Pros and cons of private money lending

private money loan

Private money lending occurs when a wealthy individual or private organization lends money to a person or business. Private money lending is common in real estate investments. Private money lenders lend money to investors who buy and, often, renovate properties for resale or rental. Private money lending is less regulated and more flexible than lending from licensed lenders such as banks. A financial advisor can help you decide if a private loan makes sense for you.

Basics of private money lending

The distinguishing feature of private money lending is that the money for the loan is provided by an individual or a private organization. Often the lender is a family member or friend of the borrower. When the private money lender is an organization, it is not a bank or other licensed lending organization.

Private money lending isn’t subject to the same regulations that govern other lenders, but the business isn’t completely unregulated. Private money lenders must follow state usury laws that limit the amount of interest that can be charged. They may also be limited in the number of loans they can make.

Interest rates on private money loans tend to be higher than loans from licensed lenders. 15% to 20% is typical. However, in the case of a loan from a friend or relative, they can even be below market rates. Private money loan payments can be interest-only for the life of the loan, with one large payment at the end.

Qualifying for a private cash loan is different from qualifying for a regular loan. The lender is likely to focus as much on whether a specific deal makes financial sense as it does on the credit history or score of the borrower.

The terms on private cash loans are often short, just six to 12 months, but they can also be paid for up to five years. They generally require a down payment and are often secured by the property. The lender will typically require a written plan outlining how the money will be spent.

Private money lending is similar to real money lending. Both are often used in real estate investing and involve obtaining finance from somewhere other than a bank. Hard money lending, however, is more like traditional lending, such as from a bank, and less like financing friends and family via private money lending. It may be more difficult to qualify for a cash loan.

Advantages of private money loan

private money loan

private money loan

Private money loans are more flexible than traditional financing. Borrower qualification guidelines are fewer and less stringent, especially when the lenders are friends or family. A key difference is that private lenders are more likely than others to be willing to finance the acquisition of distressed properties in need of significant repairs. This allows cash-strapped investors to buy low-priced properties and pay for renovations that increase the value of the properties.

The flexibility of the private money loan also makes it faster. A borrower can get the money to make a deal in a matter of days, rather than waiting several weeks to get financed by a conventional mortgage.

Cons of private money lending

Private money lending also carries additional risk for both the borrower and the lender. Private lenders are at greater risk due to their less stringent qualification guidelines. To offset the added risk, private money lenders charge higher interest rates than other lenders. This can make it more difficult for borrowers to turn a profit on deals. Also, because loans are typically short-term, a borrower must be able to sell or refinance the property relatively quickly, before the loan matures.

It can be more difficult for borrowers to find private lenders, as they may not advertise like more established banks and lenders. Talking to friends and family is one way to find loan sources. Borrowers may be able to identify other potential private lenders through professional networks, social media such as LinkedIn, internet searches, and real estate investing events.

Bottom line

private money loan

private money loan

Private money lenders are individuals and organizations that provide money to investors, usually for real estate loans. Private money lending is less regulated but more expensive than other sources of lending, such as banks. Many private money loans come from friends and family, but organizations can also be private money lenders.

Tips for borrowing money

  • Talking about your financing plans with a financial advisor can increase the chances that you will make the best decision. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you reach your financial goals, get started now.

  • Any type of loan can be tricky, especially if it’s a loan that you personally guarantee, and if you don’t pay it off in full or on time, then there’s a chance you’re hurting your chances of borrowing more in the future. It is important to understand as much as possible about personal loans before proceeding with the private money loan.

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The post How Private Money Lending Works first appeared on the SmartAsset Blog.

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