Investing in real estate is essentially one of the smartest and safest strategies to promote wealth building. With the proper foundation and knowledge, investing in real estate can be highly lucrative for anyone. But let’s be honest, you already knew that. However, of particular interest is what an investor can do with the money they make from a profitable career.
While a portion of profits will undoubtedly be allocated to the lifestyle of their choice, investors are advised to be smart with their money. Of course, you can reinvest into another property, but if you are looking for an alternative, there may be one option you haven’t considered yet: private money lending.
Investors who have the funds to do so should consider private money lending in real estate. This process offers the same type of underlying security and profit potential as rehabbing or wholesaling, but without actually acquiring new properties.
Private real estate loans allow borrowers to obtain financing from private lenders rather than traditional banks or mortgage companies. These loans are often used by real estate investors and flippers who need quick funding or have difficulty qualifying for conventional loans. While private loans can offer more flexibility, they also come with some risks that borrowers should understand. This comprehensive guide will explain everything you need to know about private real estate loans.
What Are Private Real Estate Loans?
A private real estate loan is financing provided by a private individual or company rather than a bank or mortgage lender. The lender sets their own criteria for approving borrowers and loan terms. These loans are sometimes called “hard money loans” since the lender is lending their own capital.
Private loans differ from conventional mortgages in several key ways
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Faster funding Private lenders can approve loans much quicker than banks often in days rather than weeks or months. This enables borrowers to move swiftly to purchase investment properties.
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Flexible qualifications: Private lenders focus more on the deal/property rather than the borrower’s income, credit score or debt-to-income ratio. This helps borrowers who may not qualify for bank financing.
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Higher costs Private loans typically have higher interest rates and fees than conventional mortgages This offsets the increased risk taken on by the lender,
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Shorter terms: Most private loans are for 1 year or less. Borrowers are expected to repay the loan or refinance into longer-term financing once the project is completed.
Who Uses Private Real Estate Loans?
Private lending fills a niche for certain types of real estate investors who cannot obtain traditional bank financing. Typical borrowers include:
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Fix and flip investors: Investors who purchase rundown properties, renovate them, and quickly resell for a profit need short-term financing to fund both acquisition and renovations.
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Landlords & rental property owners: Landlords often use private loans because they can qualify in a business name rather than personal name. This shields their personal assets.
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Foreign nationals: Foreigners investing in U.S. real estate may use private loans if they do not have a U.S credit profile required to qualify for traditional mortgages.
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Lower credit borrowers: Borrowers with credit scores below requirements for conventional loans may turn to private lenders who offer more flexibility.
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Time-sensitive buyers: In hot real estate markets, private capital can help investors move swiftly to purchase before being beat out by competing offers.
Pros of Private Real Estate Loans
Private lending provides an alternative financing option with several potential benefits:
Quicker Approvals
The biggest advantage of private loans is that lenders can approve them much faster than conventional mortgages. While banks may take 30-90 days to approve a loan, private lenders can provide approvals and funding in as little as a few days. This enables borrowers to jump on time-sensitive real estate deals or secure properties ahead of competing investors.
Flexible Qualifications
Private lenders generally focus more on the real estate deal itself – the property, location, repair estimates, and exit strategy. They put less emphasis on the borrower’s income, credit score, and financial history. This allows borrowers who may not qualify for conventional financing to obtain loans through private capital.
Funding for Purchases and Renovations
Private lenders are often willing to finance both the purchase price and estimated renovation costs for fix-and-flip projects. Banks usually will not fund renovations unless the property has already been purchased.
Higher Loan-to-Value (LTV) Ratios
Private lenders may offer loan-to-value ratios between 60% – 80%. This allows the borrower to get financing with a lower down payment. Banks typically cap LTVs at lower levels unless the borrower pays private mortgage insurance (PMI).
Interest-Only Payments
Most private loans only require payment of monthly interest. There is no principal paydown required. This helps investors conserve capital for the project.
Cons of Private Real Estate Loans
While private lending has its advantages, there are also some potential drawbacks to consider:
Higher Interest Rates & Fees
Private loans typically have much higher interest rates than conventional mortgages – often between 8% to 15%. There are also lender fees of 2% to 5% of the loan amount. This significantly increases financing costs.
Shorter Loan Terms
Most private loans have short repayment terms of 6 months to 3 years. The borrower must sell the property or refinance into long-term financing within this timeframe or the lender can call the loan due.
Prepayment Penalties
Trying to pay a private loan early often incurs stiff prepayment penalties. This reduces flexibility and can create problems if a project finishes earlier than expected.
Difficulty Getting Financing Later
Defaulting on a private loan or hard money loan can severely damage your credit and financing options. This happens most often when an investor misjudges renovation costs/timelines and cannot pay off the private lender in time.
Risk of Foreclosure
If the borrower defaults on a private loan, the lender may swiftly begin foreclosure since the loans are not regulated like institutional bank loans. The lender is looking to recoup their capital investment first.
How Do Private Real Estate Loans Work?
While the qualification and funding process is quicker with private lending, these loans still require extensive documentation and legal protections for the lender:
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Loan application – The borrower completes an application providing personal, income, and real estate information. Additional required items may include borrower’s credit report, bank statements, tax returns, property purchase contracts, and contractor cost estimates.
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Underwriting – The private lender analyzes the deal, property, and borrower’s ability to successfully execute the business plan. The lender evaluates the property’s purchase price, required repairs, and realistic resale projections.
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Loan approval – Once approved, the lender issues a formal loan commitment letter detailing the exact loan amount, fees, interest rate, term length, payment schedule, and other conditions. This letter functions as a contract between lender and borrower.
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Legal documentation – As with institutional loans, private loans require promissory notes, security instruments like mortgages or deeds of trust, and guaranties. A real estate attorney typically assists in drafting the paperwork.
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Loan funding – After signing paperwork, the lender transfers the loan proceeds to the borrower. Funding often happens simultaneously with the real estate closing so borrower has cash to purchase.
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Payments – The borrower makes monthly interest payments to the lender over the loan term. The principal balance is repaid as a lump sum at maturity per the promissory note.
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Collateral – The real estate property and improvements on it serve as collateral for the private loan in case the borrower defaults. The lender can foreclose to take ownership of the property.
Tips for Getting Approved for a Private Real Estate Loan
Since private lending qualifications are more flexible than conventional loans, here are some tips to improve your chances of getting approved:
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Have a solid business plan – Private lenders want to see a well-researched plan for how you will add value to the property, your budgeted renovation costs, and realistic projected sale price. Show how the lender will get repaid.
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Put skin in the game – The more of your own cash invested in the deal, the better. Come to the table prepared to put at least 20% down if possible.
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Show experience – Highlight any successful flips, rentals, or construction projects you’ve completed. This builds confidence you can execute the plan.
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Get your documents in order – Have bank statements, tax returns, contractor estimates, purchase contracts, and other paperwork ready to provide to show you are organized.
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Bring your A-team – A great real estate agent, contractor, appraiser, and attorney make your success more likely.
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Shop for the best rate – Check rates from several private lenders to make sure you’re getting the most competitive financing terms.
Alternatives to Private Real Estate Loans
If a private loan is not ideal for your situation, here are a few other options to consider:
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FHA 203(k) rehab loan – This government-backed mortgage covers purchase price + renovations for owner-occupied properties.
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HomeStyle Renovation Mortgage – Offered by Fannie Mae & Freddie Mac, this finances purchase + renovations up to 75% of the as-completed home value.
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Cash-out refinance – If you already own the property, you may be able to take cash out of the current equity to fund renovations.
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Home equity loan/HELOC – Secured loans using the equity in an existing property you own as collateral. Can provide funds for renovations.
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Transactional business financing – Non-bank lenders offer short term loans secured by the real estate contract/transaction itself rather than the underlying property
Become A Private Money Lender: Tips From The Pros
Simply put: private money lending allows you to act as the bank for other investors. Rather than directly purchasing assets, you get the opportunity to fund those owned by colleagues and partners. By now, you likely realize how beneficial this setup can be. However, you should know a few more things before getting started. Read through the following tips before taking on your first deal as a private money lender:
- Start Out Small: Identify a range you are comfortable working with, and stick to it. The number one mistake private money lenders make when starting out is spreading themselves too thin. Assess your finances and your preferred level of risk, and create clear guidelines for potential projects. If someone approaches you searching for more than you want to offer, do not be afraid to refer them elsewhere.
- Find A Good Attorney: Becoming a private money lender doesn’t make you a lawyer. You will still need help when it comes to negotiating and reviewing contracts. Additionally, if you start a private money lending business, there are several legal protections you need to have in place before getting started. Find a qualified real estate attorney in your area and bring them on to your team. Their role in your company will be invaluable over time.
- Work Locally: There are profitable real estate deals all over the country; however, there are also deals right under your nose. If you decide to start your private money lending business locally, you can meet face to face with investors. Additionally, you will likely be more available for communications and future investment options. Don’t underestimate the potential of your own market; you never know what kind of deals may come your way. You can always expand in the future.
- Be Transparent: Avoid inflating your portfolio or background to attract potential investments. No matter what point you are at in your investing career, let your work speak for itself. You don’t want to misrepresent yourself or your lending business. Always maintain transparency and stay true to your mission and values.
- Don’t Forget About Yourself: Remember, just because you aren’t purchasing assets directly does not mean you aren’t an investor. Continue your professional and financial education even if you opt for the role of lender. You still need to stay on top of market trends, financial news, and other factors impacting the real estate world. While you don’t have a hands-on role in the investments you finance, you still need to have strong business acumen.
- Learn The Subject Matter: Review the types of borrowers listed above and familiarize yourself with the different deal types. Learn what factors go into a successful rehab, buy and hold, or rental property. That way, when a borrower pitches a deal, you know how to evaluate it for yourself. Obviously, they will paint the investment in a good light, but is it actually profitable? To be a successful private money lender, it is crucial to understand exactly what goes on in the niche you choose to invest in.
How To Borrow From Private Money Lenders
When embarking on real estate investments, securing the necessary capital is a pivotal step. Private money lenders offer a flexible and accessible source of funds, especially when traditional financial routes are impractical or unavailable. For real estate investors needing to fund their projects, here is a step-by-step guide on how to successfully secure a loan from private money lenders.
How You Can Find Private Lenders As a Beginner Real Estate Investor
FAQ
What is private lending in real estate?
How to borrow money from a private lender?
Is private lending a good investment?
Are private loans legal?
How do I get a private real estate loan?
Learn the ins and outs of private real estate loans. Build a network of potential private lenders. Prepare a strong portfolio to present. Identify the right lender for the project. Wow lenders with your pitch. When you first get started in real estate, you may look at your colleagues and wonder how to find private investors for real estate deals.
Are private money loans a good option for real estate investors?
As a whole, private money lenders can represent a much more flexible refinancing agreement when compared to traditional financing. Private money loans can help real estate investors purchase new properties, including residential, commercial, and multifamily real estate.
Who provides private money loans for real estate?
We will focus on businesses that provide private money loans for real estate. Examples of institutional lenders include banks, credit unions, and government-backed mortgage lenders. They are subject to regulation by federal and state agencies. Private lenders are not subject to those regulations.
What is a private money lender?
Private money lenders have more flexibility to decide what criteria to consider. They may be able to loan money in situations where institutional lenders cannot. In the context of real estate, this can mean putting more focus on the property than the borrower. Private lenders may provide funding for real estate transactions.
What do private lenders do for real estate investors?
Private lenders can provide funding for almost any type of real estate purchase. Individuals buying a personal primary residence can get financing through a private lender. In this guide, however, we’re addressing what private lenders do for real estate investors. Read more: FAQs About Capstone Capital Partners, a Private Hard Money Lender
Can you buy a home through a private lender?
Conventional financing may be available from banks or mortgage lenders, but private lending is an option that all investors should consider. Private lenders can provide funding for almost any type of real estate purchase. Individuals buying a personal primary residence can get financing through a private lender.