What are private money lenders, and how are they different from 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.
To be a real estate investor, you need to have access to fast and easy accessible financing. Traditional lending institutions such as credit unions and banks fail to meet one-of-a-kind demands of investors focused on buying and rehabbing homes. Private lenders fill up this vacuum by offering types of financing that is specifically designed for renovating distressed properties.
Private loans are offered by firms referred to as private lenders or hard money lenders. They are privately-owned companies that raise their capital from other investors or have deep pockets of their own. Private loans should not be confused with subprime loans, loans that are specifically designed for high-risk borrowers in financial distress. Though private loans can accommodate those with dings on credit and no verifiable income, their purpose is different from subprime loans. They allow an investor to buy and rehab a property without overextending themselves financially.
If you have not worked with private capital before, here are three reasons to consider it:
1. Private loans finance residential and commercial properties that are in need of repair.
Few conventional lenders choose to finance such properties. They are simply not to set up to manage that risk and choose to focus on easier-to-service consumer business. Many sellers are aware that their property is way too gone to qualify for a traditional loan. This is why such homes are listed in MLS with the "Handyman Special" disclosure. Unless you have very deep pockets to buy it outright with cash, you will end up sitting on the sidelines twiddling your thumbs. But not with private money.
Being distressed is practically a pre-requisite for your property’s eligibility for private financing. Why? Because private lenders base their loans on the after-repair value of the property as opposed to its current purchase price. The after-repair value is the potential sales price of your home when you finish your restorations. It's determined by an accredited real estate appraisal firm that contrasts it with other rehabbed residential or commercial properties in your area. “The difference between the future after-repair value and its current price is what makes private lending work,” – says Kyle Sennott, the Managing Partner of New Funding Resources, a Maryland-based private lender. “The bigger your spread is, the more leverage we can offer you.”
2. Hard money loans have simplified underwriting criteria.
Hard money loans are typically described as collateral- or asset-based lending. Being asset-based means that the underwriting decision is primarily based on the borrower’s ability to complete the renovations and repay the lender on time – as opposed to the borrower’s ability to afford a 30-year mortgage. Though some private lenders choose not to work with borrowers whose credit scores are low, others underwrite holistically. They look at the overall strength of the transaction and take into consideration compensating factors.
3. With a hard money loan, you can settle in less than a week.
Sellers’ biggest fear is that a buyer would put their property under contract for a long time and then back out at the last moment. This is why they prefer to close as quickly as possible. Imagine you are a seller with two choices of buyers: an all-cash buyer that can close within ten days and a borrower applying for a Fannie Mae type of loan with a 45-day underwriting timeframe. Whom would you choose? The answer is pretty obvious. The benefit of the streamlined underwriting is not only that it might ignore damaged credit but that it takes days to close.
The purpose of hard money is to help real estate investors make a profit by providing a unique source of funds to buy, rehab and sell a property. It can benefit both newbies looking for ways to launch their real estate investing career and experienced investors looking for additional leverage to grow their business