Private loans are loans offered to real estate investors who buy and rehabilitate dilapidated properties. Private loans should not be confused with subprime loans – loans that cater to consumers in difficult financial circumstances. Private lenders have significant underwriting flexibility because, unlike traditional banks, credit unions, and mortgage companies, they do not work with consumers. Consumer loans are regulated to protect consumers and often have limits on their pricing and structure. The government regulates consumer mortgages to promote and protect home ownership. Private lenders lend to businesses whose goal is to make money by repairing and turning over homes. For this reason, they can offer loans on terms that make sense to both the lender and the borrower.
If you are a real estate investor trying to decide if private loans are right for you, you should keep these seven things in mind:
1. Private loans are a unique type of financing used specifically for distressed properties.
Private lenders finance residential or commercial properties that regular lenders don’t hit with a ten foot post. In MLS, these properties are easily identified by the information they contain: “Cash only”, “Special for investors” or “No bank financing”. Regular mortgage providers are unprepared for the risk of dealing with ongoing drug rehabs and choose not to fund such transactions. Unless you have a lot of money to buy such a house in cash, without private financing, you will be out of luck. “Private finance democratizes real estate investment,” says Anastasia Sennott, partner of New Funding Resources, a private lender in Washington, DC.
2. Private financing provides access to unprecedented leverage.
Private lenders structure their loans in a very different way than you might be used to. Instead of using the current value of the house you are buying, they base it on its future value. This value – commonly referred to as the after repair or ARV value – is, in theory, significantly higher than the current troubled price. The ARV-based loan provides borrowers with more money to buy and renovate the property than a loan based on its distressed current price.
3. Simplified underwriting is another advantage of private loans.
Private lenders are often referred to as asset lenders. Their primary concern is to make sure that the transaction they are financing makes sense. They want to see that their borrowers will generate profits by fixing and reversing the property. This is why many private lenders are not so concerned about the income or credit history of their customers.
4. Private loans offer unprecedented closing speed.
Another benefit of easy underwriting is that with private loans, you can close as quickly as any cash buyer. It’s common for a private lender to close within two weeks, but they can also speed up their process and get you to the closing table within days.
5. Not everyone is eligible for a private loan.
Private loans finance the lion’s share of what is needed to repair and remodel a home. Still, that doesn’t mean that you can start buying real estate without having your own capital. By lending on a residential or commercial structure in poor condition, private lenders take a significant risk. To manage this risk, their preference is to deal with clients with a proven track record of success, as evidenced by the level of their savings as well as their willingness to use this savings. By putting in some of their hard-earned money, real estate investors prove that they are committed to the purchase and that they are willing to share its risks with their lender.
6. Private lenders charge higher rates and fees.
Private loans are more expensive than regular financing. Typically, their rates vary between 9% and 14% per year. These rates reimburse lenders for the risk they take. For example, if a borrower does not rehabilitate their home, a private lender could end up with a loan that exceeds its current value.
7. Private loans are short term.
As soon as you are done with your renovations, there is no reason to continue paying the higher rates charged by a private lender. Contrary to what one might think, private lenders are not particularly inclined to hold your loan for too long either. That is why the duration of private money usually does not exceed about a year. The majority of private loans are repaid through the sale of the property. However, some borrowers prefer to keep their newly renovated homes for rent. In their case, they refinance their loan with a traditional lender.