25:["$","$L26",null,{"category":"$27","relatedArticles":[{"id":"cG9zdDozMjUzMQ==","databaseId":32531,"postId":32531,"author":{"node":{"id":"dXNlcjo1Mw==","databaseId":53,"userId":53,"avatar":{"url":"https://secure.gravatar.com/avatar/e108c21a7f5933aad20a2fed390a87d8?s=96&d=mm&r=g","size":96,"__typename":"Avatar"},"description":"Amanda Dixon is a personal finance writer and editor with an expertise in taxes and banking. She studied journalism and sociology at the University of Georgia. Her work has been featured in Business Insider, AOL, Bankrate, The Huffington Post, Fox Business News, Mashable and CBS News. Born and raised in metro Atlanta, Amanda currently lives in Brooklyn.","additionalMeta":{"expertise":null,"__typename":"User_Additionalmeta"},"email":null,"firstName":"Amanda","fullName":"Amanda Dixon","lastName":"Dixon","name":"Amanda Dixon","postCount":{"pageInfo":{"offsetPagination":{"total":184,"__typename":"OffsetPaginationPageInfo"},"__typename":"UserToPostConnectionPageInfo"},"__typename":"UserToPostConnection"},"slug":"adixon","__typename":"User"},"__typename":"NodeWithAuthorToUserConnectionEdge"},"categories":{"nodes":[{"id":"dGVybTo1NDM3","children":{"nodes":[],"__typename":"CategoryToCategoryConnection"},"databaseId":5437,"categoryId":5437,"link":"https://smartasset.com/personal-loans/articles","name":"Personal Loans","postCount":{"pageInfo":{"offsetPagination":{"total":26,"__typename":"OffsetPaginationPageInfo"},"__typename":"CategoryToPostConnectionPageInfo"},"__typename":"CategoryToPostConnection"},"slug":"personal-loans","ancestors":null,"parent":null,"__typename":"Category"}],"__typename":"PostToCategoryConnection"},"content":"$28","date":"2015-07-02T12:30:28","excerpt":"

\n","featuredImage":{"id":"cG9zdDoxOTE1OTM=","databaseId":191593,"altText":"What Is Unsecured Debt?","date":"2023-03-19T02:07:13","fileSize":47835,"mimeType":"image/jpeg","modified":"2023-03-19T02:07:13","sourceUrl":"https://smartasset.com/wp-content/uploads/sites/2/2015/07/iStock_000014702174_Small.jpg","__typename":"MediaItem"},"modified":{"datetime":"2023-8-11","readable":"August 11, 2023"},"multipleBylinesByRole":{"editedBy":null,"reviewedBy":null,"writtenBy":null,"factCheckedBy":null,"secondEditor":null,"hideAuthor":null,"__typename":"Post_Multiplebylinesbyrole"},"adTargetingOverrides":{"fieldGroupName":"adTargetingOverrides","pageGroupNewKey":null,"__typename":"Post_Adtargetingoverrides"},"seo":{"canonical":"https://smartasset.com/personal-loans/what-is-unsecured-debt","metaDesc":"An unsecured debt is a loan that doesn't have collateral attached to it. That means that if you can't pay your bill, your lender can't take anything, but...","metaKeywords":"","metaRobotsNofollow":"follow","metaRobotsNoindex":"index","readingTime":5,"title":"What Is Unsecured Debt? - SmartAsset","__typename":"PostTypeSEO"},"slug":"what-is-unsecured-debt","status":"publish","title":"What Is Unsecured Debt?","uri":"/personal-loans/what-is-unsecured-debt","tags":{"nodes":[],"__typename":"PostToTagConnection"},"__typename":"Post","adPageGroupOverride":null,"bylines":{"writtenBy":{"id":"dXNlcjo1Mw==","databaseId":53,"userId":53,"avatar":"$29","description":"Amanda Dixon is a personal finance writer and editor with an expertise in taxes and banking. She studied journalism and sociology at the University of Georgia. Her work has been featured in Business Insider, AOL, Bankrate, The Huffington Post, Fox Business News, Mashable and CBS News. Born and raised in metro Atlanta, Amanda currently lives in Brooklyn.","additionalMeta":"$2a","email":null,"firstName":"Amanda","fullName":"Amanda Dixon","lastName":"Dixon","name":"Amanda Dixon","postCount":"$2b","slug":"amanda-dixon","__typename":"User"},"editedBy":null,"reviewedBy":null,"factCheckedBy":null,"secondEditor":null},"category":{"id":"dGVybTo1NDM3","children":"$2e","databaseId":5437,"categoryId":5437,"link":"https://smartasset.com/personal-loans/articles","name":"Personal Loans","postCount":26,"slug":"personal-loans","ancestors":null,"parent":null,"__typename":"Category"},"isModifiedBeforePublished":false,"contentBlocks":["

Month after month, you may struggle to keep up with payments on all kinds of loans, from credit card debt to medical bills. Most forms of debt require you to pay back borrowed money with interest, but not all debt is the same. There are two major types of debt and it’s important to know the difference between them in order to successfully manage your debt in the long run.

","

Find out now: Which credit card is best for me?

","

Secured Debt

","

Before you can understand what unsecured debt is, it’s helpful to know about secured debt. With any secured debt, you’re borrowing money for an asset that has a lien placed on top of it. That asset becomes collateral for your loan. In other words, when you don’t pay the loan back on time, your lender can seize the asset.

","

Mortgages and car loans are two types of secured debts. If you have a mortgage, your home counts as an asset. Failing to make the monthly payments on your loan could end in your lender taking ownership of your house, leaving you literally without a roof over your head. And that won’t be the only thing you’ll have to worry about. Your credit score will likely drop as well.

","

Related Article: What Is a Secured Loan?

","

Unsecured Debt

","

Unsecured debt doesn’t come with any collateral. Credit cards are a popular kind of unsecured debt. Student loans and payday loans fall into this category as well. If you have a hard time making your credit card payments, your lender won’t have anything to confiscate. That’s why when it comes to debt, lenders generally prefer secured debts. If things go sour, at least they can walk away with something. On the other hand, because unsecured loans are riskier, lenders are typically able to charge higher interest rates. It can also be harder to qualify for an unsecured loan, especially if you have any credit issues.

","

In the event that an unsecured debt doesn’t get paid off, your lender can sue you and possibly even have your wages garnished, meaning that part of your paycheck will automatically go toward the debt you owe. Or your lender can find a debt collector who can keep after you until you cough up the extra cash.

","

Consolidating Your Unsecured Loans

","

Ideally you will pay back your debt in full and on time. But if you are having trouble keeping up with payments or are overwhelmed with multiple kinds of debt, there are some ways to make paying off your debt a bit more manageable.

","

With unsecured debt, you have the option of consolidating your loans, or putting them together. Instead of having to juggle a bunch of different loans, you’ll only have to make one payment and you can often lower your interest rate in the process. How easily you’ll be able to consolidate your loan will depend on your credit score.

","

If your credit is in pretty good shape and you’re trying to combine debt from different credit card accounts, you’ll likely be able to qualify for a personal unsecured debt consolidation loan from your bank, a credit union or another lender.

","

If you’re not interested in getting another loan, you could also apply for a credit card with a low or 0% interest rate and transfer balances from cards with higher interest rates and fees. With a lower-interest credit card, you could significantly reduce your monthly credit card bill. It’s important to check for and factor in any balance transfer fees you will have to pay.

","

What is the Best Method for Paying Off Debt?

","

If your credit score looks a little rough, it could be difficult to get an unsecured debt consolidation loan. Your best bet might be to seek out a non-profit debt management program that’s willing to work with you one-on-one to come up with a solution that’ll help you meet your financial goals.

","

Bottom Line

","

Not all loans are created equal. It’s important to prioritize and plan ahead to keep your debt from spinning out of control. Secured loans, like mortgages and auto loans, have collateral so they’re considered to be less risky in the eyes of lenders. But if you have a secured loan, you could eventually lose your home or car if you can’t pay your bills on time.

","

You might not physically lose as much with unsecured debt from credit cards and student loans, but it can be harder to make room for them in your budget since the interest rate for this type of loan is typically higher. Also, you could see a end up with debt collectors hounding you.

","

If you’re thinking about consolidating your unsecured debt or moving your balances to a lower-interest credit card, it’s a good idea to read the fine print to make sure you know whether your low interest rates will actually go up after a certain period of time. The more you know, the better decision you can make for your specific situation.

","

Photo credit: ©iStock.com/Feverpitched, ©iStock.com/CHUYN, ©iStock.com/KLH49

"],"experts":null,"link":"/personal-loans/what-is-unsecured-debt","published":{"datetime":"2015-7-2","readable":"July 2, 2015"},"shareInfo":{"title":"What Is Unsecured Debt?","origin":"/personal-loans/what-is-unsecured-debt"},"isNewsArticle":false},{"id":"cG9zdDoyNzEwNDE=","databaseId":271041,"postId":271041,"author":{"node":{"id":"dXNlcjoz","databaseId":3,"userId":3,"avatar":{"url":"https://secure.gravatar.com/avatar/47938df052bf0a5283bd6b77ab786737?s=96&d=mm&r=g","size":96,"__typename":"Avatar"},"description":"SmartAsset employs a team of writers and editors with years of experience in the editorial, news and personal finance industries. Some staff members also hold the Certified Educator in Personal Finance (CEPF®) designation from the Institute for Financial Literacy.","additionalMeta":{"expertise":null,"__typename":"User_Additionalmeta"},"email":null,"firstName":"Michael","fullName":"SmartAsset Team","lastName":"Carvin","name":"SmartAsset Team","postCount":{"pageInfo":{"offsetPagination":{"total":1417,"__typename":"OffsetPaginationPageInfo"},"__typename":"UserToPostConnectionPageInfo"},"__typename":"UserToPostConnection"},"slug":"mcarvin","__typename":"User"},"__typename":"NodeWithAuthorToUserConnectionEdge"},"categories":{"nodes":[{"id":"dGVybTo1NDM3","children":{"nodes":[],"__typename":"CategoryToCategoryConnection"},"databaseId":5437,"categoryId":5437,"link":"https://smartasset.com/personal-loans/articles","name":"Personal Loans","postCount":{"pageInfo":{"offsetPagination":{"total":26,"__typename":"OffsetPaginationPageInfo"},"__typename":"CategoryToPostConnectionPageInfo"},"__typename":"CategoryToPostConnection"},"slug":"personal-loans","ancestors":null,"parent":null,"__typename":"Category"}],"__typename":"PostToCategoryConnection"},"content":"$30","date":"2024-12-11T16:01:39","excerpt":"

\n","featuredImage":{"id":"cG9zdDoyNzEwNDY=","databaseId":271046,"altText":"A man looking up the differences between yield maintenance and defeasance.","date":"2024-12-11T15:55:59","fileSize":139532,"mimeType":"image/jpeg","modified":"2024-12-11T15:59:52","sourceUrl":"https://smartasset.com/wp-content/uploads/sites/2/2024/12/iStock-1498775342.jpg","__typename":"MediaItem"},"modified":{"datetime":"2024-12-11","readable":"December 11, 2024"},"multipleBylinesByRole":{"editedBy":{"id":"dXNlcjoxMTc=","databaseId":117,"userId":117,"avatar":{"url":"https://secure.gravatar.com/avatar/9fffe2eb35204e151b68731435d247c5?s=96&d=mm&r=g","size":96,"__typename":"Avatar"},"description":"Arturo Conde is a senior editor at SmartAsset. He has a master’s from the Graduate School of Journalism at Columbia University and a bachelor’s from the College of Arts and Science at New York University. As a certified educator in personal finance, he edits and writes content that focuses on retirement, investments, home buying and other financial topics.\r\n\r\nArturo is a bilingual native in English and Spanish, and also writes as a freelance journalist for NBC News, among other publications. 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Yield maintenance and defeasance are two common methods used to compensate lenders for the loss of interest income on commercial loans. Both terms refer to prepayment penalties designed to preserve the lender’s yield, but there are some differences in how they work. Whether you’re refinancing or prepaying a commercial loan, it’s a good idea to have a firm understanding of those differences so you can make the most informed decision for your situation. A financial advisor can also help you determine which option fits your finances.

","

What Is Yield Maintenance?

","

Yield maintenance is a type of prepayment penalty that ensures lenders receive the same yield they would have earned if the loan had been held to maturity.

","

When a borrower prepays a loan with a yield maintenance clause, they are required to pay a premium that compensates the lender for the loss of future interest income. This premium is calculated based on the difference between the loan’s interest rate and the current yield on a comparable Treasury bond for the remaining loan term.

","

Example of Yield Maintenance

","

For example, let’s say you have a $5 million loan at a fixed interest rate of 6%, set to mature in 10 years. If you decide to prepay the loan after five years and the yield on a comparable Treasury bond is 4%, you would owe a yield maintenance premium. This premium would be calculated to make up for the 2% yield difference for the remaining five years of the loan.

","

Lenders prefer yield maintenance because it provides predictable compensation. However, for borrowers, it can be costly, especially in a declining interest rate environment.

","

Yield Maintenance Formula and Calculation

","

Calculating a yield maintenance premium involves determining the present value of the remaining loan payments and compensating the lender for the difference between the loan’s interest rate and the yield on a comparable Treasury bond.

","

Below is the formula used to calculate yield maintenance:

","

Yield Maintenance (YM) = PV of Remaining Payments × (Interest Rate – Treasury Yield)

","

Where:

","

YM = Yield maintenance premium
PV = Present value of remaining loan payments
Interest Rate (IR) = The loan’s fixed interest rate
Treasury Yield (TY) = Yield of a comparable Treasury bond for the remaining loan term

","

The present value (PV) factor is calculated using this formula:

PV Factor = [1 – (1 + r)^(-n)] ÷ r

Where:

","

r = Treasury yield
n = Number of months remaining

","

Example of Calculation

","

Let’s assume a borrower has a loan balance of $80,000 with an interest rate of 6% and a remaining term of four years (48 months). The Treasury yield for a comparable term is currently 4%. Here’s how the yield maintenance premium would be calculated:

","$38","

In this case, the borrower would owe a prepayment penalty of $5,808.

","

What Is Defeasance?

","

","

Defeasance is another prepayment mechanism used in commercial real estate loans where the borrower replaces the original loan’s collateral with other assets, typically government securities, that generate enough income to cover the remaining payments. The original loan remains in place, but the new collateral ensures the lender continues receiving scheduled payments as if the loan had not been prepaid.

","

Example of Defeasance

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For example, say you want to refinance a $10 million commercial loan and before the maturity date. To complete a defeasance, you would purchase a portfolio of U.S. Treasury securities that match the loan’s payment schedule.

","

These securities are transferred to a trust, which uses their income to make the required loan payments. The borrower is then released from the loan’s obligations, and the lender continues to receive payments as originally agreed.

","

Defeasance is often used for loans securitized in commercial mortgage-backed securities (CMBS) because it allows the loan to remain in the security pool without disruption. While defeasance can provide flexibility for borrowers looking to refinance, it can be a complex and costly process, involving additional legal and administrative fees.

","

Yield Maintenance vs. Defeasance

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Both yield maintenance and defeasance serve the same purpose of compensating lenders for early loan repayment, but they differ in several ways:

","$39","

Frequently Asked Questions

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Who Benefits From Yield Maintenance or Defeasance?

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Both mechanisms primarily benefit lenders by preserving their expected yield. Borrowers may benefit indirectly by gaining the ability to refinance or restructure their loans.

","

Is Defeasance More Expensive than Yield Maintenance?

","

Defeasance can be more expensive due to the cost of purchasing replacement securities and additional legal fees. However, it provides flexibility for refinancing while keeping the loan intact.

","

Can Both Methods Be Negotiated?

","

In some cases, prepayment terms, including yield maintenance and defeasance, can be negotiated during loan origination. However, these terms are often non-negotiable in CMBS loans.

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Bottom Line

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","

Yield maintenance and defeasance both protect lenders’ interests, but they offer different advantages and drawbacks for borrowers. Considering the differences between these options can help investors and borrowers make more informed decisions when it comes to the complex nature of commercial loan prepayment. By evaluating costs, flexibility and loan structure, you can choose the approach that aligns with your investment portfolio.

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Investment Planning Tips

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Photo credit: ©iStock.com/ridvan_celik, ©iStock.com/fizkes, ©iStock.com/Delmaine Donson

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\n","featuredImage":{"id":"cG9zdDoxODUxOTM=","databaseId":185193,"altText":"How Do Payday Loans Work?","date":"2023-02-04T02:04:30","fileSize":43535,"mimeType":"image/jpeg","modified":"2023-02-04T02:04:30","sourceUrl":"https://smartasset.com/wp-content/uploads/sites/2/2015/07/payday-loans-1.jpg","__typename":"MediaItem"},"modified":{"datetime":"2023-5-16","readable":"May 16, 2023"},"multipleBylinesByRole":{"editedBy":null,"reviewedBy":null,"writtenBy":null,"factCheckedBy":null,"secondEditor":null,"hideAuthor":null,"__typename":"Post_Multiplebylinesbyrole"},"adTargetingOverrides":{"fieldGroupName":"adTargetingOverrides","pageGroupNewKey":null,"__typename":"Post_Adtargetingoverrides"},"seo":{"canonical":"https://smartasset.com/personal-loans/how-do-payday-loans-work","metaDesc":"Payday loans are personal loans with high-interest rates that can bridge a gap between paychecks. Here is what you need to know, including the risks.","metaKeywords":"","metaRobotsNofollow":"follow","metaRobotsNoindex":"index","readingTime":6,"title":"How Do Payday Loans Work? - SmartAsset","__typename":"PostTypeSEO"},"slug":"how-do-payday-loans-work","status":"publish","title":"How Do Payday Loans Work?","uri":"/personal-loans/how-do-payday-loans-work","tags":{"nodes":[],"__typename":"PostToTagConnection"},"__typename":"Post","adPageGroupOverride":null,"bylines":{"writtenBy":{"id":"dXNlcjo1MA==","databaseId":50,"userId":50,"avatar":"$3c","description":"Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.","additionalMeta":"$3d","email":null,"firstName":"Amelia","fullName":"Amelia Josephson","lastName":"Josephson","name":"Amelia Josephson","postCount":"$3e","slug":"amelia-josephson","__typename":"User"},"editedBy":null,"reviewedBy":null,"factCheckedBy":null,"secondEditor":null},"category":{"id":"dGVybTo1NDM3","children":"$41","databaseId":5437,"categoryId":5437,"link":"https://smartasset.com/personal-loans/articles","name":"Personal Loans","postCount":26,"slug":"personal-loans","ancestors":null,"parent":null,"__typename":"Category"},"isModifiedBeforePublished":false,"contentBlocks":["

Many Americans have income that fluctuates from week to week. When incomes are unsteady, any unexpected expense can leave you coming up short. If you don’t have a fully funded emergency fund, you may find yourself looking around for loans to bridge the gap and get you to your next paycheck. Payday loans are out there, but at a high cost to borrowers. Before taking out a payday loan you may want to first make a budget. You can work with a financial advisor who can help you make a long-term financial plan that you can budget your finances to meet.

","

Payday Loans: Short-Term Loans with a High Price

","

","

What are payday loans? Say you’re still 12 days away from your next paycheck but you need $400 for emergency car repairs. Without the $400 your car won’t run, you won’t make it to work, you’ll lose your job and possibly lose your housing too. High stakes.

","

If you go to a payday lender, they’ll ask you to write a future-dated check for an amount equal to $400 plus a financing fee. In exchange, you’ll get $400. You’ll generally have two weeks or until your next paycheck to pay that money back. Say the financing fee is $40. You’ve paid $40 to borrow $400 for two weeks.

","

If you pay back the money within the loan term, you’re out $40 but you’re not responsible for paying interest. But the thing is, many people can’t pay back their loans. When that happens, the money they borrowed is subject to double-digit, triple-digit or even quadruple-digit interest rates. It’s easy to see how a payday loan can lead to a debt spiral. That’s why payday loans are illegal in some places and their interest rates are regulated in others.

","

When your loan term ends, you can ask your payday loan lender to cash the check you wrote when you agreed to the loan. Or, you can roll that debt into a new debt, paying a new set of financing fees in the process. Rolling over debt is what leads to a debt spiral, but it’s often people’s only choice if they don’t have enough money in their account to cover the check they wrote.

","

Are Payday Loans a Good Idea?

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Not all debt is created equal. An affordable mortgage on a home that’s rising in value is different from a private student loan with a high-interest rate that you’re struggling to pay off. With payday loans, you pay a lot of money for the privilege of taking out a small short-term loan. Payday loans can easily get out of control, leading borrowers deeper and deeper into debt.

","

And with their high-interest rates, payday loans put borrowers in the position of making interest-only payments, never able to chip away at the principal they borrowed or get out of debt for good.

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Payday Loans and Your Credit

","

$\"How$ Payday loans don’t require a credit check. If you pay back your payday loan on time, that loan generally won’t show up on your credit reports with any of the three credit reporting agencies (Experian, TransUnion and Equifax). Paying back a payday loan within your loan term won’t boost your credit score or help you build credit.

","

But what about if you’re unable to repay your payday loan? Will that payday loan hurt your credit? It could. If your payday lender sells your debt to a collection agency, that debt collector could report your unpaid loan to the credit reporting agencies. It would then appear as a negative entry on your credit report and lower your credit score. Remember that it takes seven years for negative entries to cycle off your credit report.

","

Having a debt that goes to collections is not just a blow to your credit score. It can put you on the radar of some unsavory characters. In some cases, debt collectors may threaten to press charges. Because borrowers write a check when they take out a payday loan, debt collectors may try to press charges using laws designed to punish those who commit fraud by writing checks for accounts with non-sufficient funds (these are known as NSF checks).

","

However, future-dated checks written to payday lenders are generally exempt from these laws. Debt collectors may threaten to bring charges as a way to get people to pay up, even though judges generally would dismiss any such charges.

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Alternatives to Payday Loans

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If you’re having a liquidity crisis but you want to avoid payday lenders, there are alternatives to consider. You could borrow from friends or family. You could seek a small personal loan from a bank, credit union or online peer-to-peer lending site.

","

Many sites now offer instant or same-day loans that rival the speed of payday lenders, but with lower fees and lower interest rates. You could also ask for an extension from your creditors, or for an advance from your employers.

","

Even forms of lending we don’t generally love, like credit card cash advances, tend to have lower interest rates than payday loans do. In short, it’s usually a good idea to avoid payday loans if you can. Instead, consider working on a budget that can help you get to your next paycheck with some breathing room, and make sure you have a rainy day fund.

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The Bottom Line

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When considering a short-term loan, it’s important to not just look for low-interest rates. Between fees and insurance policies, lenders sometimes find ways to bump effective interest rates to triple-digit levels even if they cap their APRs. The risks of taking a payday loan bring home the importance of working hard to build up an emergency fund that you can draw on.

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Tips for Retirement Planning

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"],"experts":null,"link":"/personal-loans/how-do-payday-loans-work","published":{"datetime":"2015-7-1","readable":"July 1, 2015"},"shareInfo":{"title":"How Do Payday Loans Work?","origin":"/personal-loans/how-do-payday-loans-work"},"isNewsArticle":false},{"id":"cG9zdDoxNjU2NzY=","databaseId":165676,"postId":165676,"author":{"node":{"id":"dXNlcjo5Mw==","databaseId":93,"userId":93,"avatar":{"url":"https://secure.gravatar.com/avatar/04483497dbd73f712b504e401c9c7d22?s=96&d=mm&r=g","size":96,"__typename":"Avatar"},"description":"Mark Henricks has reported on personal finance, investing, retirement, \r\nentrepreneurship and other topics for more than 30 years. His freelance \r\nbyline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.","additionalMeta":{"expertise":null,"__typename":"User_Additionalmeta"},"email":null,"firstName":"William","fullName":"Mark Henricks","lastName":"Henricks","name":"Mark Henricks","postCount":{"pageInfo":{"offsetPagination":{"total":776,"__typename":"OffsetPaginationPageInfo"},"__typename":"UserToPostConnectionPageInfo"},"__typename":"UserToPostConnection"},"slug":"mhenricks","__typename":"User"},"__typename":"NodeWithAuthorToUserConnectionEdge"},"categories":{"nodes":[{"id":"dGVybTo1NDM3","children":{"nodes":[],"__typename":"CategoryToCategoryConnection"},"databaseId":5437,"categoryId":5437,"link":"https://smartasset.com/personal-loans/articles","name":"Personal Loans","postCount":{"pageInfo":{"offsetPagination":{"total":26,"__typename":"OffsetPaginationPageInfo"},"__typename":"CategoryToPostConnectionPageInfo"},"__typename":"CategoryToPostConnection"},"slug":"personal-loans","ancestors":null,"parent":null,"__typename":"Category"}],"__typename":"PostToCategoryConnection"},"content":"$44","date":"2022-07-13T14:34:55","excerpt":"

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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.

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Private Money Lending Basics

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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.

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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.

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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.

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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.

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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.

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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.

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Pros of Private Money Lending

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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.

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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.

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Cons of Private Money Lending

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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.

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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.

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Bottom Line

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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.

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Tips for Borrowing Money

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