When real estate investors pursue funding, one of the last places they look to is private lenders. In fact, most investors often view private lending as a big no-no, or at least the very last stop on the road to real estate investing. But new regulations and restrictions from traditional financing have influenced a trend in recent years and months of savvy property investors changing their view of private lending. In fact, they are adopting it as part of their real estate investment strategy. In this blog post, we’ll dig into some of the ways private lending is and will shape the smart property investor’s strategies of the next few years.
Exhausted With Traditional Lenders
So the real question is, after years of push-back when it comes to private lending, why are property investors moving towards private institutions or individuals to fund their real estate projects? The answer to this question is fairly simple. In basic terms, investors are frankly tired of dealing with all the red tape involved with securing these funds. The reality is that private funds can be secured more easily and quickly because the negotiations and parameters are a lot less stringent than with traditional lending institutions.
New rules, like the 20% down for non-owner-occupied investment properties, the “5 Door Rule” that limits financing of investment properties to 5 doors, and the reduction of amortization to 25-30 years (versus 35+ years) are changing the investment game considerably. Most investors do not have a surplus of cash lying around, and most of us own at least 5 doors. So adhering to these rules … especially if investors are looking turn a profit quickly … requires privately acquired funds.
Understanding Private Lending and Borrowing
To be perfectly clear, it’s not a huge secret that private lenders operate on a different playing field than traditional banks and lending institutions. For instance, their source of funding is a bit different. Private lenders often accrue funds through relationships with private investors and other financial groups under the radar of major banks. Many private lenders get funding through a pool of mortgages. This is often referred to as a Mortgage Investment Company (MIC).
The other major difference between private and traditional lenders has to do with freedom from scrutiny. Private lenders’ funds are not insured, so they don’t have to follow strict regulations for how they award funds to certain borrowers. For some private lenders, one of the biggest factors for awarding investment money to a borrower is ensuring the property invested in can be sold quickly in the event that the investor or buyer gets into some financial trouble. This is often determined by the location and desirability of the given property.
But Why Should I Use a Private Lender?
The number one use of private funds in the property investment space is purchasing property for rehab purposes. A very close second in this category is securing second mortgages for minor rehabs or debt payoff to stop investors from re-financing. Any seasoned property investor is well aware that traditional lending institutions frown on second mortgages, at best. In most cases, they deny any applications for 2nd mortgages. Private lender funds can dramatically increase the odds of a 2nd mortgage approval.
Although interest rates on private loans are considerably higher (anywhere from 9 to 15% depending on the investment risk to the lender) and you’ll be responsible for additional lender, mortgage broker and legal fees, private lending is a very good short term solution that can get you unstuck, solve financing cul de sac, and help you move forward with your rehab project or refinancing, whichever the case may be..
If you are exploring the private lending route, you will need to come to the negotiation table prepared so you can get the most out of the borrowing process. Tread lightly and carefully when you sign a contract. Since private lenders do not have stringent regulations to follow, there is a higher margin for error on their part. Have every document reviewed by an attorney or legal professional. In other words, as with any business transaction, know what you’re getting into before you proceed. It will save you a lot of frustration in the long run.