The Benefits of Private Money Loans
The question often arises as to why borrowers would borrow private money on real estate transactions. The immediate assumption is that these are high-risk ventures and the borrowers don’t have the credit-worthiness that would allow them to borrow from regular and conventional sources. There are, in fact, a wide variety of factors that determine whether or not a borrower would be a candidate for a private money loan. Let’s look at several more common reasons below:
Banks and conventional financial institutions typically take much longer than private money lenders to close a time-sensitive loan due to strict regulatory oversight over conventional banks and lending institutions.
Private money lenders can be more creative with complex loan situations. They can offer options like cross-collateralization of other properties, or offer more flexible terms than traditional lenders. The property may also have issues that make it difficult for conventional lenders to finance, such as the need for improvements to increase the occupancy of a building, or partially completed construction, etc. Additionally, traditional lenders will not lend on raw or un-entitled land due to their strict underwriting guidelines.
Traditional lenders require substantially more documentation than private money lenders and have more stringent loan committee processes. When time is of the essence, traditional lenders typically cannot meet the demands of the borrowers.
Loan and Market Conditions
In essence, private money lenders are equity based, and the most important component of the loan funding is the evaluation of the real estate. A borrower’s past history and level of commitment plays a part in determining the viability of the loan but is not as paramount to the decision-making process.
Reduction of Equity Participation
Borrowers may also consider private money for a portion of the traditional equity component of a project. Equity investors require a preferred rate of interest, normally around 10 percent (10%), plus a share of profit of up to 60 percent (60%). This makes private loans an economical alternative for a portion of the equity component.
The circumstances a borrower faces are not just limited to credit problems or a past or current bankruptcy, as is often assumed. There may be tax liens or other liens that need to be paid, or the property may be held up in probate, or involved in a divorce or other family situation. There may be unemployment or a medical emergency. The list is endless but the principle is basically the same; private money lenders lend on the value of the asset first, and the strength of the borrower second. Ultimately, the decision resides with an experienced underwriter to evaluate the “whole story” when evaluating a potential borrower. Private money is used by a wide variety of borrowers ranging from very high net worth individuals to sophisticated real estate investors and developers, all of whom prefer the speed and the simplicity of completing the loan process to borrowers who have limited choices for finance or need flexibility.
Just as the benefits of a private money loan for borrowers are extensive, the benefits for investors are equally compelling. With access to conservative first trust deed investments, investors are able to diversify their portfolios while minimizing their risk. Many opportunistic investors looking for residual income are taking advantage of the current economic climate and partnering with ethical and reputable lenders that will educate them on the benefits of first trust deed investments.
As you can see, despite having a higher rate than a conventional loan, there are many different reasons why a borrower would choose to borrow private money. However, every real estate transaction is different and has its own story, so it’s extremely important for borrowers to find an experienced lender that can guide them through what can be an intimidating process. Although real estate values are expected to climb in 2011, many opportunities still exist on the market for investors to take advantage of. So whether you prefer a conventional or private money loan, don’t miss out on this great time to invest.
Sacha Ferrandi is a licensed Real Estate Broker with the California Department of Real Estate, a licensed Mortgage Loan Originator with the Nationwide Mortgage Licensing System and a partner at Source Capital Funding, Inc., a leading lender that specializes in the underwriting and funding of residential and commercial real estate loans. For more information please visit, www.source-capital.com. Sacha can be contacted at (858) 705-6144, or via email at firstname.lastname@example.org.