Diving into Private Money Lending: A Comprehensive Guide
Private money lending has become an increasingly popular alternative financing option for real estate investors and developers. This guide provides a comprehensive overview of what private money lending is, how it works, its benefits and risks, and tips for both borrowers and lenders navigating this form of financing.
What is Private Money Lending?
The Basics
Private money lending refers to financing provided to real estate investors or developers by private individuals rather than banks or mortgage lenders. The loans are typically short-term, high-interest, and based on the value of the underlying property rather than the borrower’s credit rating.
The borrowers are usually investors who intend to renovate and quickly resell or “flip” properties for a profit. They may also be builders or developers engaged in rehabbing, new construction, or other real estate projects.
Compared to Hard Money Loans
Private money loans are often confused with hard money loans offered by companies specialising in real estate lending. While hard money loans are also asset-based, short-term financings, private money comes directly from individuals instead of lending companies.
Many borrowers start with private funding from people they know before turning to hard money loans, which generally have stricter qualifications.
How Does Private Lending Work?
Sourcing Deals and Financing
Borrowers seeking private money will usually start with people in their networks. That may include friends, family members, business associates or even acquaintances willing to earn higher returns backing real estate deals.
If more financing is needed, brokers can match borrowers with private lenders looking to invest. Attorneys, accountants, real estate agents and others with networks of high net-worth individuals may also be able to make introductions.
Structuring the Loan
Standard loan terms include 6 to 36 months, with interest rates generally from 8% to 15%. Loans may require a lump sum payment when they are due, instalments before the due date, or payments dependent on the timing of selling the property.
Collateral and recourse requirements vary. Generally, the property is collateral, but lenders may also require additional assets as security or employ devices like personal guarantees.
Closing and Managing the Loan
Once financing terms are agreed upon, attorneys are typically engaged to handle loan documentation and closings. Payouts may occur in instalments tied to project benchmarks rather than issuing funds in one lump sum.
Throughout the loan, borrowers usually update lenders on the project’s progress. Some lenders may also visit sites for inspections and ensure work is progressing according to plan.
Benefits and Risks
Why Seek Private Money Loans?
For borrowers, private money loans provide quick access to financing that banks would likely need to match, given their credit policies and lengthy application processes. Approvals are based on the real estate opportunity rather than personal credit or employment history.
The application and underwriting process is also much faster with individuals. Deals needing speed to capital can close within days, enabling borrowers to capitalise on opportunities swiftly before they are gone.
What are the Risks Involved?
While private lending can be a beneficial channel for securing deals, there are notable risks to consider. Without the standardisation and oversight banking institutions provide, loan terms and lender expectations can vary dramatically. Doing due diligence is vital.
It’s also critical for borrowers to make realistic assessments about whether their experience levels match the complexity of deals they are attempting, and they must retain enough operating reserves. Cost overruns or delays can quickly create problems in making interest payments to lenders.
For lenders considering funding deals, risks centre around borrowers needing to evaluate deals or complete projects properly. Unless lenders closely monitor funded projects, they may discover issues too late. Ultimately, adequate analysis or execution by borrowers can ensure the recoverability of the principal.
Tips for Borrowers and Lenders
If You are Seeking Private Funding:
- Vet deals thoroughly and is conservative in projections
- Only seek what you realistically need
- Check references and track records of potential lenders
- Involve attorneys early and document everything clearly
- Maintain regular project updates for lenders
If You are Considering Lending Privately:
- Stick to short terms until borrowers establish track records
- Engage attorneys to review deals before finalising anything
- Fund in stages based on progress benchmarks
- Complete site visits routinely during projects
- Get personal guarantees as allowable in your state
Using private money loans and lending strategies wisely can create win-win partnerships. However, best practices around evaluation and documentation are vital for ensuring positive outcomes for both borrowers and lenders. Do your diligence before diving in.
