Private money lending has become an increasingly popular way for investors to fund real estate projects. As traditional bank lending has tightened in the wake of the Great Recession, more borrowers have turned to private lenders to secure the financing they need.
What is Private Money Lending?
Private money lending refers to financing provided by private individuals or companies rather than banks or mortgage lenders. The loans are typically secured by real estate as collateral. Private lenders are often interested in funding fix-and-flip projects, new construction loans, and other real estate investments.
Pros of Private Money Loans
There are several advantages to obtaining financing from a private lender rather than a bank:
The application and approval process for private money loans is usually much faster than with banks. You can often get funded in days rather than weeks or months. This enables you to move quickly when you find a promising investment property.
Private lenders are more flexible with borrower qualifications than banks. They may use criteria like the loan-to-value ratio rather than credit score and income to approve loans. This opens up opportunities for more borrowers.
No Mortgage Contingencies
Private lenders do not require mortgage contingencies. This makes your offers on properties more attractive to sellers.
Most private lenders will allow interest-only payments for the loan term. This enables borrowers to conserve capital for other project costs.
Cons of Private Money Loans
While private money loans offer some advantages, there are also downsides to consider:
Higher Interest Rates
Private lenders charge higher interest rates than banks, often 8-15%. This cuts into investor profits.
Large Down Payments
A 30-50% down payment is typical for a private money loan. The lender wants sufficient equity to secure the loan.
Private lenders usually offer loan terms of 1-3 years. The property needs to be sold or refinanced within that timeframe.
Many private lenders will impose a prepayment penalty if the loan is repaid early. This can limit exit strategies.
Types of Private Lenders
If you decide private money is suitable for your project, there are several sources to consider:
Hard Money Lenders
Hard money lenders specialize in real estate investment loans. They are experienced at evaluating property deals. But they also charge the highest rates.
Finding a private individual to fund your loan takes networking. But the terms may be more favorable than hard money lenders.
Real estate crowdfunding sites like LendingHome allow you to access pooled funds from individual investors. Rates can be competitive.
Wealthy families sometimes act as private lenders, often with lower rates than hard money lenders. But it takes connections to tap into these sources.
Tips for Getting Approved
If you’re seeking private money for a real estate project, here are some tips that can help get you approved:
Have Skin in the Game
Put 10-20% of your money into the deal. This shows the lender you’re committed to.
Bring Strong Sponsors
Well-known, experienced partners boost a project’s appeal to private lenders. Their involvement reduces perceived risk.
Know Your Numbers
Analyze your project thoroughly and assemble a professional presentation. This demonstrates you have expertise.
Many private lenders want to work with repeat borrowers with track records—nurture relationships over multiple deals.
Offer a Guarantee
Providing a personal guarantee shows your confidence in the repayment of the loan. This gives the lender security.
Negotiating Favorable Terms
Here are some strategies that can help you negotiate the best possible deal on a private money loan:
Have multiple lenders bid on your project. Competition can lead to lower rates and fees.
Seek a Minimum Term
Push for the shortest term the lender will approve so you have the flexibility to exit early.
Additional collateral like securities or appreciated real estate can help you secure better loan terms.
Pay Interest Upfront
Offer to pay all interest for the loan term upfront for a lower interest rate.
Offer to cover appraisal fees, legal costs, etc., to shift some risks off the lender.
Managing the Lending Relationship
Once you’ve secured private financing, here are some tips for maintaining a solid relationship with your lender:
Provide Timely Updates
Keep the lender informed about project milestones and delays to avoid surprises.
Make Interest Payments Promptly
Be on time on an interest payment. This reinforces you are a low-risk borrower.
Offer to have the lender visit the property to see the project as it progresses.
Explore Refinancing Early
Discuss refinancing options well in advance of the loan maturity date.
Maintain Contact Post-Loan
Preserve regular communication after completing a project to pave the way for future deals.
Private money lending can be invaluable for real estate investors who cannot obtain bank financing for acquisition and rehab projects. By understanding the pros and cons of personal loans, researching loan sources, presenting deals effectively, and negotiating win-win terms, investors can tap into this critical source of capital. Maintaining strong partnerships with private lenders over multiple transactions can provide investors the flexibility to achieve their real estate objectives. Personal loans are not without risks and costs, but their quick turnaround, accommodating qualification terms, and lack of contingencies offer distinct advantages over institutional lending options. Investors who learn to source and manage private money prudently can gain a competitive edge in their market.
What are some standard loan terms offered by private lenders?
Typical loan terms from private lenders range from 6 months to 3 years. Interest rates often fall between 8-15%, with lenders typically requiring a 30-50% down payment from the borrower.
What types of collateral do private lenders accept?
Most private lenders provide loans secured by the financed real estate asset, whether it’s land, a residential property, or a commercial building. Some may accept additional collateral like securities or other real estate the borrower owns.
How long does it take to get approved and funded by a private lender?
Many private lenders can assess a deal and provide funding in as little as a few days, while approval and financing by banks can take weeks or months. The quicker turnaround gives investors the flexibility to capitalize on time-sensitive opportunities.
Where can real estate investors find private money lenders?
Networking is often crucial to finding private lenders. Attending real estate investor meetings and conferences can lead to connections with hard money lenders and private individuals interested in financing projects. Crowdfunding sites also provide access to pools of private capital.
What happens if a borrower defaults on repayment of a private money loan?
If a borrower defaults, the private lender can foreclose on the property used as collateral for the loan. They may also personally pursue repayment through legal action against the borrower if they provide a guarantee. Borrowers should only accept private loan terms they are confident they can fulfill.