How Do Private Money Loans Work?

When it comes to real estate, not all loan types are created equal.

From a lending perspective, Private Money Loans are just that – loans. Although there are many different types of loans you can secure by real estate, private money loans are quite a bit different than most long-term loans you would normally think of when looking into your home loan options.

To make things very simple, let’s make sure you understand the basic concepts of real estate lending.

The three main components to a lending transaction:

  1. Borrower: The person borrowing the money (this would also be the buyer in a purchase transaction)
  2. Lender: The person or institution lending the money
  3. Collateral: The property being used to as security for repayment of the loan

Private money loans are real estate loans that are funded by an individual person, whereas the traditional 30-year mortgage is mainly issued from a bank or institutional mortgage lender.

One of the biggest differences you will find between a conventional (30-year) mortgage and a private money loan is that the private loan will be for a much shorter term. Most private money loans would be for only 3-7 years compared the standard 30-year term.

Aside from having a shorter time frame to pay the loan back, you also receive higher interest rates and fees to get a private money loan. The higher fees are due to the higher risk that the lender (investor) takes in making such loan. This is one of the reasons, this type of loan is also known as a Hard Money Loan.

These loans are available as a financing option to you because the banks and credit unions have stricter guidelines to qualify for a mortgage with a low interest rate.

Terms you can expect to see on a private money loan:

Loan Amounts $50,000 – $1M and even higher in some cases. (Based on the deal)

Interest rates from 10-12%

Repayment terms from 3-7 years

Loans are generally financed up to 65% of the current appraised property value.

So how do the loans work?

Here’s the short answer. If you have a down payment or equity of 35% (or more) in a property, and you have the ability to repay the loan, you already have a good shot at getting qualified for a private money loan whether you are purchasing a property or just refinancing your existing home.

That’s pretty much the main qualifying factor: equity.

Since the loans are heavily based on equity and the property itself, the personal credit history of the borrower is not as important.

By comparison, banks and credit unions base their lending decisions on the borrower’s income and credit history. That’s the reason private money is a great back-up option if you find that you can’t get qualified for a loan through a traditional bank or credit union.

Our next article will focus more on “Why” someone would choose a private money loan in our current market.

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