How Private Money Lenders Are Different

Who are private money lenders, and how are they different from traditional banks and credit unions? Today, we examine the basics of private money loans and how they can help you compete with cash buyers, lower your cost of funds, and leverage your existing capital to take your business to the next level.

Private money lenders work differently from traditional banks and credit unions because they do different things. When you purchase a home to live in, you’re applying for mortgage products specifically designed for consumers. The term of the loan typically ranges from 15 to 30 years. The government regulates the process of origination, underwriting, and servicing to ensure that homeowners are protected from unscrupulous lenders and can sustain monthly mortgage payments in the long run.

The government also helps banks maintain liquidity by selling their consumer loans to government-backed institutions such as Fannie Mae and Freddie Mac. To sell to Fannie or Freddie, banks must comply with very specific loan criteria limiting the type of loans they offer. As a result, homebuyers enjoy low interest rates but are also saddled with the lengthy underwriting process, out-of-control paperwork, and limited financing options.

Private lenders fill out the vacuum left by conventional institutions. They work exclusively with real estate investors and typically lend only to LLCs or other business entities. Because of that, they are not constrained by the excess of government regulation the way traditional lenders are. At first glance, their goal is rather capitalistic: to help investors make money in real estate. However, by providing unparalleled leverage to small-time investors, private lenders play a key role in democratizing real estate investing and revitalizing neighborhoods.

Private Money Lenders Are Different Because They Are Asset-Based

We often say that if a deal makes sense, we will find a way to fund it.  A key determining factor is whether making money flipping a particular property is possible. If the answer is yes, you are more than halfway to being pre-approved. If the answer is no, even the most illustrious investor qualifications will unlikely sway our underwriters in approving your financing applications. In other words, private lenders are different because they focus on collateral (or asset) that secures their loan.

The better the collateral, the more borrower-related issues a lender can overlook. This is why your credit history, score, and income become less critical when working with a private lender than with a traditional lender.

Private lenders base their loans on the after-repair value of the property.

Unlike conventional lenders, private lenders base their loans on the after-repair value of the property. It’s a key difference between them and traditional lenders, who typically use the purchase price or the current market value to determine their loan amount. Basing the loan on the after-repair value allows private lenders to provide incredible leverage to their borrowers. A private loan could potentially cover 100% of your purchase price and even contribute to your renovation budget.

Private lenders finance distressed homes.

One of the main reasons real estate investors use private financing is because traditional lenders don’t lend on properties requiring renovations. Such homes are listed in MLS with disclosures such as “handyman special” and “sold as-is.” Without private financing, the only way to buy these homes would have been by paying cash, leaving these unique opportunities to wealthy investors only.

Private Money Lenders Offer Short-Term Loans

The terms offered by private money lenders are another significant difference. While consumer loans offer fifteen- or thirty-year terms, rehab loans are short-term. For example, our loans range from six to eighteen months, most coming due in a year. Essentially, they provide our borrowers with bridge financing from point A to point B. Point A is buying a dilapidated property sold at a discounted price. Point B is realizing a profit by selling the newly renovated property at market pricing.

Private Lenders set their own pricing to compensate for their risk.

Private lender are different in how they charge for their loans. Typically, their interest rates are independent of the rates on the financial market and not tied to any index. A private lender lending its own funds can charge any interest rate to compensate for its risk. In contrast, conventional lenders lend within tightly defined lending box and keep their rates low. Paying these high interest rates simply doesn’t make sense in the long run. However, in the short run, working with private lenders can help realize profits many borrowers could not have seen otherwise.

Private Money Lenders Work Closely With Their Borrowers For the Duration of the Loan

Here is another difference between private money lenders and their traditional counterparts. Once a bank originates a consumer loan, there is little need for further communication with the borrower – unless the borrower fails to make a mortgage payment. In contrast, your work with a private money lender does not stop at closing. In fact, much of your rehab’s success depends on how responsive, reliable, and proactive your private money lender is. We’ve been originating rehab loans in Maryland, Washington DC and Virginia for over ten years. With boots on the ground and local market expertise, our loans are created explicitly for investors doing business in our area.

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