Loans have become a natural tool for achieving your dreams—going to college, starting a new business, or purchasing a car, home, or other item that you do not have the money for in your bank. For many people, loans can seem confusing and downright intimidating, and while they do have their complexities and can come with certain risks if you aren’t careful, loans are simpler than you think.
If you are researching loans, you have likely heard about private money lending and may be wondering what this form of loan entails. Read on to learn more about private money lenders and how they can help you with your investments.
Where traditional loans usually come from a bank or other financial institution, private money loans come from an individual or company. Private money lenders can include anyone from a family member to a private lending company, which is why they are often considered relationship-based lenders.
While they generally have a wide range of uses, private money loans usually go toward the purchase of an investment property. They are often used for short-term fix-and-flip projects, but can also be applied in the long-term for quick funding, refinancing, and renovation and rehab projects.
A Look at Traditional Bank Loans
To understand how private money loans work, it’s a good idea to first look at how the more traditional loan from a bank works. Banks tend to lend based on your ability to pay back a loan on time and in full. This usually means submitting your credit score, income, employment information, and other financial information to determine your history with debts. Banks will also require an asset as a form of collateral, which they will liquidate should you fail to pay your loans.
As private money loans come from non-traditional sources, borrowers can generally expect different guidelines or qualifications. You generally will not have to submit your credit information, and most private money loans are secured by a note or deed of trust.
Who Are Your Private Money Lenders?
Private money lending is usually based on building relationships, which is why most borrowers will first turn to friends and family for their funding needs. This is known as your primary circle and includes coworkers, neighbors, and other people that you know and are close to. Financing from friends and family tends to be the most popular because it’s easy to get in front of people you already have a relationship with, and they are more likely to say yes. This can potentially lead to problems if you and your primary circle investors are not aware of the risks and downsides.
Your secondary circle of private money lenders comprises people or companies that your primary circle introduces you to. These are essentially friends of friends, and given the mutual contact, the secondary circle should also be fairly receptive to listening to your needs and providing the money that you need. However, this often requires more time building up these relationships and creating an investment presentation.
Beyond the secondary circle is the third-party circle, which comprises accredited investors and hard money lenders. Usually when people talk about private money loans, they are referring to hard money loans, though there are distinct differences. It will likely take longer to convert third-party lenders into capital partners because you haven’t yet built the relationship. However, hard money lenders also offer the largest capital pool, and they are the most reliable lenders and have standardized costs, fees, loan terms, and interest rates, which can be comforting for borrowers who may not know what they are getting into.
A Closer Look at Hard Money Loans
Hard money loans are considered short-term bridge loans, meaning they help to “bridge the gap” when you need financing when it is not currently available. Hard money loans are most often used for quick turnaround situations, short-term financing, and borrowers who don’t have the best credit but do have a significant amount of equity in a property and want to prevent a potential foreclosure.
Unlike the traditional bank loans that we talked about, hard money loans are not concerned with your credit worthiness. Instead, they are backed entirely by the value of the real estate property that you are borrowing money for. This often means a faster overall process without as much of the paperwork and delays of a traditional bank loan. Due to the risks involved, hard money loans tend to have higher interest rates and lower loan-to-value ratios.
The Requirements for a Private Money Loan
With the diverse range of private money lenders and the general lack of government regulations for private loans, the requirements for securing a private money loan often differ from lender to lender. For example, close friends and family members may be happy to lend you money as long as you have a clear proposal for turning a profit because you have already built a sense of trust with them. Acquaintances, colleagues, and lenders from your secondary circles may require a full presentation outlining your investment plan along with a note or deed of trust. Private lending companies and individual professional lenders will need a proof of identity, a note, a deed of trust, and written plans for how you will spend the loan and the profit you expect to generate from your property.
Other professional private lenders may also ask for information about your finances and credit score. This may not make or break their decision to provide you with a loan, but your credit score can potentially have an effect on the interest rate. These lenders may also require you to make a down payment.
Hard money lenders are usually only concerned with the amount of equity that you have invested in the property. They may ask for your credit score as a formality, but foreclosures, short sales, and other issues on your record often won’t matter as long as you have the capital (via your property) to pay the interest on your loan. The borrower also needs to present their plan to show how they plan to pay off the hard money loan, which usually means improving and selling the property or refinancing later on.
The Disadvantages of Private Money Loans
The main disadvantage to a private money loan is the price. Private loans usually come with much higher interest rates than traditional bank loans. Average interest rates for privates loans are about 15 percent, but you may see interest rates up to 20 percent, particularly if you have bad credit or if the purchase of the property poses some significant risks. That’s not including mortgage points, which are fees that you may pay at closing to bring down the interest rate. One mortgage point equals one percent of the total amount of the loan. You can expect about two to four points on a private money loan.
Remember also that private money loans are designed for the short-term. Unlike banks, which allow you to pay off a loan over the course of 30 years, private lenders may require you to pay back the loan within six to twelve months. Some lenders may give you a full two years. However, given the high interest rates, you probably won’t want to have the loan for long.
Keep in mind that you will likely be putting up your property as collateral for the loan, which poses some risks. You should do your research and make sure that any deal with a private lender meets your needs.
The Advantages of Private Money Loans
One of the biggest advantages of private money lending is the simplified requirements. Private money lenders focus primarily on the potential profitability of a real estate purchase instead of your credit worthiness or financial history. That is a big advantage if you do have some bad marks on your borrowing history, but it also allows for faster processes. Traditional loans can take up to 45 days to reach approval. They can take even longer if you have a bad credit score or other negative marks on your record. Private money lenders can grant you capital relatively quickly, sometimes within just a few days, which can be crucial in more competitive situations. For example, if you need money for a property that is receiving several bids, private lenders can provide you the money you need to beat out your competition.
Where banks and other traditional lenders may refuse to provide loans for properties that have been damaged or vandalized, private money lenders are more interested in the potential value of a property.
Private money lenders also offer much more flexibility than traditional lenders. Private lenders evaluate your specific needs and treat you as an individual. This often means that you can negotiate certain terms of the loan, like the repayment schedule and the origination fee. Where traditional lenders can be large, faceless institutions, private lenders are just people you can talk to and build a relationship with.
Who Should Use a Private Money Loan?
Private loans are ideal for investors who want to buy a property, fix it up, and sell it for a profit, usually all within one year. These short-term fix and flippers often have to compete with all-cash buyers, making private money loans a solid solution. Private money loans may also be beneficial to:
Buy-and-hold investors who want to purchase and renovate a real estate property but refinance with a more conventional mortgage later on
Long-term property investors who need to season their investment
Long-term investors who do not qualify for a conventional mortgage, HomeStyle Renovation mortgage, or a 203(k) loan and plan to refinance once they do qualify
Short and long-term investors who need financing quickly
You can find potential private investors through various platforms, including:
- Real estate networks and mortgage brokers
- LinkedIn and other social media platforms
- Friends and family
The easiest thing about finding a private money lender is that they do not necessarily have to be professionals. You just need to find somebody who wants a decent return on their money. That could mean a friend, parent, or roommate who has money and wants to make a profit on it. You can also work with multiple lenders if one person does not provide enough money to help you purchase your property.
Del Toro Loan Servicing offers personalized services for private lending professionals. Our experienced team tailors our strategies to your specific needs to deliver better results. We also have an expansive pool of industry partners who can provide you with the help you need for private lending. Contact us if you have questions or need private money loan services today.