Why would a real estate investor go with private money lenders?
Do you need to close on a real estate deal, but can’t get approved for a real estate loan? It can happen if you’ve got a bad credit history. Or is traditional financing too slow, and a conventional lender won’t speed up the process?
The easiest way for real estate investors to get commercial real estate financing might just be with private money lenders.
What is a Private Money Lender?
A private money lender is someone (or an organization) that real estate investors can go to for a loan that doesn’t come from a bank or a credit union.
Essentially, a private money loan is a lending that is given to an individual or company by a private organization or even a wealthy individual.
Because private money lending does not come through a traditional lender, it is not subject to the same regulations or requirements that you see with a conventional loan.
Individuals or companies which engage in private lending are often referred to as hard money lenders.
If a hard money lender knows what the borrower wants to use the money for—and that reason is a risky one—the interest rate may be higher if the lender feels there’s a higher chance of losing their investment.
A hard money loan often comes from a few independent investors who are looking for an investment return. They may be known in the local business community. If they are, then a house flipper will do well to speak with their business peers before signing anything.
As with any business transaction, if it looks and feels like it’s too good to be true, then it probably is.
Best Private Money Lender Options
Consider providers Lima One and Kiavi.
Lima One has options for short-term rental, fix ‘n flip, and new construction.
Get a short-term rental loan for up to 75% LTV on purchases and up to 70% LTV for cash-out refinance. But you must have 12 months of short-term income verification. The minimum FICO score they accept is 700. There are 5, 10, and 30-year options.
Get fixed rate, ARMs, fully amortizing, interest only, or balloon loans.
For fix ‘n flip or to finance new construction, get up to 90% LTC and 70% LTV. Get loans for up to $3 million, with 13, 19, and 24-month term options. These are for one to four-unit residential properties.
Kiavi offers fast closings and a variety of loan choices. These include fix ‘n flip, bridge lending, and rental loans.
With fix ‘n flip and bridge lending, get up to $1.5 million or up to 90% of the purchase price. They offer up to 75% of after-repair value. Kiavi has 12, 18, and 24-month terms with interest-only options. They will only do a soft credit pull.
For rental loans, they offer up to 75% LTV and no prepayment penalty after Year Three. You can get a 30-year fixed rate or an interest-only option. They also offer adjustable-rate mortgages.
Private Money Lender Rates, Terms & Qualifications
In May 2022, the average rate on a conventional 30-year fixed-rate mortgage was 5.09%, as per Freddie Mac. But hard money loans can have much higher interest rates, often 8 – 15%.
Hard money loans can be more expensive depending on the preferred loan-to-value (LTV) ratio of the lender. If a lender will only finance 70 – 80% (or less) of the property’s value, you’ll likely need to bring a sizable down payment to the closing table.
If you do not have the cash for this, then you might have a difficult time finding a hard money lender who will work with you. But this can also be an issue with more standard lending.
Repayment terms tend to be only a few years (most of the time, up to 24 months). Contrast this with a mortgage from a regular lending institution, which is often fifteen to thirty years long. But for house flipping, a lengthy loan is generally going to be overkill.
A national hard money lender will want a minimum credit score of at least 600. Depending on the project, some lenders will look at the project’s potential more closely than the borrower’s personal financial statement.
Private Money Lender Pros
Pro 1 – Bad Credit is No Problem
Private money loans are a great solution for a borrower with less-than-stellar credit. For a person looking for a flip loan to fix up real estate, private money loans can be the best option.
And the house flipper won’t have to take out any personal loans on the real estate. They may be able to avoid having to max out a credit card.
Working with a hard money lender who wants to sink funds into a real estate investment property means the borrower can go ahead and bring the rental property up to snuff so it can start to generate a profit.
Pro 2 – Easier Approval Process
Hard money loan requirements are laxer than those for a regular real estate loan. Underwriting is not as strict. Real estate investors provide private money loans based on the profitability of the real estate investment property.
Hard money lenders will provide, say, a bridge loan because they feel the real estate investment property has potential.
Even a house flipper with good credit can have issues getting more than a short-term loan. But the terms for a hard money loan can be better.
Pro 3 – Flexibility and Speed
If a house flipper has been recently approved for a hard money loan, then they have likely also been recently funded. An investor group isn’t waiting around to make sure their hard money loan will pass regulatory muster.
A real estate investing group is also less likely to put restrictions on a private loan. Or, at least, the private lender will add fewer restrictions. The investor doesn’t have to worry about SBA restrictions because the SBA isn’t involved.
Private Money Lender Cons
Con 1 – Risk
A private money loan can often bring with it risk—to both borrowers and hard money lenders alike. Because there is less regulation, borrowers might use a private money loan for purposes that don’t help the commercial property in question.
When a private money lender feels that borrowers are going to use the money for risky purposes, the lender might charge higher interest rates.
To avoid this issue, a borrower and the private money lender have to be on the same page.
Con 2 – Less Than Ideal Terms
Higher interest rates? Check. Shorter loan term? Check. Larger down payment amount? Check again.
A private investor knows that a borrower is coming to them because of a low credit score or some other reason they can’t get a standard construction loan. Even the kindest and most ethical private lender has the borrower over a barrel.
And for a private lender who isn’t so ethical, there is little to stop them from raising interest rates through the roof. Hard money lending is lucrative. A hard money lender can turn a profit on nearly any loan amount.
Con 3 – Experience is Often Necessary
A hard money loan often means the borrower has to be able to prove they have a history of successful house flips under their toolbelt. As a result, this is not likely to be a viable option for house flippers just getting started.
But a lot of more conventional options will shy away from startups, too. For both a bank and a private funding group, it’s all about mitigating risk. And startups—no matter which industry they are in—are notoriously high risk.
Is it Better to get Loans from Banks or from Private Money Lenders?
It depends on your circumstances and on the property.
If your personal FICO score is good, then more conventional lending—from a bank, a credit union, or the Small Business Administration—is possible. And even if your own credit is poor, if a partner is good, then you will still have more options.
For a house flipper who needs to act quickly or miss out on an opportunity, the SBA, banks, and credit unions are a poor choice, The Small Business Administration can take months from application to funding.
By that time, a house flipper could be halfway finished and just about ready to move on to their next project.
Bank lending will require less due diligence on the part of the borrower. Banks are highly regulated by the United States government and many of them are well-known. But that’s not the case with private hard money lenders.
A borrower will need to determine if a lender is trustworthy. They will also need to find out if there are any reasons why a deal would not go through or would be delayed.
Even the most ethical hard money lending groups can become overextended. If such a loan is delayed, then it defeats part of the purpose of getting this type of financing.
Private, hard money loans are out there. But the choices can be dizzying! Understanding what is best for your particular situation can take time. But if you’re a house flipper, you don’t have the time for that.
That’s where Credit Suite can really shine. Contact us today to learn more about how we can work with you to get the best financing to suit your unique needs. We know how hard money loans work.