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.
How 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?
Private money lending, as the name implies, means borrowing money from an individual investor. Real estate investors use private lenders to finance deals that either won’t qualify for a traditional loan or can’t wait the usual 30 days or so that a conventional mortgage loan needs for approval.
How Does Private Money Lending Differ From Hard Money Lending?
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). A good 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 conventional financing does, hard money lenders are semi-institutional and do have their own set of established criteria. Both types of lending should be part of an investor’s financing toolbox.
What Are The Advantages Of Private Money Lending?
As Nasdaq accurately points out, private loans are particularly ideal for investors who want to buy a property that needs a lot of repairs. Conventional financial institutions often refuse to grant mortgage loans for properties that have been vandalized or seriously damaged somehow. On the other hand, private investors see the potential in a property that can be purchased cheaply, fixed for a reasonable price, and then resold for a tidy profit.
Additionally, a private money lender 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 can be granted relatively fast, whereas a loan from a conventional lender may not be approved for up to 45 days.
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What Are The Disadvantages Of Private Money Lending?
There are a few disadvantages to obtaining private loans. The first is that private lenders most often charge a higher interest rate than the average bank loan. Private lending rates hover around 15%; however, you may be required to pay up to 20%. This is particularly true if you have poor credit and/or the purchase of the property is risky in some way. 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 a 30-year period. 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 keep in mind: you will most likely have to use the property as collateral for the money financed from a private money lender. This means doing your due diligence to ensure a deal’s framework (and potential) meets your criteria.
The good news is these disadvantages do not pose a hindrance to 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 of time, the strict repayment time frame shouldn’t cause alarm.
How Do You Find Private Lenders?
It’s a big conundrum 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 private lending rates.
Several investors specialize in offering private loans to real estate buyers. You can find such investors through a variety of platforms:
- Tapping your existing real estate network (mortgage brokers are ideal for this)
- Social media (especially LinkedIn)
- Live events (especially those that would attract investors)
- Your friend-and-family inner circle
- A simple Google search for “private money lenders”
- Direct mail marketing
- Cold calling
- Public record search (look for “grantees” on mortgage paperwork)
Bear in mind that private lenders don’t need to be professionals in the field; you want, when you’re searching for ways to find a private lender, to locate somebody who wants a decent return on their money. 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 that are 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 a great deal. 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. Acquaintances and colleagues, on the other hand, may want a note or deed of trust in addition to 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 outlining how the money will be spent and 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 have a bearing on 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.
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 a higher degree of control over what they want to put their money into. Both structures have their pros and cons, so be sure to do your research and consult with an attorney if necessary.
It can be very tempting when in the process of trying to attract a private money lender to focus on “closing the deal” and think about all the wonderful opportunities that will come your way when you secure financing.
But it’s important to think of it from the lender’s point of view. If you were dipping your toe into private money lending, what would you want to hear to ensure your investments were secure and you had 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 yet. Do that consistently, and you won’t have to go looking for investors again; they’ll come looking for you.
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