In the past, financing for real estate loans would come from traditional banks or government agencies. However, these organizations have limitations when it comes to real estate investing.
Between stringent requirements or only assessing a property’s current state, rather than its potential return, leaves a gap that many borrowers would fall into. This is where private money lenders come into play.
If you are considering a real estate investment, you may want to look into the advantages of a private money loan. Use this private money lending guide to learn how these loans differ from conventional loans.
Private Money Lending: A Guide
What is private money lending? Simply put, it means that you are borrowing money from an individual investor or company rather than a financial institution like a bank. These loans can be to individuals or companies.
Private money could come from friends or family who have the capital to invest. However, there are definite drawbacks to this type of loan. If, for some reason, your loan was to go south, it could damage the relationship.
Another type of private money lenders are known as hard money lenders. Hard money lenders approve loans based on the collateral – the real estate – rather than the borrower.
How Are Hard Money Loans Approved?
Traditional loans look at a borrower and the borrower’s ability to repay the loan. There are many reasons that a bank might reject a borrower, such as bad credit, prior foreclosures, or bankruptcy.
With hard money loans, lenders focus on the value of the property rather than the borrower’s financial history or credit score. This is known as asset-based lending.
It can also be challenging to get a traditional bank loan on future investment returns on real estate, such as a fix-and-flip or a rehab. Hard money lenders fill this need as well since they will look at the potential profitability of the property.
Because private money lenders are using their own resources to fund the loans, the approval usually happens very quickly, and the process is more streamlined than a bank.
Funding the loan is also very fast. Turnaround times can be as little as 5-14 days, unlike conventional loans, which take much longer.
Terms of a Hard Money Loan
Like conventional loans, hard money loans will have a structured term for repayment and interest rate. The loan may be a fixed-rate or adjustable, and the term can vary from short-term to fully amortized.
Documents of a Hard Money Loan
You may be familiar with the giant stacks of paper that accompany a conventional bank loan. Hard money loans have some key documents as well that you can expect as part of the loan approval and closing.
You will identify the purpose of the loan, the property, and information about yourself, such as income.
The most important document, the promissory note is your promise to pay back the loan according to the terms.
Mortgage/Deed of Trust
A mortgage or deed of trust (depending on the state) will be filed, showing the private lender’s security interest in your property as collateral for the loan.
While not subject to the same regulations as a bank, private money lenders are still required to provide you with disclosures complying with applicable laws. For example, the Equal Credit Opportunity Act prohibits discrimination based on race, age, gender, and other factors.
You will be required to agree to maintain insurance on the property for the life of the loan. This protects the lender in the event that something, such as a fire, damages the property.
Types of Hard Money Loans
Several purposes of hard money loans have been mentioned, but private money lenders typically cover a wide range of residential and commercial property loans. For example:
- Fix & Flip loans
- Business Purpose loans
- Probate loans
- Rehab loans
- Construction loans
- Loans to Corporations, Trusts, or LLCs
- Industrial properties
- Apartment buildings
- Mixed-use properties
- Second homes
Since the property itself is the primary consideration for approval, if you do not have enough equity, it may be possible for your lender to cross-collateralize and use the equity that you have in another property to get the loan approved.
Relationships Are Important
As shown in this private money lending guide, finding a private lender may be what you need to achieve your real estate goal. Whether you don’t qualify for a traditional loan because of bad credit or the bank won’t do a loan due to the type of investment, or you need money quickly, it pays to look into private money lenders.
What sets private money lenders apart from banks, outside of everything discussed, is the relationship. Whether you turn to a family member or a hard money lender, the focus will be on your situation and the best terms for you. Developing that relationship will enable you to fund loans more quickly and easily in the future.
As you make a case for obtaining a private money loan, here are some questions to ask yourself:
- Is this person knowledgeable in real estate to know if this is a good investment?
- Does this person know me, understand my goal for this loan, and the potential return on investment?
You will want to position yourself in the best manner for your investor. For a friend or family, this may be as simple as helping someone they care about. For a hard money lender, this is understanding the profitability that your loan offers.
If you are in need of real estate financing and unsure if a traditional bank is the right source of funds, you may find that private money lenders are a better fit. Between more flexible loan terms, faster turnaround, and a focus on the equity rather than credit of the borrower, there are many advantages to using a private money lender.
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