Private money loans occur when a private individual or small business loans another investor/investment company personal funds for investment purposes.
They’re often used as a short-term loan to finance the purchase of real estate.
Each party involved in the private loan establishes and agrees to the terms of the loan. Private money loans are often an attractive option to borrowing from a traditional bank or lending institution.
In this article, we’ll explain the key features of private money loans, pros and cons, use cases, requirements, and more.
Let’s dive in.
Key Features
Private loans are provided by private lenders, as opposed to traditional financial institutions (banks, credit unions, etc.).
Real estate investors rely on private lenders to finance deals that either (i) do not qualify for a traditional loan or (ii) need to close before the usual 30 days waiting period for a conventional loan.
Examples of private money lenders include friends, family, or anyone else in your inner circle. In short, private money lenders are individuals or groups who believe in your real estate investment and want to invest capital in your venture.
Because private money lenders are private, they remain less encumbered by regulations and red tape.
That makes qualifying for private loans a much faster process than qualifying for financing from traditional sources.
Although private loans usually last for a 12-month term, they can also be extended to anywhere from 2-5 years.
Pros of Private Money Loans
Private money loans can be a great way to finance a property if you can’t get funds from banks, credit unions, and other more traditional financing sources.
For instance, private money loans are ideal for investors looking to purchase a property that needs significant repairs, or a property that suffered vandalism.
Traditional financial institutions often refuse to grant loans for these sorts of properties, but private money loans aren’t beholden to many of the rules and regulations of traditional lenders.
This leads to another, more fundamental benefit of private loans: they come with significantly fewer requirements than loans from traditional lenders. Private loans are flexible.
Why?
Because private money lenders often care more about the potential financial upside of the real estate investment, not the borrower’s credit score or financial history—especially if the borrower is a trusted friend or family member.
For instance, you might have a lower credit score but years of real estate investment experience—chances are you’d be a good candidate for a private money loan.
Lastly, private money loans close fast (often in a matter of days) as opposed to the usual 30-45 days it takes for conventional loans to close.
Cons of Private Money Loans
Private money loans can be a great way to quickly raise capital for a real estate investment.
However, they also present a few disadvantages:
- Higher interest rates
Most private loan lenders will charge a higher interest rate than average financial institutions. That’s because private money lenders assume a higher amount of risk when making loans.
Private money loan interest rates typically hover around 15%. That said, some will rise to as high as 20%, especially if you have poor credit or are purchasing a particularly risky property.
- Shorter payback period
Most private money loans won’t let you pay back the loan over a 30-year period. Most private money lenders require you to repay the loan within 6-12 months; however, some more lenient lenders might agree to a repayment period of a few years.
- Collateral requirements
Most private money lenders will require you to use your property as collateral for the money you finance. That means you must do your due diligence to ensure the deal’s potential meets your criteria.
The good news is that these disadvantages can easily be overcome! Do your research and you’ll have no problems.
Use Cases
There are many reasons why you might look for a private money loan as opposed to a loan from a bank or credit union.
- Time
The market waits for no one. Many borrowers who rely on private money loans do so because they want to strike quickly when they see a great deal. Waiting for months for a bank to pre-approve a loan just isn;’t an option. Private money loans turn around often in a matter of days, which makes them perfect for borrowers who just can’t afford to wait.
- Planning
If you have a specific plan for your real estate investment, private money loans can be a great option. For instance, fix-and-flips can be risky, but not if you’ve had years of experience. Private money loans can be a great way to finance that strategy while avoiding all the excess red tape of banks and credit unions.
- Poor credit history
The traditional lending industry isn’t forgiving. Once you’ve made one bad financial decision, it feels like you’re trapped in a hole you can’t climb out of. That’s why private money loans can be a great option for you! Credit history is much less important for private money lenders. If you’re a borrower who’s suffered from sudden bankruptcy, a short sale, or a foreclosure, private money loans can help you get back in the game.
- Independence
Some borrowers like doing things their own way. For example, if you’re self-employed, it might be harder to secure a large loan from a traditional financing source. However, reputable private money lenders are often more than willing to lend money to mavericks and entrepreneurs.
Private Money Loan Requirements
Private money loans come with far less tangible requirements than banks, credit unions, and other financial institutions.
Instead, private money lenders often look for these 3 qualities: commitment, profitability, and risk.
We’ll break down each of these below.
- Commitment
Private money lenders assume a good deal of risk when they offer you a loan. That’s why most private money lenders need to see that you’re just as invested in the property as they are—and that you’re willing to lose big if your plan fails. Offer to put down a large down payment and show private money lenders that you’re serious about your investment.
- Profitability
Private lenders want a cash-positive, profitable asset—that’s how they’ll evaluate your prospective property.
For instance, if you’re running a fix-and-flip operation, you need to show the lender how exactly you can purchase the home at a low cost, perform some repairs, and make a profit from the rehab and sale of the home. With this plan in place, lenders are much more likely to give you the capital you need.
How can you show your potential lender the value of your prospective property? Give him or her estimated values of the homes in the area. Provide a detailed fiscal picture of the property’s opportunity to increase in value.
- Risk
Private money lenders might not be as concerned about your credit score as a bank, but they’ll still examine your real estate history and your investment track record. Make sure that your track record looks good. They’ll want answers to questions like: have you previously invested in real estate? If so, were you successful? Did you repeat this success with multiple properties?
If you’re new to the commercial real estate world, that doesn’t mean you’re out of luck when it comes to private money lenders—but it does mean you might need to put down a larger down payment and risk more of your own capital.
Regardless of your investment history, show your private lender that you’ve put extensive research into the property and that you’ve developed plans to turn the property into a profitable investment.
Private Money Loan Rates
Private money loan rates will vary, depending on a variety of factors: the purpose of the loan, the length of the loan, and the relationship between the lender and the borrower.
Typically, most private lenders charge between 6-15%.
However, if your lender is a parent, a close friend, or a business associate, this rate might change. The closer your relationship with the lender, the more favorable terms you’re likely to receive, including low-interest rates and minimal penalties for any late payments.
FAQs
- What is a private money loan?
Private money loans occur when a private individual or small business loans another investor/investment company personal funds for investment purposes.
They’re a common short-term financing solution for groups or individuals that need capital quickly or who don’t want to deal with the red tape of banks and credit unions.
- What’s the difference between a private money loan and a hard money loan?
The main difference between private money loans and hard money loans?
Structure.
Private money lenders are typically not organized money lenders, and they’re typically not licensed to loan money.
Conversely, hard money lenders have often organized money lenders licensed to loan money. That means they often present some sort of lending criteria, while private money lenders often do not.
- Should I get a private money loan?
It depends. Private money loans can be a great way to secure quick, easy financing for real estate you want to purchase right away. That said, they often come with high-interest rates and short payback periods.
Before committing to private money, assess your financial situation and the property you want to purchase.
Cost of Private Money Loans
Private money loans come with a variety of costs.
For example, most private lenders charge origination points along with their loan products. These origination points often range between 2-5% of the total loan amount, and that means the final cost will depend on (i) the type of loan, and (ii) the loan term.
The longer the loan, the higher the risk to the lender, and thus the more origination points they’ll charge.
Additionally, your risk profile will affect the number of origination points you pay. A quality credit score combined with high down payment and a short loan term will mean you’ll pay fewer origination points.
Always ask the lender about fees and origination points before signing your loan.
Other fees often include:
- Appraisal fee
- Title insurance
- Notary fee
- Recording fee
- Closing fee
Private Money Loan Alternatives
Private money loans are a great financing option, but they’re not always the best choice.
Some alternatives to private money loans include:
Hard money lenders operate as public businesses, and they usually provide a minimum credit score necessary for all borrowers. Hard money lenders will assess your ability to make your monthly payments before issuing you a loan.
Many borrowers use hard money loans to fund real estate projects like house fix-and-flips or buy-and-hold investments. Oftentimes hard money loans work with interest-only repayments, and they require you to pay back the full amount of the loan at the end of the term.
Hard money loans operate just like a bank, but with fewer rules, regulations, and red tape.
- Bridge loans
Bridge loans are also referred to as bridge financing, interim financing, swing loans, or gap financing.
They’re a short-term financing tool that lets you borrow against your current asset.
Bridge loans typically let you borrow money for up to a year. Interest rates on bridge loans typically fall between 8.5% and 10.5%, which means they’re more costly than traditional forms of long-term financing, and even more costly than some private money loans.
Learn more about bridge loans here.
- Conventional loans
Conventional loans are another alternative to private money loans. They typically require down payments up to 20-25% of the value of your property.
Conventional loans are not backed by a government agency, and they’re divided into two types: conforming, and non-conforming.
Conforming conventional loans adhere to the lending rules set by Fannie Mae and Freddie Mac; nonconforming conventional loans do not.
Unlike private money loans, conventional loans are originated by banks—that means they won’t present the same flexible terms and repayment periods as private money loans.
Conclusion
Private money loans can be a great way to finance your commercial real estate venture.
Whether you’re a lender or a borrower, it’s important to understand what private money loans do and how you can best use them to meet your needs.
At Loanbase, we make it easy to find and connect with both qualified lenders and borrowers. No more mountains of paperwork or time spent tracking down the right partner.
Commercial lending (and borrowing) should be easy—try Loanbase today!