How Private Money Lending Works - SmartAsset

Private money lending occurs when a wealthy individual or private organization loans money to a person or company. Private money lending is common in real estate investment. Private money lenders loan money to investors who purchase and, often, renovate properties for resale or rental. Private money lending is less regulated and more flexible than lending by licensed lenders such as banks. A financial advisor can help you decide whether a private money loan makes sense for you.

Private Money Lending Basics

The defining characteristic of private money lending is that the money for the loan is provided by an individual or a private organization. Often, the lender is a family member or friend of the borrower. When the private money lender is an organization, it is not a bank or other licensed lending organization.

Private money lending is not subject to the same regulations that govern other lenders, but the business is not completely unregulated. Private money lenders do have to follow state usury laws that limit the amount of interest that can be charged. They may also be limited in the number of loans they can make.

Interest rates on private money loans tend to be higher than loans from licensed lenders. From 15% to 20% is typical. However, in the case of a loan from a friend or relative, they may also be lower than market rates. Private money loan payments may be interest-only for the term of the loan, with a single large balloon payment at the end.

Qualifying for a private money loan is different from qualifying for a regular loan. The lender is likely to focus as much on whether a specific deal makes financial sense as on the credit history or score of the borrower.

Terms on private money loans are often short, just six to 12 months, but may also be payable over up to five years. They generally require a down payment and often are secured by the property. The lender will typically require a written plan describing how the money will be spent.

Private money lending is similar to hard money lending. They are both often used in real estate investing and involve getting financing from somewhere other than a bank. Hard money lending, however, is more similar to mainstream lending, such as from a bank and less like friends-and-family financing via private money loan. It may be harder to qualify for a hard money loan.

Pros of Private Money Lending

Private money loans are more flexible than traditional financing. Borrower qualification guidelines are fewer and less strict, especially when the lenders are friends or family members. One key difference is that private money lenders are more likely than others to be willing to finance the acquisition of distressed property in need of significant repair. This allows investors who are short of cash to purchase low-priced properties and pay for renovations that increase the value of the properties.

The flexibility of private money lending also makes it faster. A borrower can get the money to do a deal in days, rather than waiting several weeks to get funded by a conventional mortgage.

Cons of Private Money Lending

Private money lending also carries added risk for both borrower and lender. Private money lenders are taking more risk due to their less strict qualification guidelines. To compensate for the added risk, private money lenders charge higher interest rates than other lenders. This can make it harder for borrowers to turn a profit on deals. Also, because loans are typically short-term, a borrower has to be able to sell or refinance the property relatively quickly, before the loan comes due.

It can be more difficult for borrowers to find private money lenders, since they may not advertise like banks and more established lenders. Talking with friends and family is one way to find sources for loans. Borrowers may be able to identify other potential private money lenders through professional networking, social media such as LinkedIn, internet searches and real estate investment events.

Bottom Line

Private money lenders are individuals and organizations that provide money to investors, usually for real estate loans. Private money lending is less regulated but more costly than other sources for loans, such as banks. Many private money loans come from friends and family, but organizations may also be private money lenders.

Tips for Borrowing Money

Talking your financing plans over with a financial advisor can increase the chances you’ll make the best decision. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Any type of loan can be tricky, especially if it’s a loan you personally guarantee, and if you don’t pay them back fully or on time then there is the possibility that you hurt your chances at borrowing more in the future. It’s important to understand as much as you can about personal loans before moving forward with private money lending.