What is a Private Mortgage Loan? A Complete Guide

If you’re looking to buy or refinance a home, you likely know that banks and mortgage lenders provide the majority of home loans. But you may also have the option to get financing from a private lender. So what exactly is a private mortgage loan and how does it work?

In this comprehensive guide, I’ll explain everything you need to know about private mortgages. I’ll cover what they are, how they differ from traditional loans, pros and cons, requirements, and tips for getting approved. My goal is to provide a detailed overview so you can determine if a private mortgage is right for your situation.

What is a Private Mortgage Loan?

A private mortgage loan comes from an individual or company rather than a traditional bank or mortgage lender. The loan works similarly to a conventional mortgage in that you borrow money to purchase a property and use the home as collateral.

With a private mortgage, the lender sets their own eligibility and approval criteria This provides more flexibility but also potentially more risk than a traditional mortgage. Private mortgages are sometimes called “hard money loans”

Friends family members private investors, and real estate companies all commonly offer private mortgage financing. Rates and terms vary based on the lender.

How Do Private Mortgages Differ from Traditional Loans?

While private mortgages share similarities with conventional bank loans there are some key differences

• Interest rates – Private loans typically have higher interest rates, often 1-2% above conventional mortgages.

• Down payment – Private lenders may require larger down payments of 20-30%. Traditional loans offer options like FHA with 3.5% down.

• Credit requirements – Private mortgages can have more lenient credit standards, while banks adhere to minimum scores.

• Loan term – Private loans often have shorter repayment terms of 1-7 years rather than 15 or 30 years.

• Prepayment penalties – Private mortgages sometimes include penalties for early repayment. Traditional mortgages do not.

• Property types – Private lenders may finance unique properties that don’t qualify for standard mortgages.

As you can see, private mortgages provide more flexibility in some ways but less consumer protection in others. Carefully weigh the pros and cons when considering this route.

Pros of Private Mortgage Loans

Some of the potential advantages of private mortgage loans include:

• Easier to qualify – Lenders can overlook credit scores, income, and debt-to-income ratios that are too low for bank approval.

• Faster process – Private mortgages may close more quickly without lengthy bank underwriting.

• Renovation financing – Hard money lenders may fund fixer-uppers and construction projects overlooked by banks.

• Unique properties – Private capital can finance unusual homes like earth bermed or off-grid.

• Investment financing – Private loans provide funding for investment properties like flips and rentals.

• Debt consolidation – Borrowers can pay off higher interest credit cards and loans with a private mortgage.

For borrowers who don’t qualify for bank financing, private mortgages provide another option to purchase or refinance real estate.

Cons of Private Mortgage Loans

Despite the advantages, private mortgages also come with drawbacks to consider:

• Higher costs – Interest rates and fees are usually higher than traditional mortgages.

• Shorter term – Loans may come due after just 1-7 years, requiring refinancing.

• Prepayment penalties – Private lenders sometimes charge fees for early payoff.

• Variable rates – Private mortgage rates can fluctuate after closing, causing payments to rise.

• Fewer protections – Private loans lack the regulations and oversight of bank mortgages.

• Relationship issues – Borrowing from friends or family can strain relationships if problems occur.

While private financing provides needed flexibility for some, the additional costs and risks should be carefully weighed.

What are the Requirements for Private Mortgage Loans?

Since private lenders set their own criteria, loan requirements can vary significantly. Here are some typical eligibility standards:

• Credit score – Many private lenders accept credit scores under 620, versus 720+ for conventional mortgages.

• Down payment – 20-30% is often required. Some lenders may accept less with strong credit profiles.

• Employment – Steady income is required, but private lenders may not document it as rigorously as banks.

• Property type – Private capital is more open to unconventional homes that traditional lenders view as risky.

• Refinancing limits – Many private lenders require at least 30-50% equity in the home to refinance.

Always verify specific requirements with individual lenders, as standards can diverge from these general guidelines. Also confirm any home appraisal needs.

Tips for Getting Approved for a Private Mortgage

If you need flexible private mortgage financing, here are some tips to boost your chances of getting approved:

• Shop multiple lenders to compare interest rates and requirements. Local direct lenders are often the most flexible.

• Aim for the highest credit scores possible over 700. This helps reduce rates and build lender confidence.

• Have tax returns, bank statements, and other financial documents ready to document income sources.

• For refinancing, maximize your home equity as much as feasible.

• Explain any past credit issues clearly to show you’ve resolved them.

• Provide a detailed renovation plan if seeking a construction loan.

• Ask lenders if you can convert to a traditional mortgage after improving your finances.

With prudent planning and preparation, private mortgage approval is possible even with credit or employment challenges.

What are Some Private Mortgage Loan Examples?

To better understand how private mortgages work, here are two examples:

Financing a fixer-upper home: Sara finds a dated home priced below market value at $200,000. It needs $50,000 in renovations to update electrical, plumbing, and the kitchen and baths. Sara has an 640 credit score and $40,000 for the down payment. She gets approved for a 5 year interest only private mortgage at 7% interest with a 30% down payment. This provides $140,000 to purchase the property and fund renovations. After updating the home, Sara refinances into a conventional mortgage to pay off the private loan.

Buying investment property: James wants to purchase a 4-unit rental property for $500,000 but only qualifies for a primary residence mortgage. His friend agrees to provide private financing with 25% down, a 7% interest rate, and 3 year term. This allows James to buy the investment property. He plans to refinance into a longer term commercial loan after establishing a history of rental income.

These examples illustrate how private capital can help borrowers who don’t fit traditional bank criteria access real estate financing.

Should I Use a Private Mortgage Loan?

The choice between a private versus traditional mortgage depends on your specific finances and goals. Key questions to ask:

• Will I qualify for a conventional bank mortgage based on my income, credit score, and property type?

• How long do I plan to hold the property – short or long term?

• How much equity do I have if refinancing an existing home?

• Am I comfortable with higher rates and shorter repayment terms?

• Can I afford potential prepayment penalties if I sell or refinance?

Carefully consider these factors to decide if the benefits of private mortgage financing outweigh the risks and costs for your situation.

The Bottom Line

Private mortgage loans provide financing from non-institutional sources like private lenders, investors, and friends or family. They offer more flexible qualifying criteria than traditional bank mortgages but come with higher costs and risks. For borrowers unable to get approved for a conventional mortgage, private loans provide another option to buy or refinance real estate. But the shorter repayment terms and prepayment penalties should be fully understood. With prudent evaluation, private mortgages can be a viable alternative when traditional financing is not available.