Real estate financing is a complicated thing. That’s true whether you’re an aspiring homeowner, want to fix and flip properties, or are looking for financing to purchase a place for your business to call home. Throw in additional factors like a couple of blemishes on your credit history, the need to finance quickly, or the desire to negotiate repayment schedules, and things become even more difficult. The good news is that private money loans can help simplify and streamline the situation.
What are private money loans? Who needs them? How do they benefit you? These are just a few of the questions you’ll need to answer before deciding on a particular path to financing.
What’s a Private Money Loan?
You might be more familiar with private money loans by the name hard money loans. Where institutional lenders and faceless corporations offer conventional loans, private money loans come from private lenders. Unlike conventional loans, which are offered based on your ability to repay debt and your credit history, private money loans are offered based on the value of your collateral – the real estate you intend to purchase with the loan.
The Drawbacks of Conventional Loans
Conventional loans, whether for the purchase of a private residence or a business or for use in fixing and flipping homes, are problematic for many reasons.
Perfect Borrower: First, to qualify for a conventional loan, you must be an almost perfect borrower. You need lots of positive credit history. You need few or no financial missteps in your past. You need lots of proof of income and steady employment.
These days, perfect borrowers are fewer and farther between than ever before. And, as more people strike out on their own to start companies or take advantage of the gig economy to quit the 9-to-5 grind, those numbers dwindle even more. Of course, institutional lenders are slow to react to these seismic changes. The upshot is that today, fewer people than ever before qualify for conventional loans.
Slow: Another drawback to conventional loans is their speed. Well, the lack thereof. It takes 30 days at a minimum to get a conventional loan approved, and that’s only if you’re a perfect borrower with all of your paperwork ready and no hidden issues lurking in your credit history.
The truth is that, for most borrowers, it can take much longer than 30 days to get a conventional loan, if they are approved in the first place. That can have some pretty dramatic repercussions. For instance, it’s not uncommon for homebuyers to find that their dream home gets snatched up by another buyer while they wait for loan approval. Investors miss out on prime opportunities, and business owners lose choice locations for their companies.
How Do Private Money Loans Differ?
Now that we’ve looked at the shortcomings of conventional loans, how do private money loans differ? Some key facets set these apart from other options.
Speed: As mentioned, it can take over 30 days to secure a conventional mortgage loan with an institutional lender. That’s a long time to wait, not knowing if something is going to go wrong with either the loan or with the property deal. With private money loans, the situation is different.
Often, these loans can be completed in just 14 days, sometimes even less than a week. So, for borrowers with a need to move quickly, private money loans are the better option. It’s all about getting your financing squared away so you can move forward on your timetable.
Availability: Conventional lenders are risk-averse. If you’re not a perfect borrower, you’re largely out of luck. That makes them rather unavailable to many people.
Private money loans, on the other hand, are available to just about anyone. That’s because these lenders focus not so much on the borrower and their credit history, but more on the value of the property being purchased. That property will be used as collateral, as long as it can be sold quickly in the event of a borrower defaulting, lenders are more willing to make these loans available.
Flexibility: With a conventional mortgage, the terms are pretty inflexible. You abide by the lender’s requirements, and there’s little leeway for anything else. It’s an attempt to create a one-size-fits-all lending tool.
Each situation is different, so trying to force every borrower into the same mold is akin to hammering a square peg into a round hole. That doesn’t stop lenders from trying, but it does reduce the value and utility of their financing options. In contrast, private money loans are made on an individual basis, which leaves lots of room for flexibility, including the possibility of adjusting things like your repayment schedule.
As you can see, there are several critical differences between conventional loans and private money loans. Those differences play directly into the benefits offered by the loans, and the advantages they offer to various types of borrowers.
The Biggest Difference
The single largest difference between private money loans and conventional loans is that they are based on collateral, not your credit. The value of your collateral is more important to the lender than your financial situation or your credit history. Of course, that doesn’t mean that the lender will overlook an inability to repay. You’ll be required to submit a repayment plan that details how you’ll achieve that. However, it does mean that if you’ve got a black mark or two on your credit, they won’t automatically disqualify you.
Another big difference here is the length. In most cases, private money loans are designed to be repaid in as little as 12 months, but some can last five years or so. A few lenders even offer 15 or 30-year terms, although the interest in these instances would be considerable, and most borrowers will try to pay the loan off as quickly as possible.
Who Benefits from Private Money Loans?
While we’ve discussed some of the ways that private money loans differ from conventional loans, it can be a little hard to connect the dots in terms of who benefits from these loans and how those benefits are realized. Let’s take a closer look at several different types of borrowers who may find that private money loans are the better option.
Homebuyers
Some homebuyers will find that conventional loans are right for them. However, that’s not true for everyone. This is particularly true for buyers who need a way to buy a home while waiting for their current property to sell.
In this situation, a bridge loan can provide the financing necessary to buy a new home. Then, the proceeds from the current property can be used to pay off the bridge loan and refinance into a conventional loan once it sells. Another example here is a homebuyer in a very competitive real estate market who finds a home they love but is concerned about another buyer swooping in and buying it out from under them.
Because private money loans can be completed in as little as 14 days (often as few as just five days), there is less concern about cash-bearing competitors taking your dream home.
Business Owners
Dreaming of finally taking that leap and starting your own company? Perhaps you’ve been operating a business for some time, and now you’re ready to expand. Whatever the case, it means you need to consider commercial real estate.
Commercial real estate deals are never simple and rarely straightforward. There are just so many potential complications. For instance, perhaps you haven’t been able to keep your personal finances separate from your business finances.
As an owner/operator or a sole proprietor, the two can mix without tax issues. Still, it does mean that lenders must consider your personal creditworthiness and not just your business’s financial history. Or, it could be that your business is new, and it hasn’t had a chance to establish any type of credit history.
Neither of these situations lends itself well to being approved for a loan to purchase commercial real estate. Like residential mortgage lenders, commercial real estate lenders insist on perfect borrowers, lengthy (positive) credit histories, and more. However, private money loans can offer the traction you need to build a thriving, successful business.
Fix-and-Flip
One of the more common uses for private money loans is to fix and flip real estate. These financial tools are well-suited for this purpose and for flippers. They’re also far more beneficial for flippers than conventional loans would be.
In most cases, conventional lenders don’t want to work with flippers. A couple of reasons exist for this. One is that flippers don’t fit into the lenders’ “ideal borrower” mindset. Their needs also differ from what conventional lenders can offer.
With a conventional loan, lenders make money over decades as borrowers pay interest. Flippers, on the other hand, only own their property for a very short period. They buy distressed properties, or homes in need of some TLC, make the necessary improvements, and then sell for a profit, often in just a matter of months.
Private money lenders charge higher interest rates, which means they can see a return on their investment more quickly than conventional lenders. There’s also the fact that these loans are, by nature short-lived, often designed for just 12 months or even less. Flippers can get the loan they require, buy and repair the property, sell it for a profit, pay off the loan, and then move on to the next home.
Real Estate Investors
You don’t need to be a home flipper to benefit from private money loans. Real estate investors of all types can see advantages here. Buy-and-hold strategies, investors who need to make upgrades to their existing properties, and others will find that private lending is a viable solution.
Real estate investors often struggle to find financing that fits their needs. Again, this is largely because conventional lenders just haven’t evolved with the times. Their offerings are geared for long-term, slow returns and don’t fit well in a world where investors can pay the loan off very quickly.
Short-Term Borrowers of All Types
As mentioned, conventional loans are designed to deliver a return over a long period. Borrowers who want to pay off the loan sooner will find that lenders don’t want to take a chance on them because of that. For instance, perhaps you intend to pay off the loan in five years, or maybe you want to pay it off in just a single year? Whether you are going to sell investments, have a windfall headed your way, are going to inherit a significant sum, or plan to pay off your loan in some other way, private money loans are the better option here.
Pros and Cons of Private Money Loans
While private money loans are very beneficial for many types of borrowers, they are not right for everyone. You must make an informed, accurate decision regarding your financing, which requires that you have a good understanding of the pros and cons offered by private money loans.
Pros
- Tied to the Property: As mentioned, hard money loans are tied to the value of the collateral (the real estate being purchased). That means fewer requirements for borrowers, and if something goes wrong and you can’t pay the loan off, the lender will sell the real estate to satisfy the debt.
- Fast and Flexible: Private money loans are fast – with approval in 14 days on average, but sometimes they can be fast-tracked with approval in as little as five days. They’re also very flexible because they don’t go through the standard underwriting process, which empowers you and allows a custom solution suited to your unique needs.
- Your Credit Doesn’t Matter: Because the loan is tied directly to the property in question, your credit history and score matter less than in a conventional lending situation. That’s good news for homebuyers, business owners, fix and flippers, and real estate investors of all types.
- Well–Suited for Many Borrowers: You’ll find that private money loans are well-suited for a very wide range of borrowing needs. Their flexibility and ease of customization mean that whether you’re interested in real estate as a buy-and-hold investment, want to fix and flip, or just need a way to ensure that you’re able to get your dream home without having to worry about contingency offers or someone sneaking in with all cash, private money loans deliver the capabilities that matter most.
Cons
- Cost: Private money loans are more expensive than conventional loans. That’s not a big deal unless you need to extend the loan beyond its normal limits. For instance, you’ll find low-end interest rates for these loans hovering just under 9%, which is pretty high when compared to what’s offered with something like a conventional 30-year fixed-rate mortgage. Does that mean it’s not right for you? Not at all! It simply means that you need to ensure you’re using these tools for their particular purpose.
- Origination Fees: You’ll typically be on the hook for at least a couple of points in the form of origination fees. Depending on the lender, it could be as much as four points. These should be factored into the overall cost of the loan.
- LTV: In most cases, you’ll find that private money lenders keep the LTV pretty low. Some lenders require LTVs as low as 50%. However, some forward-thinking companies can offer LTVs of 70%, or even higher depending on the situation, such as ARV-based and participation loans.
- Down Payment: All private lenders will require at least some down payment. However, the amount required will vary from loan to loan, and from lender to lender. Some lenders may also be willing to accept additional collateral instead of cash as a down payment.
- Finding the Right Lender: Perhaps the single most challenging factor is finding the right private lender. They are far from being identical, and your choice will have wide-ranging ramifications on the entire process.
Is a Private Money Loan Right for You?
While private money loans offer many compelling benefits, they’re not right for all situations. Moreover, you’ll find that some private lenders are innovative and transparent, while others should be avoided. If you’re unsure whether a private money loan is the right path for you, we invite you to contact us at Pacific Private Money Inc. for an in-depth consultation. We would be happy to explore your options and help you determine whether private lending is a good fit or if a conventional loan would be better suited.
Why Choose Pacific Private Money?
At Pacific Private Money Inc., we work with a very wide range of clients to offer flexible, customized private money loans. From owner-occupied loans like bridge loans and refinance loans to construction, commercial, and non-owner occupied acquisition and rehab loans, we deliver innovative financial products designed for today’s borrowers.
From single-family homes to apartments, small commercial properties to residential developments, we have worked with clients large and small throughout California to help them achieve their goals and dreams. We can do the same for you.