A Real Estate Investor's Introduction To Private Money Loans
A private money loan, often referred to as a “hard money” loan, is a real estate loan made by private individuals or groups of investors. Unlike banks and other conventional lenders, private money lenders are primarily interested in the value of the property being used as collateral and put much less emphasis on a borrower’s credit report and debt-to-income ratio. This approach gives private money lenders the flexibility to fund loans that conventional lenders might deem too risky to approve.
Experienced investors often rely on private money to acquire investment properties in hot markets or to get funding for unique properties other lenders won’t touch, but private money loans are not for everyone. Because of the increased risk involved for the lender, real estate loans made with private money are often more expensive than loans available through conventional financial institutions both in terms of interest rates and fees charged. In addition, private money lenders typically only lend a maximum of 65-70% on the most desirable properties, and even less on special use properties or properties located in rural areas.
Even with these limitations private money loans can be an important part of an investor’s real estate strategy due to several positive features, including the following:
- Speed and Simplicity: Private money loans generally require less paperwork and fewer verifications resulting in a much simpler and faster process than conventional financing. This can be especially important in situations where time is of the essence such as investors who are trying to close an important purchase, or property owners who have a looming balloon payment or other large cash deadline coming due in the near future.
- Flexibility: Because private money loans are based almost exclusively on the value of the loan’s collateral, private money lenders are more open to lending to borrowers with poor credit, or on peculiar properties that conventional lenders shy away from. Private money lenders also have multiple loan term options to choose from and, in some cases, may be open to negotiating their fees and interest rates.
- Bridging Gaps: Private money loans are short-term loans which work well for borrowers who need some breathing room while they work through the process of obtaining conventional financing for their projects or to increase a property’s value and then sell (fix and flip) it. The shorter terms often allow borrowers to pay off their private money loans without costly pre-payment penalties or exit fees once their conventional financing comes through. Another private money loan product, interest-only loans, can keep an investor’s payments lower while they acquire, improve, and sell an investment property.
Private money loans are not the right solution for every loan scenario, but they are an important tool that should be considered by every real estate investor. Used as part of the right investment strategy, private money loans can help enhance an investor’s real estate portfolio to reach their overall financial goals.