Investing in real estate is essentially one of the smartest and safest strategies to promote wealth building. With the proper foundation and knowledge, investing in real estate can be highly lucrative for anyone. But let’s be honest, you already knew that. However, of particular interest is what an investor can do with the money they make from a profitable career.
While a portion of profits will undoubtedly be allocated to the lifestyle of their choice, investors are advised to be smart with their money. Of course, you can reinvest into another property, but if you are looking for an alternative, there may be one option you haven’t considered yet: private money lending.
Investors who have the funds to do so should consider private money lending in real estate. This process offers the same type of underlying security and profit potential as rehabbing or wholesaling, but without actually acquiring new properties.
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What Is Private Money Lending?
Private money lending is when individuals lend their own capital to other investors or professionally managed real estate funds while securing said loan with a mortgage against real estate. Essentially, private money lending serves as an alternative to traditional lending institutions, like big banks.
As rookie investors gain experience, they strive to aim higher. Leaving your hard-earned money in a savings account is no way to protect and grow your assets. Private money lending allows you to secure a loan with real estate worth much more than the loan. In some ways, this process can be less risky than owning real estate. That’s why it’s essential to familiarize yourself with the best real estate financing options available to today’s investors.
In the past, real estate financing typically came from banks, government agencies, insurance companies, and pension funds. However, with a list of strict requirements and a timeline not conducive to the average real estate investor, a need for alternative lending sources quickly developed. At the same time, it became obvious to those with appropriate funds that their money could better serve investors than large institutions. Now, private money lending is a critical component of the real estate investment industry. In fact, its presence makes it more possible for the average investor to run and maintain a sustainable career.
If you were unaware, there are several benefits involved for those who choose to lend private money. Offering alternative real estate financing options can mitigate risk while simultaneously establishing wealth if done correctly. Of course, this is not a path for everyone, and you need to ask yourself if you can afford to do so. Having a little extra money in the bank does not necessarily mean you should throw it at the first investor who comes your way. If you are equipped to mitigate potential risks and take advantage of the opportunities that present themselves, private money lending may warrant your consideration.
Who Should Consider Private Money Lending?
You may want to consider private money lending if one of the following applies to you:
You are a real estate investor looking to expand your portfolio.
You are a doctor, lawyer, CEO, or professional of another kind who has a great income or a surplus of cash.
You have a sizable retirement savings account.
You are a retiree looking for a passive income investment.
You are owner of an estate or other trust fund.
You are a tech entrepreneur who owns a successful start up.
You are a lottery winner.
You want to and are able to help out a friend or family member.
Still on the fence? Don’t worry; the following will answer any questions or concerns you may have about pursuing a private money lending business:
Private Lending Companies
As private loans become more common, so do private lending companies. Many private lending companies are groups of investors who pool their capital to finance more deals, and increase profits. These companies earn money through interest payments, similar to traditional lenders, but they often have much different application requirements. Many private lending companies operate virtually, and are even sometimes called online lenders. Overall, they can be yet another way to finance your next deal.
The Anatomy Of A Private Money Loan
The concept of a private money loan is relatively simple. Three elements are required for a loan of this nature to transpire: a borrower, a lender, and a lot of paperwork.
For all intents and purposes, private money lending is perhaps your best chance to invest in real estate with no money of your own. If for nothing else, private money loans can provide for investors in need. While they seem to serve the same purpose as traditional lending institutions, several key differences exist. Private money loans typically charge higher rates than banks, but they are also more available in cases an average bank would pass on. Additionally, banks and other financial institutions typically do not provide the same combination of speed and transparency in the decision-making process.
How To Become a Private Money Lender
As I mentioned above, private money lending can offer several benefits for everyone involved. It is not uncommon for investors to eventually expand into private money lending themselves due to these benefits. According to Shaun Heng, the VP of CoinMarketCap, “legally, anyone can be a private money lender. However, there are a variety of rules and regulations that you must follow, including usury laws. That said, private money lending isn’t for everyone. If something goes wrong with the deal, you could have heavy losses. It’s important to be an expert or work with one to make sure all the paperwork is lined up and that you aren’t at risk of being scammed. If you have a knack for figuring things out on your own, outside the normal system, then private money lending might be for you”. If you are interested in private money lending, there are a few steps you can follow:
Establish your business and obtain the required insurance.
Meet with a lawyer to create your company structure.
Identify your preferred lending focus.
Join a peer to peer lending platform or network to find possible investments.
Evaluate any potential clients by calculating potential returns and risk levels.
Start your business in private money lending.
Private Money Lending: How To Identify Borrowers
The concept of private money lending is relatively simple: without money, real estate investing does not exist. Like in every other industry, money is the lifeblood of an investor. Real estate investors need to actively work on securing private money loans to fund their deals. More often than not, the average investor cannot fund a deal with their own money. Moreover, even if the funds are readily available, investors will seek the assistance of private money. Regardless of a particular investor’s situation, there is a particular likelihood of them needing private money assistance. Instead of pooling money or stretching every dollar, investors are given more options to grow their business using private money.
Perhaps even more important is the speed and efficiency in which private money may be obtained. The speed of implementation is critical to an investor, and it can mean the difference between closing on a deal and losing one. Having the money promptly can make it that much easier to close a deal.
With private money lending, you will be confronted with several types of borrowers. While each is unique, they are all looking for the same thing. Here are the four types of borrowers you may encounter:
Rehab/Sell: This type of investor will typically purchase a residential property and complete renovations with the intention of reselling it once the project is complete. Borrowers in this sector find private money attractive because conventional banks will often not lend to properties in poor condition. Perhaps even more importantly, access to private money is more conducive to a timely and profitable flip.
Rehab/Rent: These investors typically purchase a residential property and complete renovations with the intention of renting the property for cash flow purposes. These borrowers find private money attractive for the same reasons as investors in the rehab/sell category.
Builders/Developers: Builders and developers will purchase vacant land to permit and develop into residential or commercial use. Borrowers in this sector are interested in private money primarily based on the speed with which the funds can be available. Also, many banks will not lend on speculative development.
Commercial Investors: This population of investors may seek to use private money as a “bridge loan” for a commercial property when a conventional bank will not lend on an un-stabilized asset.
Money Lending: How To Get Paid
Private money lending is attractive because of its flexibility, not only to borrowers but also to lenders. You see, with a traditional loan, lenders will generate income through interest payments made by the borrower. On the other hand, private loans allow lenders to negotiate exactly how (and when) they will be paid back for the loan. This opportunity opens up several perks not traditionally offered to investors. Read through the following agreements to learn more about making money as a private lender.
Joint Ventures: As a private money lender, a profit split can be one of the most attractive options for financing an investment. Investors can negotiate to receive a percentage of the final profits in this type of agreement. The amount will vary based on the contract and the investment, though it could be quite profitable. In some cases, private money lenders will even find borrowers who propose this option. Just make sure you believe in the potential success of the deal, and you are all set.
Exit Fees: This loan structure requires the borrower to pay a predetermined amount at the end of the loan term. The exit fee is often negotiated as a percentage of the overall price of the investment. In some cases, lenders may even negotiate an increasing exit fee that changes depending on when the loan is paid in full. For example, if the borrower needed a few extra months to repay the loan, then they would pay a larger exit fee.
Interest Payments: As I mentioned above, interest payments are one of several ways to generate income from a private money loan. In fact, this is the most common setup in private money. Lenders can set an interest rate at the time of the loan approval and sit back and wait for the money to arrive. Typically, private money loans are associated with higher interest rates than other loans, making this a particularly attractive arrangement for lenders.
Points: Points are essentially fees paid by borrowers in exchange for lower interest rates. Points are calculated as percentages of the overall loan, with one point referring to one percent of the loan amount. Some lenders prefer this system because points allow them to be paid in larger sums, with additional interest payments to follow. More often than not, points are paid at the beginning of the loan term and are suggested by the borrower as an incentive for granting the loan.
Become A Private Money Lender: Tips From The Pros
Simply put: private money lending allows you to act as the bank for other investors. Rather than directly purchasing assets, you get the opportunity to fund those owned by colleagues and partners. By now, you likely realize how beneficial this setup can be. However, you should know a few more things before getting started. Read through the following tips before taking on your first deal as a private money lender:
Start Out Small: Identify a range you are comfortable working with, and stick to it. The number one mistake private money lenders make when starting out is spreading themselves too thin. Assess your finances and your preferred level of risk, and create clear guidelines for potential projects. If someone approaches you searching for more than you want to offer, do not be afraid to refer them elsewhere.
Find A Good Attorney: Becoming a private money lender doesn’t make you a lawyer. You will still need help when it comes to negotiating and reviewing contracts. Additionally, if you start a private money lending business, there are several legal protections you need to have in place before getting started. Find a qualified real estate attorney in your area and bring them on to your team. Their role in your company will be invaluable over time.
Work Locally: There are profitable real estate deals all over the country; however, there are also deals right under your nose. If you decide to start your private money lending business locally, you can meet face to face with investors. Additionally, you will likely be more available for communications and future investment options. Don’t underestimate the potential of your own market; you never know what kind of deals may come your way. You can always expand in the future.
Be Transparent: Avoid inflating your portfolio or background to attract potential investments. No matter what point you are at in your investing career, let your work speak for itself. You don’t want to misrepresent yourself or your lending business. Always maintain transparency and stay true to your mission and values.
Don’t Forget About Yourself: Remember, just because you aren’t purchasing assets directly does not mean you aren’t an investor. Continue your professional and financial education even if you opt for the role of lender. You still need to stay on top of market trends, financial news, and other factors impacting the real estate world. While you don’t have a hands-on role in the investments you finance, you still need to have strong business acumen.
Learn The Subject Matter: Review the types of borrowers listed above and familiarize yourself with the different deal types. Learn what factors go into a successful rehab, buy and hold, or rental property. That way, when a borrower pitches a deal, you know how to evaluate it for yourself. Obviously, they will paint the investment in a good light, but is it actually profitable? To be a successful private money lender, it is crucial to understand exactly what goes on in the niche you choose to invest in.
Decide On Loan Terms
As the lender, it is in your power to decide on the terms of the loan. This includes determining the interest rate, loan term, closing costs, and whether or not there is a down payment. There is not one set formula when becoming a private money lender, instead investors often vary the terms from project to project. Consider each investor that approaches you and the factors of the property. The information included in their pitch will help you decide the best loan terms for the situation. Remember, once you are locked into a contract you must honor the terms of that loan but you can always change your approach from one deal to another to find the right arrangement.
Regulation Of Private Money Lending
Private money lenders must comply with state and federal regulations surrounding loan providers. These regulations most commonly come into play when determining how many loans can come from one lender without a banking license. Essentially, regulations aim to limit the amount of loans a private citizen can provide. After a certain point, lenders are required to seek out a license. Always make sure you are aware of your states requirements so you do not break these regulations.
What Is Hard Money Lending?
Hard money lending is another alternative to traditional lending sources and allows borrowers to use the investment (in many cases, a property) as collateral on the loan. While many lending sources rely on a borrower’s credit history, hard money lending relies on the asset in question. Hard money lending will typically require higher interest fees than traditional loans but can provide borrowers with increased access to capital and a more lenient approval process. Investors with low credit and high equity in a property will often turn to hard money for funding. Additionally, property owners at risk of foreclosure may also utilize hard money loans.
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How To Become A Hard Money Lender
Hard money lending can represent a unique opportunity for investors with extra capital on their hands. Though, with any financial decision it is important to mind due diligence and premeditate any potential risks. If you are interested in becoming a hard money lender, here are a few steps you can follow:
Name your business and create your company structure.
Set up an online presence for your business.
Seek legal counseling on the creation of a limited liability company.
Investigate potential investment opportunities.
Make a business plan and draft the criteria of future loans.
Project the future financial outcome of any potential loans.
Launch your hard money lending business.
Pros Of Hard Money Lending
Hard money lending gives investors the chance to stay active in real estate without necessarily adding a property to their portfolios. Some hard money lenders may never purchase a property themselves at all. This can be a huge perk for anyone without the time and resources to actually acquire a real estate deal, as it allows lenders to tap into the lucrative potential of real estate without “getting their hands dirty,” so to speak.
Another major benefit of hard money lending is the degree of control it offers. Hard money lenders get the final say in who they work with and on what terms. Anyone who has purchased a piece of real estate likely remembers the process of applying for funds, waiting on application approvals, and going through negotiations. Being a hard money lender puts you in the driver’s seat—and that is quite an attractive perk for many.
Cons Of Hard Money Lending
With any financial opportunity, there are going to be cons involved. For those interested in hard money lending, the most obvious challenge is coming up with enough capital to get started. The amount of funds required can serve as a steep barrier to entry, but it’s important to remember that real estate offers a great way in. Investors can work their way up by managing successful real estate deals themselves; over time, they can generate the funds necessary to start lending.
Hard money lending also has an inherent degree of risk for the lender. By operating outside of the traditional loan application process that big banks use, hard money lenders can truly choose who they work with. This means taking a risk on an investor who may not be approved by some standards. To counteract this risk, hard money lenders must come up with standards of their own. Lenders should be prepared to research investors, properties and ultimately trust their gut feeling about a potential candidate.
Continue Reading Our Private Money Lending Guide Series
Does private money lending sound appealing now? Read Part 2 of our series: “A Guide For Private Money Lenders: Breaking Down A Private Loan”, for an in-depth guide of what a private money loan really is. If you’ve had a successful real estate career thus far and have a decent amount of capital in the bank, you can benefit from providing loans for other aspiring investors. There is a specific process that occurs when it comes to generating a private loan. You must get to know who you are borrowing from—are they qualified?—while also determining the deal’s viability. Read on to understand the proper legal documentation such as a letter of intent, a purchase and sale agreement, a preliminary title report, and much more.
And if you are ready to learn how to start attracting investors, read part 3 of our series: “A Guide For Private Money Lenders: How To Attract Investors.” Part 3 will teach you the benefits loans will provide to borrowers along with the potential drawbacks. Additionally, once you’ve made the official decision to start your private money lending business, you’ll need to understand the specific steps of how to get started. Will you focus on residential or commercial real estate? Will you distribute short-term or long-term loans? Do you prefer a more direct or passive income? All of these questions will be addressed when you continue our series.
If you are unclear on the difference between private and hard money, read part 4 of our series: A Guide For Private Money Lenders: Private Vs. Hard Money. Part 4 will explain the benefits and disadvantages of funding deals with private money vs. hard money. Private money lending can involve anyone with a little extra cash they want to invest. Hard money lenders are similar; however, they are typically more organized and semi-institutional. Decide which is best for you and your deal by reviewing the last part of our series.
Private money lending can represent an attractive opportunity for both parties involved. Investors seeking alternative financing sources will find the benefits include a faster approval process and increased access to funding. On the other hand, those lending may find they have unique access to potential investments and deals. No matter which side of the transaction you are on, private money lending is a viable option for expanding your financial portfolio and wealth building.
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