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 better for investors because the approval criteria are much less strict, and a private lender doesn’t work under any major financial institution, like a central 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 application approved (and receive their funds) in days, not weeks.
What Is a Private Money Loan?
A private money loan is a type of short-term loan commonly used by investors to finance real estate properties. 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 move quickly.
Private lenders are also much more flexible about the properties they will provide funding for, and often specialize in complex loan requests like developer financing and blanket loans; many banks would not take on this type of financial risk. Since private lenders work for themselves, they can determine the level of risk they’re willing to take 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
- Income
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 (ex: Florida).
Experience
If a real estate investor is just starting out, they likely won’t have many success stories to prove reliability. If you’re new to the industry, it won’t necessarily impact loan approval, but you could be faced with higher interest rates or be asked to pay a higher down payment than you expected. It is always recommended to share your portfolio of work with your lender or provide them with a business plan, so they can get a better sense of your experience and/or investment strategy.
Exit Strategy
Real estate investors should have exit strategies. An exit strategy is a way to back out of a real estate deal while (hopefully) losing as little money as possible. Most private lenders will require you to have an exit strategy to pay off the loan at maturity. Some common exit strategies among borrowers for a private loan include refinancing, securing a construction loan (for vacant land), using income from another business venture, or selling the asset.
Borrower Credit
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 their financial standing and the quality of the asset is sound, a loan with a private lender would still be a good option for them.
Borrower Income
The good thing about private lenders is that they often require less 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 work alone, 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 1-2 days.
- 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.
A private lender loan could be a great option if you’re a real estate investor looking 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 15-30 year mortgage.
- 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, 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
At Vaster, we want to ensure that you have all the tools you need to succeed in real estate, whether you’re buying a new investment property or refinancing. We design custom mortgage solutions to fit every need and help buyers and investors close quickly.
Our skilled team makes the entire process easy and is by your side every step of the way. So whether you’re looking to land your next investment property or you're very first — we can help you get the funds you need to make the deal happen. Reach out to us today.
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
Pamela Garcia: March 27, 2023
Vincent Diaz: March 7, 2023
George Fraguio: March 7, 2023
Vincent Diaz