There may be no more exciting yet often confusing element to the real estate investing field than private money lending.
Yet, while private lending for real estate represents a real opportunity for new real estate investors, many are unsure what the endeavor entails.
Is private money lending different from conventional financing? What’s the difference between private money lending and hard money lending? And how do you find those ever-elusive private money lenders just waiting to take a chance on your new property acquisition?
To help dispel some of the confusion and boost your real estate investing IQ, here is a private money lending FAQ to get you up to speed on this most promising form of investment financing.
What Is Private Money Lending?
They are borrowing money from an individual investor. Real estate investors use private lenders to finance deals that will not qualify for a traditional loan or are not able to wait the usual 30 days or so that a conventional mortgage loan needs approval.
How Does Private Money Lending Differ From Hard Money Lending? Private Money Lending FAQ
Think of it this way: private lending involves borrowing money from people with the means to invest capital in your venture (there’s no financial institution backing this investor). An excellent example of a private money lender would be a friend or family member — anybody in your inner circle — or an individual investor who was intrigued by your proposal and wants to be a part of your investment.
Hard money lending is something that lives between private money lending and conventional bank financing. Though hard money lending doesn’t require the usual hoops to jump through that traditional financing, hard money lenders are semi-institutional. However, they do have their own set of established criteria. Therefore, both types of lending should be part of an investor’s financing toolbox.
Private Money Lender – Individuals who use their own money. Easy to qualify and get funded.
Hard Money Lender – a company or broker that uses their funds/pool or finds an individual private money lender, or provides semi-institutional funds.
What Are The Advantages Of Private Money Lending?
As Nasdaq accurately points out, private loans are ideal for investors who want to buy a property that needs a lot of repairs. For example, conventional financial institutions often refuse to grant mortgage loans for properties that have been vandalized or seriously damaged. On the other hand, private money lenders and hard money lenders see the potential in a property that can be purchased cheaply, fixed for a reasonable price, and then resold for a tidy profit.
Additionally, private money lenders and hard money lenders will have fewer requirements than other lenders. More specifically, private investors focus on the potential profitability of the real estate purchase rather than the borrower’s financial history and credit score. Furthermore, private money loans are funded relatively fast, whereas a loan from a conventional lender may not be approved for up to 45 days.
What Are The Disadvantages Of Private Money Lending?
There are a few disadvantages to obtaining private loans. The first is that private lenders often charge a higher interest rate than the average bank loan. Private lending rates hover around 8%-18%. This is particularly true if you have poor credit and property purchases are risky. Lenders also add “points” to the loan, creating an additional expense for borrowers to cover.
Another disadvantage is that, unlike banks, raising private money won’t allow you to pay off a loan over 30 years. Instead, you can expect to be required to pay the loan back within six to twelve months, although some more-lenient lenders, especially those you may be related to, may give you a couple of years.
One more thing to remember: you will likely have to use the property as collateral for the money financed from a private money lender. Do your due diligence to ensure a deal’s framework (and potential) meets your criteria.
The good news is that these disadvantages do not hinder your real estate investment plans if you have done your research before pitching an investment deal. If you know the property is a good buy and are reasonably sure you can fix it up and sell it at a profit within a reasonable amount, the strict repayment time frame shouldn’t cause alarm.
How Do You Find Private Lenders?
It’s a big puzzle many new investors have: how to find a private lender that might be able to help them with the financing of their next project and securing low lending rates.
Several investors specialize in offering private loans to real estate buyers. You can find such investors through a variety of platforms:
- A simple Google.com search for “private money lenders (your city or state).”
- Your friend-and-family inner circle
- Tapping your existing real estate network (mortgage brokers are ideal for this)
- Social media (especially LinkedIn)
- Live events (especially those that would attract investors)
- Direct mail marketing
- Cold calling
- Public record search (look for “grantees” on mortgage paperwork)
Remember that private lenders don’t need to be professionals in the field; when you’re searching for ways to find a private lender, you want to locate somebody who wants a decent return on their money. For example, a parent, relative, colleague, or acquaintance who has cash on hand — and wants to turn a profit on it — may be willing to loan you the money you need to get started. These people in your “first circle” will have the lowest barrier to entry. You can even work with more than one lender if a single individual does not have enough cash to help you buy a property. The friends and colleagues of your “first circle” are considered part of your “second circle.”
What Are The Requirements For Securing A Private Loan?
Because private lenders are so diverse and no government regulations cover private money lending, the terms and conditions for securing a loan vary greatly. Close friends and family members may be willing to loan you money simply because you have a clear proposal for how to turn a profit and because they know and trust you. On the other hand, acquaintances and colleagues may want a note or deed of trust and a clear investment plan to consider a loan.
Professional private money lending companies and individual lenders will want proof of identity, a note, a deed of trust, and a written plan (budget) outlining the profit you expect to generate.
A professional private lender may also ask about your credit score. Poor credit may not hinder you from obtaining a loan but will likely affect the interest rate. A down payment for the loan is also likely required, and you may need to use the property as collateral to protect the lender if you aren’t able to pay off the loan.
Private Money Lender –It may require a credit report and a simple application.
Hard Money Lender – a company or broker that uses their funds/pool
or finds an individual private money lender may require a credit report
, or semi-institutional funds require a credit report and a 1003 application.
Combining Private Money
Taking private money from multiple investors and pooling it together is legal under the right conditions. Two main structures exist to help you stay squeaky clean and organized: REITs and LLCs.
REITs are liquid and can use pooled money to invest in many different areas of real estate. LLCs allow investors more control over what they want to choose to fund. Both structures have their pros and cons, so be sure to do your research and consult with an attorney if necessary.
How is credit score considered?
Most Private Lenders will ask to see a credit report. However, having bad credit will not stop the deal. The lender is looking for or is the overall credit score and judgments on the credit report. A low credit score will require a higher down payment and interest rate. If the deal looks good and is secured with a reasonable LTV, the private lender will usually fund the deal. It depends on the source of funds; an Individual is more flexible.
A managed poll may have more requirements and a credit limit. For example, they would not fund with a credit score below 630, a maximum LTV of 60%.
Institutional funds require a credit report with a minimum credit score, cash flow analysis (do you have income), an LTV of 80%, and an appraisal.
One essential item that will stop all loans is whether the borrower has judgments or tax liens or is currently in bankruptcy.
When trying to attract a private money lender, it can be very tempting to focus on “closing the deal” and think about all the excellent opportunities coming your way when you secure financing.
But it’s essential to think of it from the lender’s point of view.
As a private lender, you want to hear to ensure your investments are secure and you have a good chance of seeing a decent return on your money.
Understanding how raising private money works is just the first step. The real breakthrough comes when you “think” like an investor and present yourself as the answer to a question they hadn’t even asked. Do that consistently, and you won’t have to look for investors again; they’ll come looking for you.
Level 4 Funding LLC
Hard Money Lender
Hard Money Loans
Hard Money Loan
Arizona Tel: (623) 582-4444
Texas Tel: (512) 516-1177
Dennis Dahlberg Broker/RI/CEO
NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave | Austin | Texas | 78701
About the Author: Dennis has worked in the real estate industry for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the excellent investment opportunities trust deed investing and hard money loans provided. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have two beautiful daughters and five amazing grandchildren. Dennis has been an Arizona resident for the past 45 years.