- Private money has proven, time and time again, that it is a powerful means of financing most of today’s real estate deals.
- What is a private money loan, if not for an investor’s primary source of funding a real estate deal?
- Private money loans for real estate investors are essential for not only securing deals, but securing them fast.
- The pros and cons of private money loans must be weighed before you commit to making any decisions to move forward.
Understanding the basics of private money lending represents the first step of breaking down real estate financing. private money loans are, after all, a real estate investor’s best friend; they are the quickest path to securing a deal. Nonetheless, private money lending can get complicated quickly, so you need to realize what you are getting into before making any decisions for yourself.
When exploring real estate private money lending, you need to comprehend a number of questions: What are the pros and cons of such a strategy? When should you use private financing for real estate? Where can you find private money lenders for real estate? The more you know about private money, the better. This guide should serve to lay a solid foundation for everything you need to know about one of today’s greatest sources of capital.
What Is Hard Money Lending?
Many investors looking for alternative financing that doesn’t involve their local bank may have heard the term “private money.” They may have even asked themselves a simple follow up question: what is private money lending?
Private money lending is a short-term loan obtained from private investors or individuals, at terms that may be more strict than a traditional loan. Though the terms of this creative financing option may be stricter, this form of private financing for real estate generally has more lenient criteria.
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Investor Q&A: What Is Private Money Lending?
1. The Big-Picture Of Private Money Lending
Private money lending is another way an investor can finance their real estate projects, outside of the traditional mortgage means. This is a short-term loan secured from private investors or individuals, as opposed to other traditional institutions like banks or credit unions.
Private money lending is often used by investors who aim to improve or renovate a property, and sell it. Given that you can usually get a loan in a matter of days (as opposed to weeks from banks), this is a fine choice for house flippers and real estate developers. This is also an option for investors who only need to do quick fixes to raise a property’s value, then secure another loan based on the new value to pay off the private money lender.
2. Private Money Lending Vs. Other Lending Types
The main difference between private money lending and other types of loans is that this type of financing does not focus on your credit history or income as collateral. Instead, lenders will see the property’s value as the determining factor, placing emphasis on its after-repair value (ARV). ARV is the worth of the property once your renovations are done.
Other differences include:
- Private money lenders do not invest in primary residences. Owner-occupied residential properties are subject to many rules and regulations, thereby increasing the risk for lenders.
- Private money lenders do not sell loans to Freddie Mac or Fannie Mae. More often than not, lenders use their own money or raise it from a pool of investors. The amount they loan is based on their property specialization (if there are any) and the risks they are comfortable taking.
- Private money loans are short term. You will not have the luxury of 15 to 30 years to repay your loans. Private money loans are typically needing to be repaid anywhere between 6 to 18 months.
- Private money lenders have their own lending criteria. A private lender, for example, could be your friend, family, or business associate. As such, they may not have any preset criteria before lending you money, giving you more flexibility in negotiating terms. Private money lenders, on the other hand, come with a specific set of upfront points, interest rates, and defined durations.
The Pros And Cons Of Private Money Loans
Private money loans are one of the most valuable funding opportunities that investors can take advantage of. Few sources of capital, if any, can compete on the same level as hard money and offer the same competitive edge. It is hard money loans, after all, that many investors have to thank for acquiring their deals in the first place. That said, hard money is not without its own caveats. Despite its superior benefits, there are downsides to private money that warrant the consideration of every investor.
Securing financing with a private money lending loan offers you a number of benefits, including:
- Speed: The Dodd-Frank Act is financial reform legislation enacted in the past decade. It began with new regulations on mortgage lending, which meant a lot of time (often, months) was needed for an investor to close a loan. Private money lending, on the other hand, is fast, because you can secure a loan in days or weeks (depending on negotiations). Time is of the essence, especially for large development projects, and hard money lending can help speed that process along.
- Flexibility: Terms can be negotiated with private money lending loans, since you are dealing directly with individual investors. Banks are not as flexible.
- Collateral: With private money financing, the property itself is your collateral for the loan. Some lenders even accept other assets, like your retirement account or a residential property under your name, as a basis for starting a loan.
- No “Red Tape”: Getting a loan for an investment property with a traditional mortgage is difficult, if not impossible. Traditional borrowers need to worry about credit score, LTV ratios, debt-to-income, and a number of other indicators they need to meet criteria for. Private money lenders, however, function as asset-based lenders who are more concerned with the property than the borrower’s credentials.
- Convenience: There is something to be said for the convenience of being able to close with cash. Having to supply a lender with bank statements, income documentation, tax returns and leases can become overbearing and consume your focus and energy. Private money, on the other hand, cuts out the middleman and a lot of the headaches.
- Volume: Private money lenders allow investors to leverage other people’s money. That means investors could potentially fund more than one deal at a time. Traditional loans will do no such thing. If you want to fund multiple deals at a time, you should really consider a private money loan.
- Competitive Edge: Private money allows investors to beat out the competition, or at least those using a traditional loan. If for nothing else, sellers prefer the two things private money offers: cash and a timely transaction.
There are, however, certain disadvantages to using using private money for real estate investments:
- Cost: The convenience that comes with hard money lending may be its primary benefit; however, it is also its main drawback. Given that private money lenders are at higher risk than borrowers, many may demand up to 10 percentage points higher than traditional loans. Interest rates range from 10 to 15 percent. Expect other fees to be also at a relatively increased rate, including origination fees and closing costs.
- Short Repayment Schedule: A shorter repayment period is the price to pay for being able to get a property listed on the market ASAP. This can be anywhere between 6 to 18 months. Make sure that you can sell the property and profit in the soonest time possible.
When To Use Private Money For Real Estate
Although private money lenders will often issue loans for almost any type of property, there are certain types of property investments which were absolutely made for private money. Rehab projects, construction loans, and land loans were made to be financed through private money.
This doesn’t mean that other types of investments should not be financed through private money. If a property buyer has credit issues or one needs to act quickly on a deal before it disappears, the speed and convenience afforded by a private money loan can be worth its weight in gold.
Using private money lending for real estate acquisitions has become commonplace in the housing sector. If for nothing else, a private money loan gives investors an edge over those that are using traditional financing methods. Not only should private money borrowers be able to secure capital faster, but sellers will also favor their offers because they are made with cash. That said, if you are looking to fund a deal, you may not want to ignore private money; it could be the one thing that gets you what you need.
Have you ever bought an investment property with private money? What was your experience like? Feel free to let us know how things went in the comments below.