured by the real estate asset.
Sometimes, depending on the hard money lender's equity in the property, the lender may opt for an assignment option of the property as part of the repayment plan. But this could happen only if the lender agreed to the terms and if the borrower had enough equity in this property as well as some other holdings so that a foreclosure wouldn't affect the borrower's overall financial situation.
Usually, hard money loans and mezzanine financing stand on their own merits. In general, a lender will not want to commingle an equity assignment with the rest of the loan because it could present issues regarding cash flow and property valuation down the road, especially if other lenders have taken a subordinated position in the equity.
In the commercial lending world, timing is everything. Understanding the turnaround time for these loans is critical.
Hard money loans are typically funded much quicker than mezzanine financing. Mezzanine financing first requires a valuation of the asset and then an appraisal to establish the debt or equity component of this round of borrowing. A hard money loan can be funded as soon as the appraisal is done. Another advantage to a hard money loan is that sudden business opportunities may come up that could help the borrower pay it back while the mezzanine financing application is still going through the underwriting and syndication phase.
Mezzanine loans tend to be larger than hard money loans. Generally, mezzanine lenders won't conduct their due diligence for a loan under $2 million. This level of need is better served by hard money loans. Mezzanine financing is also tied to debt and equity components. Small deals aren't feasible or cost effective. On the other hand, interest rates are less on a mezzanine deal than on a hard money one.
Working with a reputable lending resource will help you decide which type of financing is right for you.