Private loans are loans offered to real estate investors who are purchasing and rehabbing dilapidated properties. Private loans should not be confused with subprime loans – loans that cater to consumers in tough financial situations. Private lenders have significant underwriting flexibility because, unlike banks, credit unions, and traditional mortgage companies, they do not work with consumers. Consumer loans are regulated to protect consumers and often have limitations on their pricing and structure. The government regulates consumer mortgages to promote and protect homeownership. Private lenders lend to businesses whose goal is to make money by fixing and flipping homes. Because of that, they can offer loans on terms that makes sense to both the lender and the borrower.
If you are a real estate investor trying to decide whether private loans are right for you, you need to keep these seven things in mind:
1. Private loans are a unique type of financing used specifically for distressed properties.
Private lenders fund residential or commercial properties regular lenders won’t touch with a ten-foot pole. In the MLS, such properties are easily identified with disclosures they come with: “Cash Only”, “Investor Special” or “No Bank Financing.” Regular mortgage providers are not prepared for the risk of managing rehabs-in-process and choose not to finance such transactions. Unless you have plenty of money to buy such home outright with cash, without private financing, you will be out of luck. “Private financing democratizes real estate investing,”- says Anastasia Sennott, a partner in New Funding Resources, a private lender in Washington, DC.
2. Private financing delivers access to unparalleled leverage.
Private lenders structure their loans in a very different way from what you might be accustomed to. Instead of using the current value of the home you are buying, they base it on its future value. This value – commonly referred to as the after-repair value or ARV – is, in theory, significantly higher than the current distressed price. The loan based on the ARV provides borrowers with more money to buy and renovate the property than a loan based on its current distressed price tag.
3. Simplified underwriting is another advantage of private loans.
Private lenders are often referred to as asset-based lenders. Their primary concern is to ensure that the transaction they are financing makes sense. They want to see that their borrowers will generate profit fixing and flipping the property. This is why many private lenders are not as concerned with their clients’ income or credit history.
Another benefit of simplified underwriting is that, with private loans, you can close as quickly as any cash buyer. It is common for a private lender to close within two weeks, but they can also rush their process and get you to the closing table in days.
5. Not everyone can qualify for a private loan.
Private loans fund the lion’s share of what’s required to fix and flip a home. Yet, it does not imply you can start buying real estate without having some capital of your very own. By lending on a residential or commercial structure that is in disrepair, private lenders take a significant risk. To manage that risk, their preference is to deal with clients with a displayed record of success, as attested by the level of their savings as well as their readiness to use such savings. By pitching in some of their hard-earned cash, real estate investors prove they are dedicated to the purchase and are ready to share its risk with their loan provider.
6. Private lenders charge higher rates and fees.
Private loans are more expensive than regular funding. Typically, their rates vary between 9% and 14% annually. These rates reimburse the lenders for the risk they take. As an example, if a borrower fails to rehab the house, a private lender could end up with a loan that surpasses its present value.
7. Private loans are short-term.
As soon as you are done with your renovations, there is no reason to keep paying higher rates charged by a private lender. Contrary to what you might think, private lenders are not particularly keen on keeping your loan for too long either. This is why the term for private money typically doesn’t exceed a year or so. The majority of private loans are repaid by selling the property. However, some borrowers prefer to keep their newly remodeled home as a rental. In their case, they refinance their loan with a traditional lender.
Chrissy Ryland - I'm a freelance writer and blogger from Northern California. I grew up loving all things entertainment and travel and now I am blessed with a career that lets me write about both of those topics along with many others. For inquiries about a story you think I might want to cover, please contact me at firstname.lastname@example.org