If you’re in the real estate investment industry, there will come a point where you’ll realize that obtaining financing is one of the most challenging and overwhelming aspects of real estate investing. Getting approved for funding from traditional bank lenders is far from the easiest thing to do especially if you’re on a tight project deadline as is often the case for fix-and-flip loans for properties in particular. It becomes even harder to acquire capital when you are a property flipper since the property you want to purchase will typically need to be revamped and traditional banks are notorious for rejecting applications for funds for old, worn-out houses.Â
This is in large part why real estate investors of all experience levels have been migrating towards private money lending in recent years due to the numerous advantages that this financing route has over traditional lenders. Still, it should be noted that private money lending is not a one-size-fits-all affair. You need to be proactive and do your homework to learn the ins-and-outs of private lending companies, what terms and conditions best fit your particular real estate portfolio and the lenders servicing your area.
Private money is a form of finance that is sourced from an entity that is not a traditional banking or financial organization. Private money can be comprised of funds from your family, or from individuals or entities that you have no previous affiliations with. In the latter scenario, in which the financing is being sourced from private organizations, the capital is termed ‘hard money lenders‘ and differs slightly from private money lending.
You can find out more about hard money lending in the video below:
Private money lending is premised mainly on establishing and maintaining relationships compared to other traditional loans. That’s not to say that private lenders still don’t require a solid project proposal to agree to extend you any amount of money upfront. When it comes to private loans, the interest rate ranges between 8-12%, which is considerably higher than the rate typically associated with conventional mortgages. This is attributable to the inherently higher risk profile associated with this financing option. But private lending offers other advantages that make it an ideal choice for many real estate investment projects. All you need to do is contact professional private lenders for real estate.
What Are Some Different Types of Private Money?
Private money refers to funding solutions provided by private individuals or organizations, rather than traditional financial institutions like banks or credit unions. There are several types of private money sources, each with its own characteristics and purposes:
Hard Money Loans: Hard money loans are short-term loans secured by real estate. They typically offer more flexible loan terms than traditional lending institutions and are provided by private investors or companies. They are often used by real estate investors who need quick financing or who may not qualify for traditional mortgages due to credit issues or property conditions. Types of hard money loans include construction loans, bridge loans and fix and flip loans.
Private Equity: Private equity involves investing in privately held companies or assets. Private equity funds pool money from investors and use it to acquire or invest in businesses, often with the goal of improving operations, increasing profitability, and eventually selling the company for a profit.
Private Debt: Private debt encompasses various types of loans and debt instruments provided by private lenders. This can include direct lending to companies, mezzanine financing, distressed debt investing, and other forms of private credit.
Peer-to-Peer Lending: Peer-to-peer lending platforms connect individual borrowers with individual lenders, cutting out traditional financial institutions. Borrowers can access funding for personal loans, small business loans, or other purposes, while lenders can earn returns by funding loans.
Crowdfunding: Crowdfunding platforms allow individuals to raise funds for projects or ventures by soliciting small contributions from a large number of people, often via the internet. This can include equity crowdfunding, where investors receive ownership stakes in the project or company, or reward-based crowdfunding, where contributors receive non-equity rewards or products in exchange for their support.
Family and Friends: Many entrepreneurs and small business owners rely on loans or investments from family members and friends to fund their ventures. While this can provide access to capital without the need for formal applications or approvals, it’s important to carefully consider the potential impact on personal relationships and to formalize the arrangement with clear terms and documentation.
These are just a few examples of the different types of private money sources available. Each type of private money has its own risk-return profile, investment criteria, and regulatory considerations, so it’s important to carefully evaluate your options and consult with financial professionals as needed.
If you are just starting out in the real estate investment sector, you may experience some initial confusion regarding what category of financing you should utilize, whether it be a conventional loan, private money, cash, or hard money. The following is a brief overview of the two main instances where you should consider private money lending as a potential financing option.
You Need Financing…NOW
One of the primary advantages of private money lenders is the faster approval process compared to traditional financing options. To illustrate, in order to obtain approval for a conventional loan, you will usually have to wait for up to 45 days, and even then, there is no guaranty that you will be approved at the end of this waiting period.
Banks and financial institutions impose strict regulations when it comes to what projects and individuals it can offer funding to. Houses that are in relatively poor condition, such as those typically targeted by real estate investors looking to fix and flip, usually don’t have a favorable financing approval rate from banks. Flipping an investment property is inherently a very time-sensitive affair, and you will need funding as quickly as possible in order to get a favorable return on investment.
If you are entertaining the idea of buying and holding a property, you will still require efficient funding. A property that is priced to sell will not linger on the market for long and a house purchased at a reduced price point will produce optimal cash flow down the road. That’s where private money lending comes in. it can take as little as three minutes to get pre-qualified and then it typically only takes a matter of days to get funding. That is the big reason why private money is considered the best option for many investors.
Your Credit Score is Sub-Optimal
It could be that you are in no particular rush to obtain funding. Still, the credit score is one of the most decisive factors banks take into account when considering a loan application. Alternatively, private money lending organizations prioritize the quality of the deals you propose as opposed to your credit score when deciding whether or not to approve your application. Put simply, if they believe that they can make a solid profit from the deal you have in mind, then they will offer you the cash you requested.
Private money lending is a viable option for real estate investors to get streamlined financing with the least amount of red tape involved. It can make all the difference between sealing the deal and you walking away with empty hands.
FAQ
Applying for a hard money loan typically involves several steps:
Research Lenders: Start by researching potential lenders in your area or online. Look for lenders who specialize in the type of property you're interested in and who have a good reputation.Â
Gather Documents: Gather Documents: Hard money lenders do not require the extensive documentation that traditional lenders do but you'll still need to provide some basic information. This may include financial documentation such as proof of income, financial statements, tax returns, debt to income ratio and information about the property you're using as collateral.Â
Loan Application: Once you've chosen a lender, you'll need to submit an application. This may be done online or in person, depending on the lender's preferences. Be prepared to provide detailed information about yourself, your financial situation, and the property you're borrowing against.Â
Property Evaluation: The lender will evaluate the property to determine its potential return and ensure that it's suitable collateral for the real estate loan. This may involve an appraisal or inspection.Â
Approval Process: If the lender decides to move forward with your application, they'll typically provide you with a loan agreement outlining the terms and conditions. Review this carefully to make sure you understand the interest rate, repayment terms, and any fees associated with the loan.Â
Closing: Once you've accepted the loan offer, you'll need to sign the necessary paperwork to finalize the loan. This may involve working with a title company or attorney to ensure that the transaction is legally binding.Â
Receive Funds: After closing, a lender like Express Capital Financing will provide you with the access to funds. Depending on the lender and the specifics of your loan, this may happen relatively quickly or take a few days.
Obtaining private financing, whether through hard money loans, private equity, or other sources, entails various costs beyond just the principal amount borrowed. Understanding these costs is essential for borrowers to make informed decisions about their financing options.
Â
One significant cost associated with private financing is interest rates. Private lenders typically charge higher interest rates compared to traditional banks, reflecting the increased risk they take on by lending to borrowers who may not qualify for conventional loans. Interest rates for private financing can vary widely depending on factors such as the borrower's creditworthiness, the type of loan, and prevailing market conditions.
Â
In addition to interest rates, borrowers may also incur origination fees or points when obtaining private financing. These fees, which are typically calculated as a percentage of the loan amount, cover the administrative costs associated with processing the loan. Origination fees can range from 1% to 5% or more of the loan amount and are paid upfront at the time of closing.
Â
Private mortgages may also involve closing costs, which include various fees and expenses associated with finalizing the loan transaction. Closing costs can include appraisal fees, title insurance, attorney fees, and recording fees, among others. These costs can add up and should be carefully reviewed and negotiated as part of the loan agreement.
Â
Furthermore, individual investors should be aware of prepayment penalties that may apply if they repay the loan before the end of the loan term. Prepayment penalties are designed to compensate the lender for lost interest payments and can significantly impact the overall cost of borrowing. Borrowers should carefully consider whether the benefits of early repayment outweigh the costs of prepayment penalties.
Â
Finally, borrowers should factor in the opportunity cost of using private financing compared to other sources of funding. While private financing may provide access to capital that would otherwise be unavailable, it often comes with higher costs and stricter terms. Borrowers should weigh the costs and benefits of private financing against alternative financing options to ensure they choose the most cost-effective solution for their needs.
Private money lending, including hard money lending, can offer lucrative opportunities for investors, but it also comes with potential risks:
Default Risk: One of the primary risks of private money lending is the risk of borrower default. If the borrower fails to adhere to their repay,emnt schedule, the lender may incur financial losses, including the loss of the principal amount lent. Hard money loans generally involve a shorter repayment period so it's always worth bearing this in mind when considering your investment strategy.
Collateral Risk: Private money loans are a type of asset based lending often secured by collateral, such as real estate. However, if the value of the collateral decreases significantly or if it's difficult to liquidate, the lender may not be able to recoup their investment in the event of default.
Market Risk: Private money lenders are exposed to market risks, including fluctuations in property values and interest rates. A downturn in the real estate market or an increase in interest rates could impact the value of the collateral and the borrower's ability to repay the loan.
Regulatory Risk: Private lending is subject to regulations at the state and federal levels. Lenders must comply with laws governing lending practices, interest rates, disclosures, and licensing requirements. Failure to comply with these regulations could result in legal and financial consequences.
Operational Risk: Private money lending involves various operational risks, including underwriting errors, documentation errors, and fraud. Lenders must have robust processes and controls in place to mitigate these risks and ensure compliance with regulatory requirements.
Liquidity Risk: Private money loans are typically illiquid investments, meaning they cannot be easily bought or sold on the open market. If the lender needs to access funds quickly, they may face challenges in liquidating their loan portfolio.
Credit Risk: Private money lenders must assess the creditworthiness of borrowers to determine their likelihood of repaying the loan. However, assessing credit risk can be challenging, particularly for borrowers with limited credit history or financial difficulties.
Reputation Risk: Lenders may also face reputation risk if they are associated with predatory lending practices or if borrowers perceive them as unfair or exploitative. Maintaining a positive reputation is essential for attracting borrowers and investors.
Overall, while private money lending can offer attractive returns, it's important to carefully evaluate and manage the risks associated with these investments. Conducting thorough due diligence, diversifying the loan portfolio, and implementing risk management strategies can help mitigate potential losses.
To help with all of these questions and more, we've put together this handy guide on evaluating fix and flip properties.