Whether you’re thinking about buying a new home, starting a new business, or investing in real estate, financing is an important consideration. For the vast majority of Americans, that means turning to a bank or other conventional lender. However, those are not your only options. Private lenders also exist and may be a preferable choice in many instances.
Not sure what private lenders are, what they do, or even why they exist? In this guide, we’ll explore what you need to know to understand their role and even decide whether you’d be better off working with a private lender than with a big-name bank.
What Is a Private Lender?
We’ll start with the most obvious question – what’s a private lender? It’s a pretty broad term that applies to a wide range of funding providers on the market. Technically, any non-institutional lender (not a bank or credit union) can be considered a private lender. In addition to financial organizations, private lenders can also be:
- Direct lenders
- Mortgage brokers
- Mortgage companies
- Online lenders
- P2P lending networks
Why Do Private Lenders Exist?
In a world where there’s a major bank on every corner and every city and town has one or two credit unions, it’s natural to wonder why private lenders exist. What purpose do they serve? When there are already plenty of lending options out there, why do we need yet another? Private lenders bring a lot to the table, and there are some very compelling reasons for their existence.
The Great Recession changed a great deal about the American financial landscape, including ushering in new lending rules and regulations to stave off another subprime mortgage meltdown. The knock-on effect here, though, was that it ultimately put millions of Americans out of the running for home loans they would have previously qualified for, at least with big banks and credit unions.
Private lenders, because they are non-institutional lenders and therefore not bound by the same rules and limitations as big banks, make things easier. They offer easier qualification requirements, ensuring that even would-be borrowers with low or no credit can access financial tools suited to their plans and goals.
A Wider Range of Products
Banks and credit unions offer a very limited range of loan products. They must limit their risk exposure and only cater to the very middle of mainstream America. The problem here is that there is no “mainstream” any longer. More and more, borrowers have unique needs and requirements that are not met by big banks and other institutional lenders.
Private lenders can offer a much broader range of financial products, including various home mortgage packages, a combination of interest rate and APR options, business financing solutions, and a great deal more. This includes things like bridge loans, which make it possible for homeowners to buy a second home while still waiting on their old home to sell, and hard money loans.
Real estate investors also find that private lenders offer them access to the liquid capital they need when banks and other lenders would balk at the prospect. For instance, house flippers and renovators often work with private lenders. They are more comfortable with a nontraditional loan format than what a bank would accommodate.
Think about it this way – would a bank agree to a home mortgage that would typically come with a 30-year term and require a very high credit score and a significant down payment to a renovation professional with little money down and no intention of living in the home? In most cases, the answer would be no. However, that doesn’t alleviate the need for that renovation pro to get access to capital to fund the repairs and upgrades necessary to fix the home and put it back on the market. Private lenders can offer a viable solution here.
Many private lenders are not single organizations or individuals, but groups of people looking for a return on a modest investment. By pooling their funds together, they can help fund projects as wide-ranging as home flipping and multi-family housing construction, and then reap financial rewards when those projects are completed. For individual lenders and institutional lenders, the risks in these situations are simply too high.
Conventional lenders, despite what common sense might dictate, are risk-averse. Anything that lies outside their comfort zone (which means it might impinge on their return) is simply too risky, so they stick to conventional lending with well-defined parameters, even though those products increasingly don’t fit the needs of borrowers.
Private lending platforms, particularly online lenders, but also P2P networks, help to mitigate risk, bring together individuals who would otherwise be unable to invest their capital, and provide funding solutions to people and companies who would not otherwise be able to achieve their goals and make their dreams a reality.
Shorter Repayment Period
All loans must be repaid, but institutional lenders are rigidly focused on long-term repayment periods. For instance, a 15 or 30-year mortgage falls under their purview. However, what if you want to pay the loan off in five years? What if you intend to pay it off in just a single year? In many cases, big lenders simply don’t support shorter repayment periods.
Of course, this often means that private lenders are not ideally suited for borrowers looking for a long-term investment. For instance, if you’re interested in purchasing your first home and you intend to remain in that home for 10 years or longer, a conventional home mortgage is probably going to be the best option for you.
However, things change if you need something with a shorter duration. Think about it this way:
You’ve lived in your home for some time and built up around 30% equity. Your family has grown, and your needs have changed, and you decide it’s time to look for a new place to live. You’re stuck between a rock and a hard place, though. How do you buy a new home without selling your old one? Do you arrange for temporary housing during the interim and essentially move twice? It’s not a very comfortable position to find yourself in, but a private lender can help.
In this situation, a bridge loan gives you the ability to buy a new home with the equity that you’ve built up in your current home. Working with a private lender, you could leverage that equity, make a down payment and pay for closing costs on a new home, and then wait until your old home sells to pay off the loan. In most cases, bridge loans are made for just six months to a year, and institutional lenders generally don’t offer them because of that limited duration.
If you have ever applied for a conventional loan, you know that “labyrinthine” is probably the best word to describe the amount of paperwork you need to provide. There are documents on top of documents. Some papers need to be sent to this person, while others must go to this person. You need tax information, proof of income, and more, often stretching back many years. Just gathering the information that the lender requests can take weeks. And, even once you think you’re done, the chances are good that the lender is going to ask for yet more, or maybe also ask for additional information that supports data you have already provided.
It’s enough to make anyone want to throw up their hands and quit in disgust. You can be an eternal renter, right? Who wants to own a home anyway!
Private lenders require minimal paperwork. Often, particularly in asset-based lending, there is next to no paperwork necessary. You need documentation on the asset, a loan application, and a few supporting forms, but that’s it. Compare that to the exhausting process involved with regular lenders, and you begin to see why so many people are choosing to work with private lending options today.
A Viable Alternative
Perhaps the single most important reason that private lenders exist, and the foundation of everything we’ve touched on so far, is this: private lenders exist to offer a viable alternative to stick in the mud banks and traditional lenders. Increasingly, institutional lenders simply are unable to meet the needs of borrowers.
Private lenders, on the other hand, are flexible and forward-thinking and able to offer innovative solutions to pressing capital needs. This is true whether it is financing the purchase of a home while you’re still waiting to sell your current one, start your dream business, flip real estate, or something else entirely.
Types of Private Lenders
We’ve touched on it a time or two so far, but the topic of private lender types must be explored in greater length to help you understand these options.
P2P platforms, or peer-to-peer, if you prefer, are becoming more and more common today. Many of these operate online, but quite a few can be found in the offline world, as well. Essentially, these programs allow individual investors with relatively little money to pool their capital and offer it to those in need. You might need a loan to renovate your home, to open a business, or for something else. These platforms connect you with the funding you need, and your payments go to increase the return of the investors providing the capital. Note that P2P platforms generally charge a fee to both the borrower and the lender, which is how they cover things like administrative costs, advertising, and the like.
If you are a business owner and have unpaid invoices, but need capital to build a stronger company, then invoice factoring might be the right way to go. In this situation, businesses without an extensive credit history can gain access to liquid capital and only pay a small amount for the opportunity.
If you have an established business, then a merchant advance (or merchant cash advance, if you prefer) may help you obtain the capital you need. Merchant advances are typically made against a percentage of your future debit and credit card sales and will cost you a little bit in the long run. However, that’s often a small price to pay for a lump sum now. Note that in many cases, merchant advances also come with additional fees, so make sure to read the fine print before signing on with a private lender. Due diligence is your best friend and will help minimize your costs.
Often, institutional lenders lack any sort of understanding when it comes to industry-specific requirements. For instance, trucking companies have needs that vary dramatically from retail stores, but big banks attempt to serve them both with the same financing options. Many private lenders are capable of offering financing packages that suit industry specifics to ensure that you’re able to deal with elements unique to your market segment.
As an example, a private lender might be able to offer a trucking company financing options that allowed them to pay drivers, for fuel, to cover insurance, and the like, while still providing flexibility for logistics industry net billing.
Private Real Estate Loans
Many private lenders deal specifically with real estate. Some work with both residential and commercial real estate buyers/sellers, but others specialize in one or the other. Private real estate lenders base their offerings on hard assets – real estate in this case – and can deliver flexible terms, much shorter loan terms than what you’ll find with traditional lenders. They’ll also have higher loan amounts than what some lenders may be comfortable offering.
How to Choose the Right Private Lender
Private lenders can offer some serious benefits, but they are not all the same. You must make an informed decision here. Not sure how to choose the right private lender for your needs? The following guidance will help.
- Consider Credibility: How credible is the lender? Are they trustworthy? Do past clients support the company’s claims? How well established are they? What kind of history do they have? Make sure that any lender you’re considering has a good reputation and plenty of satisfied clients.
- Lending Flexibility: One of the most common reasons to go with a private lender rather than a traditional bank or credit union is for access to flexible lending options. Make sure that you’re getting those. Scrutinize the terms and conditions. Ask questions about anything that you don’t understand. If there is a lack of flexibility, or the lender cannot or will not answer your questions, consider choosing a different one.
- Industry Expertise/Specialization: If you’re seeking funding for a business, make sure that the private lender has at least some experience in the industry. This is particularly true for industries that don’t conform to the norm, such as logistics/trucking. The more familiar the lender is with your industry, the better the terms will be, and the more applicable the financial products will be to your actual needs.
- Check the Fees: All private lenders will charge fees on top of the interest on your loan, but not all of them will charge the same fees. Even those that assess similar fees may not charge the same amount. Make sure you ask about any fees that aren’t listed on the lending documentation. Add up the fees and charges so that you know exactly how much you’ll be paying for your loan.
- Pay Attention to Points and Interest Rates: You’ll find that points are common with private lending. You also need to pay close attention to the interest rate and the APR that you’re being offered. Basic financial know-how will put you in good stead here, but don’t be afraid to ask questions if you’re not sure how everything works and what you’ll ultimately be paying in the end.
- Scrutinize the Terms: Every loan comes with a contract that you must sign. This stipulates the terms of the loan agreement. Yes, the contract will most likely be written in legalese, but you must read it. This is where unscrupulous lenders will hide things that they don’t want you to know about that will increase your costs or put things more in the lender’s favor. If you do not understand something in the contract, ask for clarification, and don’t settle for anything less than clarity.
The lending industry is vast and far more complicated than many people realize. It is only becoming more complex over time, too. While conventional lenders might have offered plenty of benefits many years ago, that’s not the case today. In fact, for a growing number of private and business borrowers, institutional lenders simply no longer work. Instead, private lenders offer innovative new products, reduced repayment times, flexibility found nowhere else, and many other advantages. From real estate to business loans, private lenders can help you fund your dreams.