Why You Should Consider Private Lending for Your Financing Needs
When it comes to investing in real estate, or starting and scaling a business, one of the most critical aspects you have to think about is money—funding.
Capital is always at the heart of a business venture, and it can make or break a business.
But what is lost on many business owners is that you don’t have to dip into your own pocket to finance a business.
There are several strategies you can employ to raise funds to finance a deal, and one of those is private lending.
Understanding Private Lending
Borrowing from conventional lenders has a lot of red tape involved, which can be daunting even for the most optimistic. Now, imagine being a house flipper or a heavy equipment broker where you have to dash to the bank or credit union for financing every time you come across a good deal.
Not at all, feasible, is it?
If your credit is damaged, your options become even thinner.
Enter private lending.
Private money lenders are basically individuals or investors who lend money to real estate investors and businesses to purchase or refinance a property or large equipment.
They are non-institutional lenders who are not subject to any regulation and fall into three categories:
- The primary circle: This comprises family and friends.
- The secondary circle: This circle is made up of those immediately outside your social circle. Think colleagues, professional acquaintances, and personal acquaintances.
- Third-party circle: These are lenders furthest away from a borrower with regard to relationship. They include hard money lenders and accredited investors.
Hard Money Lenders
When people talk about private lending, mostly they are referring to hard money lenders—the kind that we will be discussing in this article.
Hard money lenders are individuals or private groups looking for better returns than they are likely to get through traditional investment vehicles. Others could be institutional groups seeking a more competitive return that is actively managed at the same time.
These lenders do look at your credit some times, but they focus more on the collateral securing the loan than your ability to repay. In the event things go pear-shaped and you are unable to pay back the money, hard money lenders recoup their funds by taking over the collateral and selling it.
Also of great importance is your track record in the game. Private lenders, for obvious reasons, are mostly at ease with real estate investors who have a proven track record flipping houses. You would be, too.
Where does that leave the new investor, then?
Well, it all has to start somewhere, so if you have a compelling enough reason for them to jump into bed with you, there is no reason they wouldn’t be willing to finance your deal since they are also benefiting from it.
However, this might take some convincing to do. If you can successfully tap into your immediate sphere first (the primary or secondary circle), that should be enough to build you some bit of credence.
It is also worth noting that hard money loans, also known as bridge loans, tend to be mostly short-term in nature—usually between one to five years (or even a couple of months if you want to borrow for only a short while).
By and large, they are a great source of financing for every type of investor out there, whether a short-term fix-and-flipper or long-term investor.
The Pros and Cons of Borrowing from Hard Lenders
Hard money lending is a great option for those who cannot get traditional funding when they need it.
It’s hard to even compare the speed at which funds are processed to the awfully slow process associated with traditional lenders, even for those with impeccable credit and a steady income stream. In a hot market where multiple offers are commonplace, the importance of this cannot be emphasized enough.
Private lenders don’t use a standardized underwriting process like their traditional counterparts, something that makes hard money agreements a lot more flexible. You are dealing with an individual who might be willing to accommodate your needs, not a large corporation with strict policies.
Hard money lending may have its benefits, but it comes with the huge downside of being a bit pricey. Interest on these loans might be in the double figures since the duration is typically shorter.
The shorter duration also means hard money loans charge more in pre-paid interest, thus making them costlier.
We also cannot overlook the fact that borrowers are required to have a significant stake in the deal. This will depend on your agreement with the lender, but on average, most lenders require you to stake 25% equity in the deal.
As a real estate investor or business owner, it behooves you to evaluate each and every deal before you approach a hard money lender. For all its benefits, you don’t want to have a white elephant on your hands.
Do you use private or hard money lending for your deals? Why or why not?
[Editor's Note: This article was originally posted on BiggerPockets.]