“Private Money”, also referred to, as “Hard Money,” is a source of capital for real estate that does not get as much attention as traditional commercial lending. However, Private Money occupies an increasingly important niche in today’s market. As a result it is important to better understand what is going on in this industry and how it might affect you and your clients.
A Private Money lender provides loans to individuals and other entities purchasing or refinancing real estate. This financing is available for a wide variety of properties including those that traditional lenders would not favor.
Private Money lenders use their own money, money that they obtain from investors, and lines of credit from other lending institutions to make loans. What they try to offer their investors is a higher-than-average rate of return on their investment with a controlled amount of risk.
The way these lenders provide the above average returns is by charging a greater interest rate than charged by conventional lenders. To avoid risk they try to limit the loan to value and/or qualify the borrower. There is a wide range of interest rates and fees being offered – much of it do to the different risks associated with each loan.
Traditional lenders look to the cash flow of the property and/or the cash flow of the borrower to make a lending decision. They look at the value of the property as a secondary source of repayment. A source of repayment they would rather not deal with. As a result, traditional lenders are less likely to work with a borrower or a property that has financial issues.
Private Money lenders are also known as collateral backed lenders. The loan to value and ease of getting out of a property are their primary concerns when looking at a loan. The current cash flow of the borrower or the property is not as important to them. However, Private Money lenders are often more aggressive when it comes to foreclosing on borrowers who default on their loan.
For the Private Money borrower this typically means that the up-front loan fee and the interest rate will be greater than that of traditional lending. Before getting involved with a Private Money loan a borrower should seriously consider why he would want to use such a product.
Good reasons for obtaining a Private Money loan include having a plan to increase the value or income of a property or to get quick access to capital in order complete a purchase at a below market price.
Some examples of these are as follows:
It is important to remember when dealing with a Private Money loan that a plan is needed to get out of that loan prior to accepting the funds. A significant percentage Private Money loans end up with the lender taking back the property that is used for the collateral. These are properties that should have been sold prior to getting that loan. Getting a Private Money loan based on the hope that one’s personal economic situation is going to get better is a recipe for disaster.
The other thing that is important to remember is that the rates and terms for Private Money loans vary to a much greater extent than conventional loans. Various Private Money lenders have different risk appetites and price their money accordingly. Depending upon the lender and their risk appetite, interest rates can range from 8% to 15% and the loan fee can range from 2% to 6%.
Therefore it is important to match your Private Money request with the right lender. Sometimes the higher rate and fee is justified and sometimes it is not. It has been my experience that, often, a borrower who needs a Private Money loan goes with the first lender they can find. This can be very expensive.
So if you are in a situation where you feel that you might need a Private Money loan; what should you do?
One last important point when it comes to Private Money lending.
One of the many differences between a traditional lender and a Private Money lender can be reflected in the escrow documents. Bank loan documents tend to be somewhat similar and there really is not that much negotiation in reference to the documents.
Private Money loan documents can vary widely from lender to lender. While the vast majority of Private Money lenders are honest, some of them do stick things in the loan documents that were not previously clear to the borrower. Furthermore, Private Money loan documents are usually easier to negotiate than bank loan documents.
As a result it is very important that you review your loan documents prior to signing them. If you have questions, get legal advice. Under no circumstances should you sign any loan documents that you do not understand. Mistakes and miscommunication on loan terms are somewhat rare, but when they do happen it often can be devastating to the borrower.
If you have questions about Private Money lending or any other commercial real estate question please do not hesitate to contact me.
Contact Bill Hand to learn more about Debt Coverage Service Ratio and how it applies to commercial real estate financing.
Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com
A Private Money lender provides loans to individuals and other entities purchasing or refinancing real estate. This financing is available for a wide variety of properties including those that traditional lenders would not favor.
Private Money lenders use their own money, money that they obtain from investors, and lines of credit from other lending institutions to make loans. What they try to offer their investors is a higher-than-average rate of return on their investment with a controlled amount of risk.
The way these lenders provide the above average returns is by charging a greater interest rate than charged by conventional lenders. To avoid risk they try to limit the loan to value and/or qualify the borrower. There is a wide range of interest rates and fees being offered – much of it do to the different risks associated with each loan.
Traditional lenders look to the cash flow of the property and/or the cash flow of the borrower to make a lending decision. They look at the value of the property as a secondary source of repayment. A source of repayment they would rather not deal with. As a result, traditional lenders are less likely to work with a borrower or a property that has financial issues.
Private Money lenders are also known as collateral backed lenders. The loan to value and ease of getting out of a property are their primary concerns when looking at a loan. The current cash flow of the borrower or the property is not as important to them. However, Private Money lenders are often more aggressive when it comes to foreclosing on borrowers who default on their loan.
For the Private Money borrower this typically means that the up-front loan fee and the interest rate will be greater than that of traditional lending. Before getting involved with a Private Money loan a borrower should seriously consider why he would want to use such a product.
Good reasons for obtaining a Private Money loan include having a plan to increase the value or income of a property or to get quick access to capital in order complete a purchase at a below market price.
Some examples of these are as follows:
- The purchase of a property that is in a state of disrepair. For a traditional lender this would include a construction loan which requires significant documentation. Often, the items needed by a traditional lender to close a loan on a property such as this will not be available prior to the completion of escrow.
- Rehabilitate your own property. The money will come directly to you and you can spend it on the rehabilitation as you see fit. This avoids the site inspections and other requirements that may be imposed by traditional lenders. A Private Money loan will sometimes sit in second position allowing a borrower to keep an attractive first loan.
- Get someone out of your life. Sometimes things just don’t work out. There are times when one partner wants cash out of a property and the timing for a new loan is not right. Private Money, either as a new first loan or a second loan is the appropriate alternative.
- Money is needed quickly in order to close a transaction. Some of the best deals available to a buyer are as a result of the seller needing money very quickly. Typically, a traditional lender will not be able to respond quickly enough for a transaction to be completed within the seller’s time frame.
- Your income is not documented. For a traditional lender, tax returns or audited financial statements are necessary to determine cash flow. If you do not have these, your chances of getting a conventional loan are slim.
It is important to remember when dealing with a Private Money loan that a plan is needed to get out of that loan prior to accepting the funds. A significant percentage Private Money loans end up with the lender taking back the property that is used for the collateral. These are properties that should have been sold prior to getting that loan. Getting a Private Money loan based on the hope that one’s personal economic situation is going to get better is a recipe for disaster.
The other thing that is important to remember is that the rates and terms for Private Money loans vary to a much greater extent than conventional loans. Various Private Money lenders have different risk appetites and price their money accordingly. Depending upon the lender and their risk appetite, interest rates can range from 8% to 15% and the loan fee can range from 2% to 6%.
Therefore it is important to match your Private Money request with the right lender. Sometimes the higher rate and fee is justified and sometimes it is not. It has been my experience that, often, a borrower who needs a Private Money loan goes with the first lender they can find. This can be very expensive.
So if you are in a situation where you feel that you might need a Private Money loan; what should you do?
- Make sure that this loan is part of a greater plan for your real estate that includes getting out of the Private Money loan at the end of the plan.
- If you already own the property for which you are considering getting a Private Money loan for, think about selling that property as an alternative to getting the loan. This is especially important if you not see an easy way back into conventional financing.
- If you do not know much about Private Money lending consider hiring a mortgage broker who does have knowledge of Private Money lending and who can, and will, advise you of the best alternative for your current situation. This will help you avoid wasting time dealing with lenders who want not to give you a loan in the first place. More importantly it can save you from paying significantly more for the loan than you would otherwise have to.
One last important point when it comes to Private Money lending.
One of the many differences between a traditional lender and a Private Money lender can be reflected in the escrow documents. Bank loan documents tend to be somewhat similar and there really is not that much negotiation in reference to the documents.
Private Money loan documents can vary widely from lender to lender. While the vast majority of Private Money lenders are honest, some of them do stick things in the loan documents that were not previously clear to the borrower. Furthermore, Private Money loan documents are usually easier to negotiate than bank loan documents.
As a result it is very important that you review your loan documents prior to signing them. If you have questions, get legal advice. Under no circumstances should you sign any loan documents that you do not understand. Mistakes and miscommunication on loan terms are somewhat rare, but when they do happen it often can be devastating to the borrower.
If you have questions about Private Money lending or any other commercial real estate question please do not hesitate to contact me.
Contact Bill Hand to learn more about Debt Coverage Service Ratio and how it applies to commercial real estate financing.
Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com
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