Private lending is a financing strategy for investors looking for ways to purchase real estate – however, private money lending can also be an investing strategy itself for those who have money to invest and want it backed by the security and stability of real estate.
Private lending is an opportunity to put funds that you have available to good use and achieve rates of return much higher than you can achieve through other means such as savings accounts, money market accounts or certificates of deposits. You also benefit from having the backing of an asset that is traditionally much more stability than stocks or bonds. It is not unusual to negotiate rates of return that are 3-10% higher than the rates charged by conventional lenders – something many borrowers are willing to pay for in lieu of the strict lending rules of traditional financial institutions.
As a private lender, you are in essence, playing the role the bank takes in conventional real estate financing. As a private lender though, you have significantly more flexibility in the terms and conditions you place on the borrower.
Greater Flexibility with Private Lending
Where traditional banks have very stringent controls and criteria on deciding whether to lend funds, you can negotiate and structure lending terms with the borrower in ways that make sense for you as the lender and the borrower. This allows you and the borrower flexibility that larger financial institutions just don’t have available to them. This might include:
- Amount of funds – from small amounts used for down payments, earnest money deposits, rehab and construction loans all the way to fully funding the purchase of a property.
- Length of loan period – private lenders usually keep terms relatively short compared to conventional institutions, but this might vary from a few weeks up to a few years.
- Interest rate paid, but usually several percentage points higher than traditional funding.
- Fees associated with a loan – whether there is an upfront fee, or fees for extending the length of the term, etc.
- Repayment approach, which might be regularly monthly payments, periodic payments at key intervals, or receiving all interest at the end of the loan period.
They key here is negotiating terms that are acceptable to both the borrower and lender.
Where Do You Find Private Lenders?
Private lenders, in the context we are describing, are individual lenders funding other individuals or small groups of investors. Private Lenders can be family members or friends, but for the professional real estate investor, they are usually found through investing relationships, business associations, real estate investing groups, or organization memberships.
While “Hard Money” lending is considered by many to be a form of private lending – and hard money lenders may describe themselves as such – that’s not the type of lending we’re referring to here. Hard money lenders have their place but are typically business entities that are more stringent in their lending models.
As a lender, you are concerned with the rate of return you’ll receive for lending funds, the risk associated with how your funds will be used, and when you’ll receive the return of your loaned funds. When providing the services of a private lender, you do not have an equity position in the deal so you won’t benefit from the profit the investor may earn, but you also will not take the risk of potential downside of the investment.
The Private Lender Perspective
As a private lender you are most concerned about the investment and payback strategy of the borrower – you are lending based on your confidence that the borrower will be able to pay you back based on how their investment works out. You will want to understand all you can about the deal and the likelihood that the borrower will have success with the deal and will be able to return your principal to you. What the private lender is not focused on is the personal credit worthiness of the borrower and ability to repay based on such things as the borrows personal income, their employment status, and their other outstanding credit.
As the private lender it is important that you have something from the borrower to backup and secure the funding you are providing. This will usually be a mortgage or lien on the property so if the borrow defaults you can take possession of the property, some other form of collateral pledge to cover your loan such as other real estate, or another asset of value that can be transferred to you. You should also ensure that you properly create contracts, agreements, ensure proper title and recording of the lien with the appropriate county records departments.
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