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Frequently Asked Questions

WHAT IS A PRIVATE MONEY LENDER?

A private money lender is an investor who makes loans secured by real estate, typically charging higher rates than banks but also making loans that banks would not make, funding more quickly than banks and/or requiring less documentation than banks.

WHAT DIFFERENTIATES PRIVATE MONEY LENDERS FROM BANK LENDERS?

Private money lenders differ from bank lenders in that they often fund more quickly, with fewer requirements. Private money lenders are sometimes called “asset-based lenders” because they focus mostly on the collateral for the loan, whereas banks require both strong collateral and usually excellent credit and cash flow from the borrower.

Private money lenders are willing to foreclose on and “take back” the underlying property if necessary, to satisfy the loan. Bank lenders typically look at the borrower to be able to pay back the underlying loan from the borrower’s income, whereas private money lenders are comfortable looking to a sale or refinance of the property as the method of repayment.

WHY DO PRIVATE MONEY LENDERS EXIST?

Private money lenders exist because many real estate investors need a quick response and quick funding to secure a deal when looking for a real estate loan. Banks and other institutional lenders that offer the lowest interest rates don’t provide the same combination of speed and transparency in their decision-making process, along with quick access to capital.

WHEN DOES IT MAKE SENSE FOR DEVELOPERS TO USE A PRIVATE MONEY LOAN?

In our experience, even investors/developers with strong financial statements and access to bank credit frequently choose to use private money loans (also called “private money loans”). Situations, where private money loans make the most sense, include those where the borrower:

• Requires a quick closing and banks cannot meet the deadline;
• Has more good opportunities than cash;
• Wants to avoid spending too much time raising equity or debt from many different smaller investors, but prefers to instead focus on finding new opportunities;
• Lacks the patience or time to deal with¬†the bureaucracy¬†of securing a loan from a bank;
• Has an excellent investment opportunity, but does not have sufficient financial strength to get a bank loan, and/or;
• Has a bank line of credit but needs a larger loan than is allowed under the existing bank line.

The common theme is that there is an opportunity for the borrower to generate substantial profit (or savings) quickly, and the cost of interest and origination fees is small relative to the anticipated profit, even given the higher interest rates charged by private lenders versus banks.

WHAT ARE OTHER TERMS FOR PRIVATE MONEY LOANS?

Private money loans are also sometimes referred to by the following terms: (1) private money loans; (2) bridge loans; (3) short-term loans; (4) transitional loans; (5) asset-based loans; (6) rescue loans.

ARE PRIVATE MONEY LOANS USED MAINLY WHEN THE BORROWER IS IN DISTRESS?

Private money loans are also sometimes referred to by the following terms: (1) private money loans; (2) bridge loans; (3) short-term loans; (4) transitional loans; (5) asset-based loans; (6) rescue loans.

WHAT ARE THE ADVANTAGES OF PRIVATE MONEY LENDERS?

Private money loans can have a number of advantages over traditional bank financing including:
* A simpler application process and quicker approval/disapproval decision;
* Less scrutiny of the borrower’s personal financial situation, including income and historical tax returns, compared to bank loans;
* Borrowers can allocate less time to seeking financing and instead concentrate on other business;
* Borrowers can avoid the humiliation of being rejected by a bank;
* Most private money lenders do not expect perfect credit and substantial amounts of disposable income from borrowers, but instead focus on the merits of the specific deal under consideration;
* Self-employment is not seen acceptable to private lenders, whereas many banks view self-employment negatively and strongly prefer lending to professionals with very steady income.

WHAT ARE SOME DISADVANTAGES OF PRIVATE MONEY LENDERS?

Disadvantages of seeking a private money loan may include:
* Private money loans are more expensive than bank loans, with higher interest rates and origination fees;
* The quality of private money lenders varies substantially from one lender to another; some are unscrupulous and may be seeking to have the borrower default in order to foreclose on the underlying real estate as a business strategy;
* Some lenders may collect non-refundable deposits without having the capital required to make the loan; they may either hope to find the capital once the loan is “tied up” or in rare cases, they may simply aim to collect the deposit with no intention of funding the loan.

WHAT KINDS OF PROPERTY DO PRIVATE MONEY LENDERS LEND ON?

Private money lenders will lend on both commercial and residential properties, although many will not lend on owner-occupied residences due to higher thresholds of scrutiny required by law. Commercial properties can include industrial, shopping centers, and office buildings. Some, but not all, private money lenders will also invest in raw land slated for development and even hotels.

Vacation homes (single family residences), even if not a primary residence, are considered “owner occupied” and may or may not be financeable depending on the lender’s criteria regarding owner-occupied home loans.

WHEN SHOULD YOU USE A PRIVATE MONEY LENDER?

A borrower might consider using a private money / private money loan in situations where he or she is willing to pay a higher interest rate and/or higher up-front fees in the interest of gaining access to capital more quickly, dealing with less bureaucracy and more transparency during the application process, and finding capital to pursue an opportunity that banks will not finance, either because they are unwilling or unable to do so.

WHAT DOES THE TERM “HARD” MEAN IN “PRIVATE MONEY LENDER”?

The “hard” in private money lending refers to the higher price which is charged to borrowers both in terms of interest rates (typically high single digits or low double digits) and higher loan origination fees (often around 2 percent of the loan amount, versus 1 percent or less for a typical bank loan).

WHO FUNDS PRIVATE MONEY LOANS?

Private money loans are typically funded by individuals or by funds that aggregate capital from multiple wealthy investors. Individuals who invest directly into a single loan are known as trust deed investors. Many trust deed investors are real estate investors/owners who invest in “bridge loans” to keep available capital working to generate a higher rate of return, rather than leaving the capital in banks earning minimal interest rates. Investors who prefer to invest passively in a fund are typically not as experienced in real estate investment and choose to pay the fund manager a fee to oversee the process of sourcing, selecting and originating a series of bridge loans.

HOW DO I GET A PRIVATE MONEY LOAN?

The best way to secure a private money loan is to know or be referred to a reputable private money lender. The prospective borrower can simply call and describe the nature of the project for which capital is desired. When presenting a project to a lender, the borrower should be prepared to provide the following information:

Deadlines and dates which are critical to the transaction (for example, the closing date for a purchase if the borrower is seeking a purchase money loan);
The specific property address;
Whether the loan is for a property acquisition or refinancing of an existing loan;
The purchase price of the property;
The intended renovation budget;
The intended asking price for the property (assuming the project is going to be resold after renovation);

WHAT COMPANIES PROVIDE PRIVATE MONEY LOANS?

A variety of companies provide private money loans, with some specializing in commercial, some residential, and some investing in both categories. Major commercial banks often have bridge lending programs targeted at opportunities in the $20MM and greater loan size, while many privately operated funds specialize in the $10MM – $20MM range. At the $5MM and less loan size, there are mostly small regional operators, often comprised of real estate developers with sufficient cash liquidity that prefer to invest short-term real estate loans rather than the stock or bond markets.

On the residential front, in addition to private investors, there are a number of funds that will invest in single-family homes, including Arixa Capital Advisors, Lone Oak Fund, Genesis Capital, Athas Capital and Anchor Loans.

WHAT DOCUMENTS ARE INVOLVED IN A PRIVATE MONEY LOAN?

Typical loan documents required for a Private Money loan include a Note and a Deed of Trust; other documentation requirements do vary but may include a personal guarantee from borrower (sometimes non-recourse loans are issued without a personal guarantee); personal financial statements such as past tax returns and proof of income; and assurance that the borrower has access to sufficient cash to perform any and all proposed property renovations.

WHAT IS THE PURPOSE OF A LETTER OF INTENT?

The purpose of a Letter of Intent (LOI) for a Private Money loan is to provide a quick means to be sure that both the prospective borrower and lender are on the same page.

Although this document is not legally binding on either party, it serves to put the prospective deal “in writing” and helps to avoid any miscommunication or misunderstandings.

WHY DOES THE LENDER NEED TITLE INSURANCE?

Title insurance helps protect someone who has purchased real estate against another party making a claim challenging the ownership of the property and the seller’s right to enter into a transaction. Well known title insurance companies include Fidelity National, First American Title, and Chicago Title. The title insurance company will handle any issues that arise during the property sale, and if a competing claim of ownership is deemed legitimate, the title insurance company is responsible for payment of any fees to the claimant. The reason why Private Money lenders insist on being covered under title insurance is to enjoy the same protection as the borrower.

WHAT HAPPENS IN THE EVENT THAT A MECHANIC’S LIEN IS FILED ON A PROPERTY?

A Mechanics Lien is used in the construction trade when a property owner either fails to pay a general contractor for services rendered, or the general contractor fails to pay sub-contractors according to the terms of their agreements. Since title insurance does not provide any protection against this, Private Money lenders will protect against possible Mechanics Liens by making sure that if a loan includes a renovation budget, that all sub-contractor and general contractor releases are properly executed before disbursing funds to a borrower.

HOW MUCH DO PRIVATE MONEY LENDERS CHARGE?

Private Money lenders typically will charge interest rates in the high single digits to low double digits, with a range of 7.5 percent to 12 percent is considered standard. Additionally, origination fees can range from 1-3 points, with any additional points above this range usually signaling that there are numerous brokers involved in the transaction. It should be noted that points paid on a longer-term loan may be beneficial if the borrower needs capital for a longer period of time, as it is not uncommon for many Private Money lenders to include pre-payment penalties which guarantee the lender a minimum number of months of interest on the loan principal.

Borrowers should also be aware that extension options are possible on Private Money loans and are a matter of negotiation with a lender.

IS A PRIVATE MONEY LOAN PERSONALLY GUARANTEED?

Some lenders may require that a Private Money loan be personally guaranteed by the borrower, although there are instances where lenders are willing to offer no-recourse loans based on the borrower’s history and the appeal of the specific opportunity.

WHAT ARE TYPICAL PRIVATE MONEY LENDERS TERMS?

The typical term for a Private Money loan is 6 months to 3 years. Loans requiring greater than a 3-year maturity are usually outside the scope of this form of financing.

Single-family home renovations would tend to be 6-12 months in duration, while a commercial shopping center renovation term would likely be 2-3 years.

Private Money loans often require a personal guarantee and require first positioning as the lender of record, although some lenders are willing to make subordinate junior loans where another lender holds the primary mortgage.

SHOULD I GIVE A DEPOSIT TO A PRIVATE MONEY LENDER?

Prospective borrowers for a Private Money loan should think carefully before paying a deposit to a lender; if a loan is for a single family home renovation there should not be a deposit charged. However, for larger, more complex transactions with a lot of underwriting requirements, payment of a deposit is more warranted.

WHAT ARE TYPICAL PRIVATE MONEY LENDERS FEES?

The fees usually associated with a Private Money loan will include origination fees of 1-3 points, possibly a deposit fee, plus an underwriting fee to ensure the loan conforms to necessary lender requirements.

Borrowers should be wary of individuals or entities trying to make money from the deposit fee with the hope of getting a loan done “after the fact” due to a lack of available capital.

HOW CAN BORROWERS NEGOTIATE THE BEST RATE ON A PRIVATE MONEY LOAN?

A borrower can negotiate the best rate for a Private Money loan by having multiple lenders willing to compete for the business. This, in turn, means that the prospective borrower needs to be well-organized and have all necessary documentation ready for inspection; ideally having a strong credit history, and impressing upon prospective lenders that the proposed project meets their needs and risk profile.

WHAT HAPPENS IF A BORROWER DOESN’T PAY THE PRIVATE MONEY LENDERS BACK?

A borrower who defaults on a Private Money loan ultimately is subject to having the lender foreclose on the property which has been put up for collateral. It should be noted that lenders typically follow a sequence of steps in order to try to avoid this final recourse. Such steps may include the lender attempting to reach the borrower to find out the current status and disposition of the property in order to see if things can be worked out cordially; the penultimate step is to file a Notice of Default if necessary to trigger the legal foreclosure process.

WHAT IS THE MAXIMUM LOAN-TO-COST FOR PRIVATE MONEY LENDERS?

Private Money lenders utilize two different measures to evaluate deals: loan-to-cost (LTC) and loan-to-value (LTV) metrics. While risk tolerance is highly dependent upon the lender, most prudent Private Money lenders will not exceed a loan-to-cost ratio of 75 percent, while the loan-to-value ratio is usually kept in the 60 to 65 percent range to ensure a sufficient safety margin.

Lenders may use the lesser of the LTC or LTV values to assess a loan, depending on when the property was purchased; in the instance of more recent purchases, lenders will look at what the borrower paid for the property.

WHAT DO DUE DILIGENCE INFORMATION PRIVATE MONEY LENDERS REQUIRE?

Private Money lenders have different requirements for the due diligence process, but generally speaking, the origination of commercial loans will require the most comprehensive list.

Residential loans may require an appraisal from an outside party; a property inspection report; a geology inspection (particularly based on the locale of the structure); and the borrower’s financial records. An in-person inspection of the property is nearly always part of the decision-making process, which is why Private Money lenders tend to have a localized focus.

ARE PRIVATE MONEY LOAN INTEREST RATES USUALLY FIXED RATE OR FLOATING RATE?

Most Private Money lenders that specialize in single family homes offer loans that are based on a fixed rate but with commercial properties, a floating rate is more common due to the longer term of maturity.

It is worth noting that floating rate loans may have a lower initial rate, but this can quickly exceed fixed rates if interest rates rise during the term of the loan.

ARE ALL PRIVATE MONEY LOANS BACKED BY REAL ESTATE?

While most Private Money loans are backed by real property as collateral, some bridge loans are not real estate backed, the most notable exceptions existing when a Private Money loan is backed by another loan from a third-party institution.

ARE OWNER-OCCUPIED HOME PRIVATE MONEY LOANS DIFFERENT FROM ALL OTHER TYPES?

Owner-occupied Private Money loans are different from other types, due to state laws requiring extensive documentation intended to protect the borrower from predatory lenders. Many Private Money lenders are not set up for compliance in this regard and therefore will not make loans for owner-occupied residential properties.

CAN BORROWERS GET A PRIVATE MONEY LOAN EVEN IF THERE IS ANOTHER LOAN ALREADY IN PLACE?

It is possible for borrowers to secure a Private Money loan even if another loan is in place, although this will require either the borrower getting a new Private Money mortgage to replace the existing first mortgage or qualifying for a subordinate junior loan which leaves the first mortgage in place.

WHEN DOES IT MAKE THE MOST SENSE FOR BORROWERS TO USE PRIVATE MONEY LOANS?

While seeking a Private Money loan is a personal decision which will vary depending on the individual, situations where Private Money loans are generally a good recourse are when the borrower is anticipating a large profit from a real estate transaction or realizing large savings in a short amount of time.

HOW CAN BORROWERS NEGOTIATE THE BEST RATE ON A PRIVATE MONEY LOAN?

A borrower can negotiate the best rate for a Private Money loan by having multiple lenders willing to compete for the business. This, in turn, means that the prospective borrower needs to be well-organized and have all necessary documentation ready for inspection; ideally having a strong credit history, and impressing upon prospective lenders that the proposed project meets their needs and risk profile.

WHAT RISKS DO BORROWERS FACE WHEN WORKING WITH A PRIVATE MONEYLENDER?

Borrowers that secure a Private Money / Private Money loan face the following risks:
Risk of lost time if a lender does not perform;
Risk of lost deposit if a deposit is required, and the lender does not ultimately make the loan;
Market risk and execution risk on the underlying project;
Risk of associating with a less than reputable lender;
The risk that the lender fails to come up with the loan amount in a timely manner, possibly endangering a deal (for example, if money is not placed into escrow by a pre-determined deadline).
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HOW ARE PRIVATE MONEY LENDERS REGULATED?

Private Money lenders are typically regulated at the state level via the Department of Real Estate, as at least one person associated with Private Money lending must have a valid Real Estate Broker License. Additional licensing requirements may be required on a state-by-state basis.

Cross-state transactions fall under the jurisdiction of both states involved and are subject to each state’s respective requirements. Securities licenses are usually not required for Private Money lending unless a loan is classified as a securities offering due to the loan being syndicated to multiple investors.

HOW DO PRIVATE MONEY LENDERS COMPARE WITH BANKS?

Private Money lenders are licensed differently with less regulatory scrutiny than traditional banks and can look at the merits of a loan more so than a bank, which must meet certain non-negotiable criteria to issue a loan.

HOW CAN YOU TELL IF PRIVATE MONEY LENDERS ARE REPUTABLE?

It is essential for borrowers to ascertain whether a lender is reputable, to avoid disappointments, wasted time, and lost opportunities. A borrower can research a prospective lender using the following techniques:

Ask for references from clients/borrowers and mortgage brokers; talk to the references.
Consider working with a local mortgage broker who has done transactions with that lender;
Confirm that the lender has a valid Real Estate Broker License;
Determine whether any complaints have been filed against the Real Estate Broker License;
Consider checking with the Better Business Bureau (BBB);
Find out what industry events the lender attends and ask people at the event about the lender’s reputation.

HOW LONG DOES IT TAKE PRIVATE MONEY LENDERS TO FUND A LOAN?

It generally will take a Private Money lender 30 days or less to fund a loan, although some are equipped to do this in two weeks or less.

CAN BORROWERS WHO START WITH PRIVATE MONEY LENDERS MOVE ON TO WORKING WITH BANKS INSTEAD?

It is possible for borrowers who start with a Private Moneylender to transition to working with a bank later in the process. This may happen if the borrower has a recent credit issue (such as a past foreclosure or bankruptcy) and the Private Moneylender is used to “age out” that credit issue until the borrower qualifies with the bank. A borrower may also choose to enter into a Private Money loan prior to seeking a traditional bank loan in order to demonstrate performance and creditworthiness.

Borrowing from a Private Money lender can act as a bridge to receiving future credit in that it builds a track record and can also enhance the borrower’s financial strength, assuming the underlying investment for which the loan is used proves successful.

WHY ARE BANK LOAN INTEREST RATES SO MUCH LOWER THAN PRIVATE MONEY LENDERS INTEREST RATES?

Banks can offer lower interest rates than Private Money lenders because banks can fund loans via retail deposits on which they pay minimal interest rates. Private Money lenders fund loans via private capital which has higher expectations. For example, in early 2013 most bank depositors earn 1% or less on their deposits while most investors in Private Money loans expect 7% or more, to compensate for the greater risk of loss of principal.
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HOW DO PRIVATE MONEY LENDERS COMPETE?

Private Money lenders will compete on fees, interest rates, their reputation, and quality of service, which includes the ability to fund a deal quickly and being more accessible to the borrower during the term of the loan and/or flexibility in case of unforeseen events and how the lender responds to special borrower requests that may arise.

HOW DO PRIVATE MONEY LENDERS DIFFER FROM ONE ANOTHER?

Private Money lenders differ from one another in a number of ways, including their lending criteria such as loan-to-cost and loan-to-value guidelines; the type of real estate on which they lend; minimum and maximum loan size; the geographic region they serve; their industry reputation; and level of service which is provided.

DO PRIVATE MONEY LENDERS COMPETE ON PRICE?

Private Money lenders will compete on price, but the reputable firms tend to be close to each other in pricing due to the competitive nature of the market. Service is typically the greatest differentiator, along with the lender’s relationships, dependability, and ability to perform once a loan is agreed to.

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