Many real estate investors use private money lenders to finance their investment properties. Investing in real estate is much different from buying a primary residence. Getting approval for a traditional mortgage can be lengthy, and investors need to move quickly once they spot a great deal on an investment property.
Private lending is well suited for investors because the approval criteria are much less strict, and a private lender doesn’t work under any major financial institution, like a bank. This allows a private lender to be more flexible and set their own lending criteria, which means real estate investors can typically have their loan approved (and receive their funds) in days, not weeks.
What Is a Private Money Loan?
In real estate, a private money loan is a collateral-based commercial loan provided by a private organization instead of a traditional bank, commonly used by investors to finance real estate acquisitions or cash-out on the equity they have built up in their real estate holdings.
Private lenders aren’t bound by the rules and regulations set by a traditional bank or other financial institution, making them an attractive option to real estate investors looking to secure their closing quickly and give them more time to qualify for a long-term financing solution.
Loans offered by private lenders are often short-term ranging from 12-36 months, as they are designed to bridge a gap in liquidity until a permanent solution is put in place. They are also collateral focused, meaning your approval odds for a private loan will depend more on the quality of the asset than your personal financial profile.
Private lenders are also much more flexible about the properties they will provide funding for, compared to a traditional bank. You can often find private lenders catering to more complex financing scenarios such as spec home financing, commercial developments, land acquisitions, non-warrantable condos, and super luxury estate - transactions that a big box lender would usually be unable to execute on.
What Do Private Lenders Consider Before Offering A Loan?
Before offering a loan to an investor, a private lender will look at certain factors to assess their ability to pay it back. Here are some of the most commonly considered factors when a lender is reviewing a loan application.
- Collateral
- Experience
- Exit strategy
- Borrower credit history
- Borrower liquidity
Collateral
Collateral is an asset a borrower offers to assure a lender they’ll receive the payment no matter what (ex: real estate). If the borrower cannot pay back the loan for any reason, the private lender can seize the asset. Collateral must have a high value that does not stand to depreciate over time and be easy to cash out on if it becomes necessary.
Private lenders for real estate financing will set their own parameters for the types of collateral they will lend on. For example, some lenders will only lend on residential assets, whereas other lenders will lend on commercial and land assets as well. The location of the asset also plays a role as many lenders like to focus on specific markets (e.g.: South Florida).
It's important to keep in mind that how the borrower intends to use the property plays a role in their ability to get approved as well. Most private lenders only offer commercial loans. This does not mean that they only lend on commercial assets, rather that the property is intended for business or investment purposes. For example, a private loan can be used to purchase a single-family residence, but it cannot be owner-occupied.
Experience
Private lenders may be more willing to work with borrowers who have a track record of success in real estate transactions. The borrower's experience is often considered an important factor because it provides the lender with confidence in the borrower's ability to successfully manage a real estate investment. This is especially true for high risk transactions such as purchasing vacant land for future development. For this reason, it is always recommended to share your portfolio of work, a short bio and/or business plan with your lender so they can get a better sense of your experience and investment strategy.
Exit Strategy
Having a clear and well-thought-out exit strategy is crucial in real estate investing, especially when seeking financing, including private money loans. An exit strategy outlines how an investor plans to sell or dispose of a property to realize profits or mitigate risks. When a private loan is involved, your exit strategy must also detail how you plan to pay off the loan. Keep in mind that private loans are short-term loans, making a solid exit strategy essential for getting approved.
The most common exit strategies for a private money loan include:
- Refinance the loan (either with a bank or another private lender)
- Sale of the asset
- Pay off using income from other source
Borrower Credit History
Private loans approvals are not credit score driven, which means there is typically no minimum FICO score required. However, a private lender may pull your credit to ensure your credit history does not show any recent bankruptcies or foreclosures. So if a real estate investor doesn’t have a great credit score, or no credit history in the U.S. at all, but has no major credit delinquencies and the quality of the asset is sound, a loan with a private lender would still be a good option for them.
Borrower Liquidity
The good thing about private lenders is that they often require minimal income documentation than a traditional bank. Instead of requesting 2 years worth of tax returns, pay stubs and W2s, a private lender may only ask for a copy of your most recent bank statement that shows enough liquidity to cover 6-12 months of interest payments.
Advantages of Private Lenders
Many advantages come with private money loans, especially if you’re a real estate investor. Here are a few upsides to obtaining a loan from a private lender.
- The loan terms are more flexible. Since private lenders set their own lending appetite, investors will have a much easier time structuring loan terms that fit their investment needs.
- The approval process is typically quicker. With many banks and financial institutions, getting approved for a loan is quite a lengthy ordeal. Private lenders usually don’t have to adhere to the same rules and can approve a loan in less than 24-hours.
- Loans on properties banks won’t take on. Private lenders often see value where other lenders do not, and are more willing to take on the risk for a property with untapped potential in their target market.
A private lender loan could be a great option if you’re a real estate investor looking for reliable access to capital to put towards your next investment purchase. A private real estate loan can also be used to tap into your property’s equity with a cash-out refinance.
Disadvantages of Private Lenders
As with anything, it’s smart to consider the risks. While they are usually easier to approve, private money loans also have downsides.
- Interest only. Most private loans are interest only. This means that your monthly payment will only cover the interest, and the principal amount will be due as a lump sum at loan maturity. The borrower must have an exit plan in place on how they will pay off the loan, or they could risk defaulting on the loan.
- Shorter loan term. Private loans have much shorter repayment periods than standard mortgage loans. This means monthly payments will be more expensive, compared to a traditional mortgage that is amortized over a 15-30 year term.
- Investment property only. Most private loans are considered commercial loans, or business purpose loans. This means the asset must be an investment property. A residential home or apartment can be financed with a private loan, but the owner cannot use the property as a primary residence or second home.
If you’re considering a private loan to fund your investment property, make sure you’re aware of the potential risks associated with taking on this level of responsibility. Make sure to work with a mortgage professional who can guide you through your options.
Regulations To Consider With Private Lender Loans
Private money lenders must follow federal and state usury laws, and they can still be subject to certain regulations even though they work independently. In some states, private lenders must own a banking license if they want to lend over a certain amount in loans.
Who Should Consider Private Lender Loans?
Private money loans are ideal for real estate investors who are faced with contractual obligations that require a fast closing, have an existing loan that is maturing soon, or are still in the process of qualifying for long-term financing.
Private lender loans are also great for investors who own an investment property free and clear, and would like to tap into the property’s equity to reinvest, pay off other debts, or renovate the property. A cash-out loan through a private lender requires minimal documentation, allowing real estate investors to receive their cash proceeds in days, not weeks.
Final Thoughts
Leveraging debt is important in real estate investing for several reasons, and it can be a powerful strategy when you can partner with a lender you trust. At Vaster, we offer competitive pricing, fast funding, and prioritize building long-term relationships with our clients and brokers.
Our skilled team of private loan consultants and our "lend to earn" philosophy ensures that your success is our success. Reach out to us today and find out how we can help you execute on your next investment.
Sources:
Exit Strategy Definition | Investopedia
What Do Private Money Lenders Look For? | Longleaf Lending
What Is Collateral & Collateralized Lending | Connect Invest
Private Mortgage: What You Should Know Before You Borrow | Rocket Mortgage
Private Money Loan - Definition, Regulation, Risks | corporatefinanceinstitute.com
What is a Private Money Lender? | civicfs.com
Private Lenders: How To Find Them Fast | FortuneBuilders
Private Money Loans Explained | We Lend LLC
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