private money lending

Private Money Lending: How It Works & How To Become A Lender

real estate business real estate financing real estate investing strategies real estate terms Jan 02, 2024

Private money lending emerges as a compelling proposition to diversifying investors' portfolios.

In this guide, we'll unpack everything from the basics of what private money lending is, strategies on how to structure a private money loan, to intricate details on becoming a private lender or even founding a private lending company:

Diversifying one's approach to real estate is undeniably a cornerstone of sustainable wealth-building. Investing in real estate is often seen as one of the safest and smartest strategies to amplify wealth. But once profits start rolling in, the dilemma arises: how can one maximize these earnings further? Read on to find out!

*Before we begin our guide on private money lending, we invite you to view our video on How To Get Into Real Estate With No Money!

Host and CEO of Real Estate Skills, Alex Martinez, provides the perfect guide for beginners to utilize private money loans, hard money loans, and more. If you're an investor who needs capital, this video is a must-watch!

What Is Private Money Lending? 

Private money lending represents an innovative alternative to traditional lending avenues such as banks and larger financial institutions. Instead of borrowing from these entities, one turns to individuals or private organizations. This might be a close acquaintance, a family member, or a specialized private lending firm.

what is private money lending

In real estate investing, traditional financing options like banks, government agencies, and pension funds were once the mainstays. But these came with their own set of stringent requirements, often out of step with the dynamic needs of the modern real estate investor. This mismatch birthed the need for nimble, alternative lending channels. 

Private money lending offers flexibility in terms of lending criteria, but it also introduces an element of personalization. Qualification for such loans often hinges as much on the feasibility of the deal in question as it does on the borrower's financial standing.

It's crucial to remember that private money lending is not a free-for-all. While it isn't shackled by the same regulations as conventional lenders, it isn't entirely unfettered. State usury laws, for instance, cap the interest rates private lenders can charge. And while these rates can often surpass those of traditional lenders, they're balanced by the shorter terms of private money loans, usually ranging between six months to five years.

For potential borrowers, it's vital to approach this avenue with both eyes open. Understand that while freedom and flexibility are undeniable advantages, there's a heightened risk inherent to these deals, especially given the high-interest rates and shorter loan durations.

But, when done right, private money lending can unlock unparalleled growth and profitability in the real estate sector. Whether you're a seasoned real estate pro or just getting started, private money loans, distinct from their close relative, hard money loans, present an avenue well worth exploring. As always, ensure that you're making well-informed decisions, weighing the risks and rewards in equal measure.

Thinking about investing in real estate? Join Alex Martinez at his FREE training to learn how to get started with house flipping and wholesaling!

How Does Private Money Lending Work In Real Estate?

Private money lenders play a pivotal role by providing bridge loans, anchored by the real estate asset itself as collateral. These specialized loans empower investors to diversify their portfolios, enabling the acquisition of multifamily units, single-family homes, condominiums, mobile homes, vacant land, and more.

The unique facet of private money lending is its interpersonal nature. Often, the lender might be a trusted friend or mentor, making this mode of financing deeply rooted in existing relationships. As such, it's no surprise that private money lenders are frequently termed “relationship-based lenders.”

A common misconception is equating private money lenders solely with hard money lenders. While there's an intersection, they aren't synonymous. Hard money lenders, though part of the broader private lending ecosystem, operate with a more institutional approach, bringing a structured framework to their lending practices.

On the other hand, private money lenders often emerge from personal circles, encompassing real estate mentors, acquaintances, family members, and other contacts within one's professional network with ample capital to invest.

To clarify, hard money lenders fall under the umbrella of private money lending, but the converse isn't always true.

So, why might an investor gravitate towards hard money rather than private funding? The allure lies in the transparency and consistency of hard money loans. Their interest rates, associated fees, loan terms, and costs tend to be more predictable and standardized, making them appealing to certain investors.

Hard money loans shine particularly when it comes to purchasing investment properties and covering renovation expenses. Additionally, they sometimes cater to long-term investors seeking a buy-and-hold strategy.

Read Also: 11 Ways To Invest In Real Estate With No Money

Types Of Private Money Lenders In Real Estate

Private money lenders emerge in distinct tiers based on their relationship proximity to the borrower:

  • Inner Circle: This includes close friends and immediate family members, who often have a strong personal bond with the borrower.

  • Extended Circle: Here, we find personal and professional acquaintances, spanning from distant relatives to coworkers and professional peers.

  • External Circle: Predominantly composed of accredited hard money lenders and institutional investors, this group is less personally connected to the borrower but brings a structured lending approach.

Private money lending caters to real estate investors who either don't fit the mold for traditional financing or prefer to bypass the often tedious and prolonged approval processes associated with conventional mortgages.

Read Also: Real Estate Financing: The 6 Best Funding Options For Investors

How Are Private Money Loans Structured For Real Estate Investments?

When you first start real estate investing, you quickly discover the versatility in the structuring of private money loans. These loans are tailor-made to fit various sectors within the real estate market, such as multi-family properties, single-family residences, commercial real estate, and non-owner-occupied rehab ventures.

Frequently, these lenders operate as niche entities, heavily relying on referrals and the power of word-of-mouth to grow their business. This can make the initial hunt for the perfect private lender somewhat daunting. Thus, it's essential for investors to embark on comprehensive research to pinpoint a lender aligning with their real estate investment goals.

Diving into the diverse structure of private money loans, here are some prevalent formats:

  1. Full-Spectrum Funding: The loan covers between 50%-100% of both the property acquisition and the associated rehab costs.

  2. Acquisition Only: Designed solely to finance property purchases without considering additional costs.

  3. Straightforward Interest: These loans shoulder all costs, with a clear-cut interest rate, free from complexities.

  4. All-Inclusive Loans with Deferred Interests: Not only does the loan handle all expenses, including holding and closing charges, but it also grants the privilege to defer interest settlements until the property's eventual sale.

  5. Profit-Sharing Structures: Here, the loan covers all necessary costs. However, the lender earns through both periodic interest payments and a share in the eventual profits post-sale.

To navigate the intricate avenues of real estate finance, always grasp the nuances of your prospective private money loan's structure. This understanding empowers you to evaluate its suitability for your investment needs.

Read Also: How to Start & Grow A Real Estate Business In 12 Steps 

Hard Money Lenders Vs. Private Money Lenders in Real Estate

At first glance, hard money and private money lenders may seem interchangeable in the realm of real estate financing. In essence, while private money sources emerge from more personal, less traditional avenues, hard money lenders bring a more structured and regulated approach to real estate financing.

  • Private Money Lenders: Typically, these are individuals keen on allocating their capital to promising investments. They channel their funds to support real estate transactions, making them an asset for investors needing swift financial solutions for time-sensitive deals. Since private money can stem from a varied mix of sources like friends, family members, business associates, or other close contacts, the loan conditions tend to be more adaptable. Often, the interest rates offered by private lenders can be more attractive and lower than their hard money counterparts.
  • Hard Money Lenders: These are structured, often semi-institutional entities, specializing in providing short-term, high-interest loans. They cater to investors seeking funding for property acquisitions and renovation expenses. A defining trait of hard money lenders is their requirement to be licensed, ensuring they adhere to industry regulations when issuing loans.

Read Also: 9 Best Hard Money Lenders For Beginners & First-Time Investors 

How To Get Private Lending For Real Estate

Your first time getting a private money loan can often feel like you're navigating a labyrinth, especially when searching for the right options for your real estate business.

how to get a private money loan

Here are 5 steps to successfully secure a private money loan for your real estate endeavors:

  1. Educate Yourself On Real Estate Finance: First, familiarize yourself with key concepts, terminologies, and the distinction between private and hard money lenders. Recognize that private lenders are typically individuals or entities independent of banking institutions, seeking promising ventures to fund. Their decisions might be based on both the project's appeal and the investor's rapport.

  2. Network With Real Estate Professionals: Engage with real estate agents, attorneys, fellow investors, and title companies. Often, word-of-mouth referrals within your professional circle can lead to promising private lenders. Outside of the real estate industry, reach out to friends, family, and acquaintances. They might be potential lenders or connect you with someone seeking investment opportunities.

  3. Create A Presentable Portfolio: Design a compelling presentation encapsulating your past real estate achievements, including images, financial outcomes, and project details. Clearly convey your real estate vision, your strategy, and the potential returns on investment. Familiarize yourself with the private lending process and be prepared with necessary documents like promissory notes and insurance.

  4. Find The Right Lender: Your search for private money lenders can begin at real estate investor clubs, seminars, or in online forums dedicated to real estate discussions. You can also leverage online directories that catalog lenders based on location, loan type, and other specific criteria. Finally engage with local real estate agents, brokers, and other professionals who may have insights into reputable private lenders in your vicinity. Understand their loan conditions, interest rates, repayment timelines, and potential fees. Ensure that their criteria align with your project's nature, whether it's based on current property value or after-repair valuation.

  5. Create & Present Your Pitch: Approach potential lenders with a dual focus—educate them about the project and establish trust. Address their primary concerns, such as profit splits, risks involved, and repayment assurances. And finally, avoid rushing; a well-thought-out pitch can significantly influence a lender's decision.

What Do Private Money Lenders Look For?

Before issuing a loan, private money lenders take several factors into account.

One of the most important factors is the property value. Remember that in real estate, borrowers tend to use the property types they want to invest in as collateral.

Private money lenders also consider the plan their borrower has for the property. A well-thought-out plan will increase one's chances of getting the loan approved. For instance, a borrower may plan on renovating a property or even renting for passive income property.

Other key factors may include the proposed amount of the loan, the property’s neighborhood, and future value in the market. For answers to specific financial questions, be sure to review the FAQ section below!

Read Also: How Does Seller Financing Work In Real Estate?

How To Become A Private Money Lender

Becoming a private money lender involves a degree of risk and requires due diligence and understanding.

how to be a private money lender

Here’s a concise guide to setting yourself up as a private money lender:

  1. Educate Yourself: Understand the nuances of private money lending. The promise of predictable returns and the security of having property as collateral can be enticing, but it’s vital to be informed about the potential risks involved. The more knowledgeable you are, the better equipped you'll be to navigate the challenges.

  2. Risk Management: In the world of private lending, there's always the potential for things to go awry, such as borrowers defaulting. To safeguard your investments, prioritize partnering with reliable investors. Seek referrals, examine their track records, and study previous deal outcomes. A trustworthy investor is your best defense against potential risks.

  3. Stay Organized: Efficient organization is key. Develop systematic procedures and maintain meticulous documentation. This not only streamlines your lending process but also ensures that you’re well-prepared for any eventualities. Always perform thorough due diligence before funding any deal and consider lending in smaller tranches to manage risk better.

  4. Legal and Regulatory Compliance: Consult with legal professionals to establish your company structure and understand any pertinent regulations, including usury laws. It’s essential to operate within the legal framework to avoid potential pitfalls.

  5. Determine Your Niche: Decide on your lending focus, whether it's residential, commercial, or a specific type of property. This allows you to concentrate your efforts and become an expert in that particular domain.

  6. Network: Joining a peer-to-peer lending platform or a related network can be a great way to connect with potential borrowers and other investors. This broadens your opportunities and keeps you in the loop about prevailing market trends.

  7. Evaluate Investments Carefully: Before committing to any deal, analyze the potential returns against the associated risks. Make informed decisions based on thorough research and financial analysis.

Becoming a private money lender requires foresight, prudence, and expertise. While it’s an avenue worth exploring for many, it’s also crucial to approach it with a comprehensive understanding and the right support systems in place.

How To Make Money As A Private Money Lender

Private money lending stands out as a dynamic platform in the investment landscape, offering myriad strategies for lenders seeking profitable returns.

Here's a strategic breakdown to maximize profit in the realm of private money lending:

  • Joint Ventures: Within the spectrum of loan strategies, diving into profit-sharing models emerges as a leading avenue for substantial returns. By collaborating in a joint venture, you, as the lender, can harness a percentage of the final profits, contingent on the specifics of your investment agreement. Confidence in the project's potential is vital to ensure loan approval and, eventually, the fruition of your investment.

  • Exit Fees: Integrating exit fees is a crafty private money lending strategy to guarantee returns once the loan tenure concludes. Often, this fee, expressed as a percentage of the investment's quantum, can be adjusted based on the loan's repayment dynamics. For instance, prolonging the repayment might escalate the exit fee, serving as a mechanism for risk mitigation and timely repayments.

  • Interest Payments: A staple in the lending domain, interest payments remain a cornerstone in private money lending. The privilege to set an interest rate during the loan's inception translates to consistent and profitable returns. The often-elevated interest rates associated with private money loans further amplify this earning potential.

  • Points System: Points, representing loan percentages, can be a lender's boon. Extracting points as upfront fees while offering reduced interest rates can be a win-win, fostering trust and ensuring immediate profits. The gesture of offering points often expedites loan approval, underlining the borrower's commitment.

Read Also: How To Invest In Real Estate: 10 Best Ways To Start Building Wealth

Benefits Of Private Money Lending

There are several reasons to use private money lenders for real estate investing. Here are the major benefits of using private money lenders when investing in real estate:

  • Quick Approval: A good real estate deal won’t wait for you to get money. Unlike traditional lending institutions, private lenders approve loan applications faster. That means you can have the financing you need to lock in a real estate deal within days.

  • Minimal Security Requirement: To get a loan from a bank, you have to collect, sign, and submit documents making this process tedious. Private money lenders on the other hand know how critical time is when it comes to executing an effective deal. Therefore, they just need a trust deed and a promissory note to be signed before issuing a loan.

  • Flexible Terms & Conditions: Private money lenders do not have strict terms and conditions like conventional lenders. Terms of private money loans are decided during the meetings of lenders and investors. Loan terms and conditions are tailored to suit the needs of investors making the process of fixing and flipping a home with a flip loan much smoother.

  • Creditworthiness Is Not An Issue: As discussed, private money lenders just need a signed trust deed and the property to act as the collateral. For this reason, most lenders may not be interested in the credit score, track record, and income of the investor. Thus, you will most likely not be asked about your credit score when getting a private money loan.

  • Transparency: Private money lenders are mostly local investors that want to fund local projects. They are generally interested in seeing the projects they invest in succeed because they are part of the community. Private lenders are also transparent about the costs, fees, and interest rates that are added to the principal amount issued.

Drawbacks Of Private Money Lending

While laden with opportunities, private lending is not devoid of its challenges. Both borrowers and lenders need to be cognizant of the associated private money lending risks.

  1. Elevated Interest Rates: One inherent challenge is the propensity of private lenders to levy higher interest rates. Given their flexible qualification metrics, which inherently introduce more risk, these inflated rates serve as a countermeasure. Consequently, this can strain the borrower's potential to reap fruitful returns on real estate investment deals.

  2. Constrained Loan Duration: A distinctive feature of private money lending is the short-term nature of the loans. Borrowers must be agile in their strategy, ensuring they can either sell or refinance their assets expediently, aligning with the impending loan repayment deadline.

  3. Navigating the Lender Landscape: Unlike their conventional counterparts, private lenders don't ubiquitously advertise their services. For borrowers, this translates to an augmented challenge in finding private lenders. Traditional methods include tapping into personal networks or seeking recommendations from acquaintances. Yet, in the digital age, platforms like LinkedIn, targeted internet searches, and events centered on real estate investment can be invaluable resources. 

*For in-depth training on private money loans, Real Estate Skills offers extensive courses to get you ready to make your first investment! 

Attend our FREE training and gain insider knowledge, expert strategies, and essential skills to make the most of every real estate opportunity that comes your way!

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Private Money Lending: Frequently Asked Questions (FAQ)

Need specific questions answered for private money lending? Here are the most frequently asked questions to guide you through this unique financial landscape:

Is Private Money Lending Legal?

Private money lending is legal as long as it complies with federal usury and state laws. A private money lender is not exempt from the existing banking laws in their state. Nevertheless, they can be exempt from the routine regulations that may include banking exams. In states like New York, private money lenders that give more than 5 real estate loans are required to acquire a lending license.

Licensed private money lenders are transparent with their charges, interest rates, eligibility requirements, and fees. They also do their due diligence when giving loans. For instance, they consider the income of borrowers and their total debt to determine their ability to repay the loaned amount.

It’s usually advisable for borrowers to choose private lenders wisely. That’s because some lenders have more aggressive collection methods when borrowers are unable to repay.

Do Private Money Lenders Need To Be Licensed?

This isn’t always the case! In some places, private money lenders may not need licensing because they are not banks or lending/financial institutions. In some states, there is a limit set on the number of loans a private money lender is allowed to offer. Exceeding this number of loans can require the lender to get a banking license.

Keep in mind that private money lenders are required to follow both federal and state usury laws. The lenders can also be subjected to the banking regulations of their states. Basically, there are no routine regulations applied to these lenders as well as their loans.  

Should I Use Private Money Lenders For House Flipping?

When it comes to house flipping, there are costs associated with holding a renovation. These include utilities, taxes, and insurance costs amongst others. Unfortunately, securing funding with mortgage companies and banks is not easy even for experienced flippers.

Private money is a great solution to the major funding hurdle most flippers face.

Can I Use Private Money For A Down Payment?

Yes. Private hard money lending enables you to venture into real estate investing without money. You can get 100% financing for buying a property and its rehab. However, you need to identify the right private money lender. Usually, most private money lenders will lend you up to 70% of the property’s after-repair value (ARV). That means if you find a well-purchase-price property, you can get away without money down.

Will Private Money Lenders Do A Loan With No Money Down?

Yes. Some private money lenders will give you a loan with no money down as long as a real estate deal meets their criteria for the requested loan type. Some lenders have direct lending models that do not require down payments! Even more, these private money loans can typically fund up to 70 percent of a property’s after-repair value (ARV). The 70 percent of funding covers property purchase, loan costs, and renovation costs.

In place of a down payment, a private money lender may require a borrower to have collateral. This is the reason that if the borrower fails to meet the loan payments, their collateral can be seized and liquidated by the lender to make up for the missing payments and capital.

Similar to a down payment, collateral mitigates the lender from the risk of default by the borrower. It also shows your private lender that you have “skin in the game” & stand to lose if you do not repay the loan.

What Interest Rates Do Private Money Lenders Charge In Real Estate?

Generally, private money lenders are all a little different. Therefore, their interest rates for real estate deals can vary. Nevertheless, private money lenders, like hard money lenders, give loans with interest rates that range between 7% and 13%. Lender fees or points can range from 1% to 10%. Closing costs can range between 2% and 5% while independent appraisals can charge an amount that ranges between $300 and $500.

Unlike conventional mortgages, monthly payments for private money loans are not amortized. Although a private money loan may have a higher interest rate than a conventional mortgage, monthly payments can be less when compared to a mortgage.

Private money interest rates may fluctuate based on the property's loan-to-value (LTV), a measure of lending risk used to determine the appraised value of your home compared to the loan amount you are seeking to borrow.

This can make fix and flippers that want to reduce holding costs as they prepare to sell their properties prefer private loans. Even more, these loans can become a preference for buy-and-hold investors because the monthly payments do not cost too much when looking for alternative conventional mortgage financing.

Are There Private Mortgage Lenders For Bad Credit?

Securing a mortgage via a conventional financial institution like a credit union or bank is not easy when you have bad credit. However, there are private mortgage lenders that will lend you money even when you have bad credit.

It’s important to know that the meaning of ‘bad credit’ varies from one lender to another. That’s because there are many types of credit which can vary depending on the scoring model and credit bureau.

However, 90% of lenders use FICO scores when making lending decisions. Experian, a credit reporting agency breaks down FICO credit score as follows:

  • 800 or higher - Exceptional

  • 740 to 799 - Very good

  • 670 to 739 - Good

  • 580 to 669 - Fair

  • 579 or lower - Very poor

When it comes to private mortgage lenders, it’s crucial to note that lenders have varying underwriting standards. Factors that affect credit’s role in the approval process include assets, income, and the property you need financing for.

Will Private Real Estate Investors Work With Me If I Have Little To No Experience?

Experience within the real estate industry plays a vital role when working with private money lenders. While some lenders may give out private loans to new investors, the majority prefer working with investors who have a lot of experience. This gives them reassurance that their money is safe.

However, new real estate investors can build strong relationships and build trust with private money lenders to receive funding for their deals.       

Will Private Money Lenders Work With Me If I Have No Credit?

A bad credit score is often considered detrimental to real estate investments. This is particularly the case when financing a rental property. Fortunately, private money lenders will work with you even if you have a below-average credit score. Essentially, private money lenders will lend you money without subjecting you to the traditional credit guidelines and requirements.

Credit unions and banks avoid working with investors with no proof of steady income or those with bad credit. Private money lenders on the other hand give private loans to real estate investors, many times regardless of credit and income.

As a real estate investor, you can sit down with a private money lender to discuss your options, negotiate terms, and agree upon the amount of money to borrow. However, due to the increased risk these private money lenders are taking, the interest rate on these real estate loans tends to be higher than a conventional loan.

Can I Get Private Money For Real Estate Investing Today?

The internet is awash with information about private money lenders. Sometimes it is hard to filter out the truth from the fluff. This is why we have created an in-depth training that walks any investor through the strategies that have been proven to raise money for thousands of deals thus far.

With years of experience, this training covers the steps on how to obtain all the money you need, how to invest in any type of real estate deal, how to use OPM (other people’s money) as leverage, and how to generate passive income.

Final Thoughts On Private Money Loans

Private money lending offers a win-win scenario for everyone involved. Investors can relish quicker approvals and a broader funding scope, while lenders gain a front-row seat to promising investment opportunities.

If you're keen on maximizing your wealth-building potential through this route, don't miss out on our FREE training on wholesaling real estate and flipping houses designed to guide you every step of the way!

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