Private Money

Private Money Definition

“Private money” is a term often used to describe a loan or equity contribution to a company or investor by a private organization or individual. Private money lenders can extend loans when traditional lenders cannot or will not. Private money can be a valuable source of capital when other conventional sources of funding are not available.

REtipster does not provide tax, investment, or financial advice. Always seek the help of a licensed financial professional before taking action.

What is Private Money?

Financing is a common obstacle for real estate investors who want to scale their business. Institutional lending rules often stand in the way of traditional financing for investment properties. This is where private money comes in.

Private money is exactly what it sounds like. People with money in the bank use it to make loans secured by real estate to investors. Organizations can also be private money lenders, but in most cases, these are high net worth individuals looking for passive real estate investments.

private money bag

Private money lenders establish their own lending guidelines; bank underwriting standards[1] do not limit them. Unlike hard money lenders, private money lenders control their capital and approval process.

Private money loans tend to be relationship-based. Whereas hard money loans are generally asset-based, private money lenders often look at the borrower’s track record and the potential benefits of an ongoing relationship in addition to the value of the asset.

Private money lenders may or may not look at traditional metrics of creditworthiness such as credit score, debt-to-income ratio, and net worth.

Because they are unregulated products, private money loans are infinitely flexible. Private money lenders can structure loans to meet any circumstance that meets their overall investment objectives. They are literally invested in the success of a project, so they are more willing to adjust terms in response to unforeseen situations.

How Are Private Money Loans Used?

Although private money loans can be used for several different purposes, the deals typically fall into one of four categories:

  • Fix and flip. Investors need private money loans for these properties because conventional lenders often will not make loans for property in poor condition. The speed with which a private loan can be closed makes them especially attractive for rehab projects.
  • Rehab and rent. Instead of rehabbing the property to sell for a quick profit, these investors purchase property with the intent to hold it for long-term rental income. Private money is attractive for the same reason it works for fix-and-flip deals.
  • Building on spec. Traditional lenders often will not lend on speculative development, so private money may be the only option.
  • Commercial development. Commercial developers sometimes use private lenders for bridge loans when conventional loans are unavailable, especially in the case of non-stabilized assets.

Private money lenders can structure loans in different ways[2]. They can be long- or short-term loans, disbursed in lump sums or installments, and even include profit-sharing agreements. Some lenders even make no-down payment loans for as much as 70% of the after-repair value on a fix-and-flip and allow borrowers to defer interest payments until the property is sold.

Although most people associate private money loans with rehab projects, some lenders agree to finance buy-and-hold properties for income stability.

Example of a Private Money Loan

Antonio found a vacant property he wants to rehab and flip for $85,000. The house needs a new roof and has some structural damage to the foundation. The estimated repair costs are $35,000, and the property has an after-repair value (ARV) of $175,000.

Due to the property’s condition, he is unable to get a conventional loan. He pitches the deal to a private lender, itemizing the repair costs and providing documentation that supports the ARV. The lender is convinced and approves a loan for $120,000.

Antonio buys the home and completes the repairs. Four months later, he sells the property for $175,000. His profit breakdown looks like this:

  • Acquisition cost – $85,000
  • Repair costs – $35,000
  • Financing costs to lender- $8,000
  • Selling costs including commission – $7,000
  • Sales price – $175,000
  • Net to investor – $40,000

RELATED: Hard Money 101: Everything You Need to Know About Hard Money Loans

Private Money Loan Costs

Costs vary depending on the lender and the project, but private money loans generally have high interest rates compared to conventional loans. The rates are comparable to hard money loans and typically range from 6% to 14%. Borrowers often pay between 2 and 10 points in loan origination fees, and closing costs can be as much as 5%. There may be additional costs, such as independent appraisal fees, as well.

private money fanOn the other hand, private money loans are not amortized like conventional mortgages. This means monthly payments can be significantly lower than conventional mortgage payments, lowering the holding costs for investors planning to sell their property.

Who Should Consider Private Money Loans?

Every real estate project is different, and there will be situations where traditional lenders are a better fit. However, generally speaking, private money loans are best for people:

  • Who need immediate access to cash. The most lucrative real estate investments often depend on immediate access to working capital. With private money loans, investors can have cash in as little as 24 hours. This means they can move quickly on time-sensitive opportunities, which is a huge advantage in a competitive environment.
  • Who do not have a qualifying credit profile. Conventional lenders need proof of income, a good credit score, and a low debt-to-income ratio to approve real estate loans. Private money lenders can make loans to individuals who do not qualify with other lenders because they focus more on the nature of the project, the borrower’s track record, and how the deal fits with their investment objectives.
  • Who are buying property that does not meet conventional lending criteria. Banks generally will not make loans on non-stabilized commercial property or property in disrepair. Private money lenders are not limited to particular property profiles and have the flexibility to make loans on any type of property.

RELATED: How to Become a Hard Money Lender and Investor with Ryan Wright

How to Find a Private Money Lender

This type of financing is often relationship-based[3], so cultivating a network of real estate professionals is a good first step to finding a private money lender. Real estate brokers, agents, and attorneys may have connections to tap; title companies and fellow investors may also have good leads.

The internet is another place to look for private money loans. Google is a great place to start, but social media sites such as LinkedIn may also provide leads.

private money search

It is a good idea to have a portfolio of previous projects to show a prospective lender, but the most important thing is to have a solid pitch that addresses the key points lenders care about:

  • Why is this project an attractive investment for the lender?
  • How long will the project take?
  • What are the risks involved in the project?
  • Is another lender such as a bank providing part of the financing?
  • How will the funds be allocated?
  • Who is managing the project, and who are the key players?
  • When will the lender be repaid?
  • How much can the lender expect to make on the loan?

Also, be prepared with a Plan B that mitigates the lender’s loss if the project does not go as planned.

What Are Some Private Lending Companies

The Tax Cuts and Jobs Act of 2017[4] changed the rules surrounding the ways real estate operators could raise capital for their projects. Before the Act, real estate operators without an established network had little access to private money. Investors with money to lend were excluded from the real estate project pipeline as well.

The Act essentially democratized syndication through the creation of peer-to-peer lending platforms. Crowdlending serves many of the same purposes as private money lenders, although the application and approval process might differ.

A private lending company is an option for investors who cannot (or prefer not to) get conventional financing and have no relationship with a private money lender.

Several crowdlending platforms specialize in real estate financing. They include:

  • Fund That Flip. This platform funds fix-and-flips, fix-and-rents, new construction, and cash-out refi loans. The site states that interest rates start at 9.99%, and they loan up to 65% ARV with terms of 3 to 24 months.
  • GroundFloor. GroundFloor focuses on short-term (6 to 12 months) loans for fix-and-flip and fix-and-rent projects. The site lists origination costs of between 2% and 4.5%, an application fee of $250, and interest rates starting at around 5% to more than 10%.
  • Lending Home. Lending Home claims to be the largest hard money lender in America. It offers 12-month loans for fix-and-flips and rentals with rates starting at about 7% for flips and 6.125% for rentals.

RELATED: Today’s Top Real Estate Crowdfunding Websites

Takeaways

Private money is an alternative source of capital for real estate investors. It is useful when traditional mortgage loans are not an option, such as for fix-and-flip properties. Approval is based on a different set of metrics than traditional loans, which means private money is an alternative for those with less than excellent credit. Private money loans are generally short term and carry a higher interest rate.

Sources

  1. Office of the Comptroller of the Currency. (n.d.) Underwriting. Retrieved from https://www.occ.treas.gov/topics/supervision-and-examination/credit/commercial-credit/underwriting.html
  2. Turner, B. (2018.) How to Structure Your Private Loans: An Interview with 4 Real Estate Investors. BiggerPockets. Retrieved from https://www.biggerpockets.com/blog/structure-private-loans-interview
  3. Patterson, M. (2020.) Private Money Lenders: How to Get Private Money Loans. Fit Small Business. Retrieved from https://fitsmallbusiness.com/private-lenders-private-money-loans/
  4. York, E. (2018.) The Tax Cuts and Jobs Act Simplified the Tax Filing Process for Millions of Households. Tax Foundation. Retrieved from https://taxfoundation.org/the-tax-cuts-and-jobs-act-simplified-the-tax-filing-process-for-millions-of-americans/

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