A brief overview
Real estate investors have a host of options for financing that don’t include traditional lenders. Private money lenders are an interesting alternative because they offer loans based on the real estate deal itself. Read on as we answer the question, what are private money lenders?
Key Points
For real estate investors looking to start purchasing real estate, there are a variety of financing options to choose from outside of traditional lenders and this can make it difficult to decide. From crowdfunding to hard money loans and private loans, there are options to suit a variety of investing needs.
To help investors make an informed decision on their financing, we’ll take a closer look at private money lenders, the benefits and drawbacks, and ultimately whether they’re a good financial solution for you. So, what are private money lenders?
What are private money lenders?
A private money lender is essentially a type of investor who provides loans to other investors. Private money lenders can be individuals or companies, and they use their own private funds to provide these loans. Private money lending involves 3 elements: a lender, a borrower and an investment property.
For example, an investor could provide the funds to someone who is purchasing a fix and flip property, this would make them a private money lender. The person purchasing the property would need to repay the loan and make it worthwhile for the investor, often this will include a cut of the profits.
A private money lender provides the loan under an agreement which usually takes the form of a promissory note. This note will contain the terms of the agreement, such as the length of the loan, the loan amount, and the interest to be paid. The lender will typically get a lien on the property, which means that this can be used as collateral in the event of the borrower defaulting on their repayments.
What does private lender mean?
A private lender is a person or organization that provides loans to individuals or companies who are struggling to get a loan, for example if they are unable to get a bank loan due to an undesirable credit score.
What sets private lenders apart is that they aren’t affiliated with a financial institution, such as a bank or credit union, and they deal directly with borrowers. The loan terms are entirely up to the lender and they aren’t bound by any rules or regulations that traditional loans are.
Private lenders can essentially be anyone who has the capital to provide a loan to someone else, usually an investor. Private lenders are often funded by investors, and they take this money and make it available as loans to those who need it.
What is an example of a private lender?
There are two types of private lenders:
Private individuals: People who have the capital to provide loans often do so, instead of keeping their money in the bank, because it means that they can get better returns on it than they would from simply earning interest. This can be a family member, a friend or even someone from the same industry. These individuals make their own agreement with a borrower for the loan terms, which can therefore be quite flexible.
Private companies: Companies that provide private money loans are not tied to any financial institutions like banks, however their process may not be that different. For example, some private lending companies provide loans to real estate investors in niche areas, such as residential properties only, or non-owner occupied rental properties.
Advantages of private money loans
Flexible loan terms
Due to the fact that private lenders aren’t bound by the same rules and regulations as traditional financial institutions, they can set their own loan terms. Which often means that these are flexible and can be adjusted according to each borrower’s unique situation and real estate deal. For real estate investing, flexible loan terms are a major benefit because each deal is different, and being able to adjust the loan terms to the deal and your financial situation can be invaluable.
Fewer loan requirements
There is often no formal loan application process for private money loans and if there is, it’s typically much simpler and easier than traditional loan application processes. The requirements aren’t as stringent as conventional loans, and this makes private money loans easier to qualify for. The traditional loan red tape is nowhere to be found when it comes to private money loans.
Fast access to funds
Private money loans are typically quicker to provide funding than traditional loans because the loan process itself is quicker. Funding can be provided in as little as 7 days in some cases, and up to 21 days in other cases. This is useful for real estate investing purposes particularly, when time is of the essence to beat the competition and snap up good real estate deals before anyone else does.
Asset-based lending
Private money loans are usually based on the underlying asset, which means that a borrower’s financial standing is not the lender’s primary concern. So, borrowers who have a lower credit score or can’t qualify for a bank loan can often turn to private lenders and find what they’re looking for, based on the quality of the real estate deal.
Larger funding amount
Private money loans don’t have the same limits as many other loans, so borrowers can get access to larger amounts than they would’ve been able to with traditional loans. This means that real estate investors can purchase properties that they might not have been able to before, and even fund multiple projects at once.
Disadvantages of private money loans
Limited to investment properties
Private money lenders are usually focused on lending to investors purchasing investment properties, so owner-occupied properties are typically not on the menu. This means that private money loans are generally reserved for people who are investing in real estate and not buying it for personal use.
Large down payments
Depending on an investor’s experience and the property deal itself, some private money lenders may require a large down payment to show that the investor has some skin in the game. While this should be easy enough to pay back, it can be a downside for investors who simply don’t have enough money to put down.
Higher interest rates
One of the biggest downsides to private money loans is the fact that they usually have higher interest rates than conventional loans. Private money loan interest rates can be anywhere between 5% and 15%.
This is because they’re generally shorter loans, and they run a higher risk, so this interest rate is to compensate lenders for the risk. It’s also to make it worthwhile for private lenders, as they are investing this way rather than having their money in the bank, which means that they’re looking for better returns on their investment.
Short loans
Private money loans are generally no longer than 2 years, and for some people this may not be long enough. The shorter loan period means that these loans need to be paid back quicker, and if an investment property is being bought for rental purposes, and not for house flipping purposes, this may not be the best solution.
Can anyone become a private money lender?
Private money lending can offer unique benefits for those wanting to invest their capital in an alternative way. The following types of people often consider private lending:
- Real estate investors who are looking to expand their portfolio
- The owners of trust funds
- Those with a large retirement savings
- People with a large income and surplus of funds
- Those who wish to provide assistance to a friend or family member
- Retirees who are looking for ways to generate a passive income
Legally, any person can become a private money lender, however this is a decision that should be considered carefully first, by weighing both the pros and the cons. There are certain laws that need to be followed so it’s important to brush up on your knowledge on the lending rules and regulations of the country and state. Those who choose to become private money lenders should consult an expert to get the paperwork done accurately.
What happens if the borrower doesn't pay a private lender back?
Private money loans are asset-based, which means that the property itself is used as collateral for the loan. If the loans aren’t paid back, this means that the lender can potentially seize the property and take ownership of it themselves. However, this will depend on the private lender and the borrower, as some will have different ways to make the repayment structure work out.
Alternatives to private money lenders
Real estate investors who are looking for creative financing methods have quite a few other options outside of private money lenders, here are a few:
Hard money lenders
Hard money lenders are another asset-based lending option for real estate investors who are looking for short-term loans. While they have higher interest rates than traditional loans, hard money loans are a fast funding option for investors who are looking to beat the competition. Hard money loans are easier to get approval for and require less paperwork than other loans.
Home equity line of credit (HELOC)
Using the equity that has already been built up in a property is another avenue for real estate investors. With a HELOC, investors can borrow up to 80% of the value of the home. The draw period for HELOC’s is typically about 10 years, and then there’s a repayment period. It’s a revolving line of credit, which means that it can be used for doing repairs or renovations on an investment property.
Seller financing
Sometimes property sellers can provide financing for buyers, similar to a conventional loan, seller financing works by the buyer paying the seller back monthly over an agreed upon period of time. This is only possible for sellers who have paid off their home entirely and are willing to enter this arrangement, however it can be a useful way to finance a property without buyers having to use their own capital.
Crowdfunding
Real estate crowdfunding is done online through crowdfunding websites, where people pool their money to provide a loan to someone for a project or deal that they’d like to undertake. The person who needs the funds will submit their information on the crowdfunding platform, and investors can begin adding funds to the project if they see it as a viable opportunity. Crowdfunding platforms like CrowdStreet are specifically for real estate purposes and therefore a great solution for real estate investors.
The bottom line
Finding the right financing option is one of the most crucial decisions for real estate investors. This can make or break their real estate deal and even their real estate investing journey if they make the wrong decision and get themselves into hot water. It’s best to get a good idea of what each financing option entails, in order to make an informed decision based on the particular project and your financial needs.