Private money financing is when you borrow money from individuals rather than banks or traditional lenders. This could be friends, family, or other private investors looking for a return on their investment.
Private money loans tend to be more flexible, and the terms vary widely. They can come with below or above market interest rates and short or long terms.
Let’s break it down.
Eligibility/Requirements
Private money lenders are typically more flexible than traditional lenders, but they still have their own requirements:
- Relationship-Based – Private money financing often depends on the relationship you have with the lender. Trust is key, and some private lenders will likely want to know your track record with real estate investments.
- Financial Statements – Some private lenders may still require you to provide financial statements or a detailed business plan, but it’s generally less formal than a traditional loan application. The closer your relationship is with the person, typically the less rigorous the loan requirements. Mom, Dad, Grandma and Grandpa will typically not require as much as an acquaintance from work might.
Owner-Occupancy Requirement
Private money loans don’t usually have owner-occupancy requirements:
Flexible Owner-Occupancy Options– These loans can be used for both investment properties and owner-occupied homes. They’re a good option if you’re looking to add rentals to your portfolio, do a fix-and-flip project, or finance a primary residence. Some private money lenders may be open to financing Nomading™ or house hacking strategies if the deal makes sense but since you’re not required to owner-occupy to get them, you may not need to utilize an owner-occupant investment strategy with private loans.
Down Payment
Down payments for private money loans can vary widely depending on the lender:
- Flexible Down Payments – The down payment is often negotiable between you and the lender. Some private lenders may fund the entire purchase amount including closing costs and repair costs, while others might require 10-30% down, depending on the deal’s risk and your relationship with the lender.
Loan-to-Value (LTV) Ratio
LTV ratios for private money loans are generally more flexible than those for conventional loans:
- No Formal LTV Limits – Private money lenders don’t typically adhere to strict LTV ratios. They may be willing to finance 100% of the purchase price, or even more in some cases. For instance, they might cover additional costs like repairs or furnishing for a short-term rental property. The amount they’re willing to lend depends more on the potential of the deal and your relationship with the lender rather than predetermined LTV ratios.
Interest Rates
Interest rates for private money loans are completely negotiable:
- Flexible Interest Rates – Private money loan rates can be higher or lower than current traditional financing rates. The interest rate is typically negotiated based on factors such as your relationship with the lender, the property’s potential, and current market conditions. This flexibility allows for potentially more favorable terms compared to conventional loans in some cases.
Amortization Period
The amortization period for private money loans is negotiable, just like almost every other aspect of these loans. The terms can vary widely based on the agreement between the borrower and the lender:
- Flexible Loan Terms – Private money loans can be short-term (six months to five years) or long-term, depending on the needs of both parties.
- Amortization Options – These loans can be fully amortizing, where you pay both principal and interest over time, or interest-only, where you only pay interest during the loan term.
- No Payment Options – In some cases, especially when the private lender is using retirement funds, the loan might accrue interest with no payments required until the end of the term. This can be desirable for lenders looking to compound their profits over a longer period.
- Customized Repayment – The repayment structure can be tailored to suit both the borrower’s project needs and the lender’s investment goals, offering significant flexibility compared to traditional loans.
Private Mortgage Insurance (PMI)
Private money loans typically do not require Private Mortgage Insurance (PMI).
This is because private lenders operate outside the guidelines of traditional lending institutions. They have the flexibility to structure loans based on their own risk assessment and the specific deal at hand.
Even for loans with higher loan-to-value ratios, private lenders often prefer to mitigate their risk through other means, such as higher interest rates or stricter terms, rather than requiring PMI.
This can be advantageous for borrowers, potentially reducing their overall costs despite higher interest rates.
Loan Limits
Private money lenders don’t have the same loan limits as traditional lenders:
- No Set Loan Limits – Loan amounts are based on what the lender is willing to offer and your ability to negotiate. Some private lenders might only be wiling to do smaller deals (or smaller amounts), while others might fund larger transactions.
Number of Loans Allowed
There are no restrictions on the number of loans you can get from private lenders:
- No Loan Limits – You can take out multiple private money loans, as long as you have access to lenders willing to fund your deals. This makes private money ideal for scaling your real estate portfolio quickly limited by your personal connections and relationships.
Seller Concessions
Remember that seller concessions are typically negotiated directly with the seller at the time of offer and not with the private lender.
Most private lenders are not concerned with seller concessions and generally don’t impose strict limits on how much of the seller’s contribution can go towards closing costs or repairs. In fact, many private lenders are open to financing these costs into the loan, providing additional flexibility for the buyer.
Waiting Period After Major Financial Events
Private money lenders are often more flexible when it comes to financial difficulties in your past. Unlike traditional lenders, they don’t typically have formal waiting periods after events like bankruptcy or foreclosure.
Instead, these lenders focus on the current opportunity and your ability to execute it successfully. If they believe in you or the deal you’re proposing, they may be willing to work with you regardless of past financial issues.
Refinancing Rules
Refinancing options for private money loans can vary depending on your agreement with the lender:
- Rate/Term Refinance – You may have the option to refinance your private money loan with another private lender or a traditional lender, subject to the terms of your original agreement.
- Cash-Out Refinance – Cash-out refinances are typically available. You can refinance with another private lender or transition to more traditional financing to pay off the original private lender.
- Recast – If your private lender agrees, you might be able to negotiate and restructure the terms of your existing loan.
It’s important to note that replacing one private lender with another and using the new loan to pay off the first lender’s profit could potentially resemble a Ponzi scheme if not structured properly. This practice may raise legal and ethical concerns, especially if not disclosed fully to all parties involved. We strongly recommend consulting with a qualified attorney to ensure that any refinancing or loan restructuring is done legally, ethically, and with full transparency to all parties involved. This will help protect you from potential legal issues and maintain the integrity of your investment practices.
Property Types Eligible
Private money offers exceptional flexibility when it comes to property types.
Unlike traditional lenders, private money lenders are often willing to fund a diverse range of real estate investments.
This can include single-family homes, condos, townhomes, multi-family properties, commercial buildings, and even undeveloped land.
The key factor for private lenders is typically the potential return on investment and their relationship with you rather than adhering to strict property type guidelines.
This flexibility allows investors to pursue a wide variety of real estate opportunities, tailoring their investments to market conditions and personal strategies.
Special Loan Features
Private money loans offer several unique features:
- Flexible Terms – Private money loans are highly negotiable. You can structure the deal to fit the needs of both you and the lender, which can include flexible repayment terms, interest rates, and loan duration.
- Fast Closing – Private money loans are known for their speed. They can close in as little as a few days to a couple of weeks, making them ideal for investors looking to close quickly on a deal.
- Buying In Entities– Many private lenders allow you to buy property in the name of an entity like an LLC. They often trust you to protect their interests and repay the loan. While they may not require a personal guarantee in the technical sense, these lenders rely heavily on your relationship and your commitment to repayment.
Approval and Underwriting Process
Private money loans have a streamlined approval process compared to traditional loans:
- Fast Approval – Since private money loans are based on the relationship and the deal rather than strict underwriting guidelines, approvals can happen quickly.
- No Formal Underwriting – There is often no formal underwriting process, making it easier for investors to qualify, especially if they have a history of successful real estate deals.
Risks and Considerations
Private money loans come with unique risks:
- Potentially Higher Interest Rates – The higher cost of private money loans can reduce your overall profit margins, so make sure the deal supports the higher payments.
- Potentially Shorter Terms – Many private money loans are short-term, meaning you’ll need to have a solid exit strategy, whether that’s selling the property, refinancing with a traditional lender, or paying off the loan.
- Soliciting and Licensing– Be aware of legal restrictions on advertising for private lenders. Seek legal advice before marketing to the public. You’re less likely to encounter legal issues if you approach people with whom you have existing relationships (friends and family) without formal marketing.