For a real estate investor who needs quick access to capital or whose project does not fit into the narrow parameters of conventional lending institutions, private lenders can represent a viable alternative source of funding. In this post, we’ll discuss what private lending is and how it could help in your next real estate investment.
What Is Private Lending?
Private lending refers to funding from sources not defined by regulators as “public lending institutions” – which is how the federal government describes banks, mortgage companies, credit card companies, and other conventional sources of financing. In other words, a private lender is any individual or organization loaning money outside the traditional financial services industry.
How Does Private Lending Differ from Conventional Lending?
First, private loans are typically asset-backed. When you apply for a loan from a conventional lending institution, that lender will in most cases base its decision largely on your personal financial history.
A private lender, by contrast, will make its funding decision based primarily on the viability of the underlying asset. In the case of a real estate investment loan, the private lender will evaluate the market value of the property you are trying to acquire, determine how much equity you will have in the property after you’ve purchased it, and make projections about the property’s ongoing revenue potential.
This is why private lending is also often called “hard money lending” (although hard money lenders represent just a subset of the private lending industry). The term hard money does not refer to the level of difficulty in raising capital but rather to the fact that the loan will be secured by a hard asset such as a piece of real estate.
A second distinction between private and traditional lending is that private lenders offer shorter-term loans. Conventional lending institutions typically offer longer-term loans on real estate investment projects, such as 15- or 30-year mortgages.
Private lenders often structure their loans to be repaid after only a few years (or even as little as a few months). Although private loans often have higher monthly interest rates, many business borrowers – such as fix-and-flip property investors – opt for these loans because they plan to repay them quickly. Moreover, private lenders’ ability to fund loans in less time than conventional lenders can make these loans an attractive alternative for investors who need funding in a hurry.
Why Would an Investor Borrow from a Private Lender?
Under some traditional real estate investment scenarios, borrowing from a bank or mortgage firm might be the most logical option. But many real estate investment opportunities fall outside these narrow parameters. In such cases, an investor might need to seek a more creative and non-conventional funding source. Here are two reasons you might be better off with private lending.
1. Private lenders can usually fund your loan quickly.
Because they are not classified as public lending institutions by federal regulators who oversee the financial industry, private lenders are not subject to the same degree of red tape as banks or conventional mortgage companies. This regulatory red tape is often responsible for much of the delay between your application for a real estate business loan and the lenders’ ability to fund it.
As a result, private lenders are able to move much more quickly to process your loan, evaluate the underlying asset with which they’ll be securing the loan if they decide to green light it, and getting the funds to you.
When you need real estate funding quickly – to finance the next stage in a complex commercial property upgrade, for example: the speed of funding from a private lender could mean the difference between keeping your project on track or suffering a costly delay.
2. Private lenders focus more on the asset itself than your financial history.
Conventional lenders base much of their funding decisions on the personal backgrounds of borrowers, and they usually make those decisions according to an inflexible set of requirements for income history, assets, debt, credit scores, and other personal financial details.
This often means that if you do not have enough credit history or cannot show enough assets to satisfy a traditional lender’s underwriting team, you might not be able to secure the loan you need for your real estate investment project – even if the project itself is demonstrably viable.
This is where private lending can offer a helpful alternative. Private lenders do look for borrowers with strong credit scores and above-average financial histories. These organizations are lending their own money, after all, and want to minimize their risk as much as possible. But these private lenders also focus on the asset itself – specifically on whether the asset has enough inherent value to protect them against loss from default.
With this in mind, if you can demonstrate to a private lending company the viability of your proposed real estate project, you will often find that private lender willing to provide you the funding you need.
Learn More About Private Lending
If you are looking for real estate funding from a private lender in the Kansas City area, or if you’re interested in investing in a private-loan fund operated by a longtime leader in Kansas City commercial real estate, let us introduce you to Worcester Financial.