How Private Money Lending Works - SmartAsset (2024)

How Private Money Lending Works - SmartAsset (1)

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.

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How Private Money Lending Works - SmartAsset (2024)

FAQs

How Private Money Lending Works - SmartAsset? ›

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.

How does private lending work? ›

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.

How does money lending work? ›

Each lender determines the borrower's interest rate and will determine their own sets of terms and conditions. Borrowers will typically pay back the loan to the bank over a set amount of time and with a predetermined interest rate – and a monthly payment that does not change for as long as you have the loan.

Is it better to go with a private lender or a bank? ›

Bank lenders typically offer better rates and the added security of working with a well-established lender, but loans from private online lenders are often quicker and easier to get. The best option for you depends on your specific circ*mstances.

Is private lending profitable? ›

Large Profit

You can earn from your capital as a lender, and private lending is a more lucrative investment than keeping cash in a bank. You also have the option to establish a greater interest rate than traditional lenders like banks and credit unions, which implies you will make more money.

Does a private loan have to be paid back? ›

Unlike federal student loans, each private loan has its own repayment process. Some private student loans require payments while you are in school. Others let you delay your first payment for a period of time – called a student loan grace period.

How long does it take to get money from a private loan? ›

Typically, funds for a personal loan arrive within a week, but your loan may be funded faster, depending on the type of lender and how quickly you move through the application steps. There are three main steps to getting a personal loan: application, approval and loan disbursem*nt. Applying for a loan can take minutes.

What is the disadvantage of private loan? ›

High Interest Rates.

Additionally, lender fees charged by private lenders sometimes can be as high as 10%. An independent appraisal and assessment for prepayment can also be charged to borrowers. Overall, the cost of borrowing from private lenders can be expensive.

Do private loans go to your bank account? ›

Private student loan funds are usually disbursed (sent) directly to your school's financial aid office. Personal loan funds are deposited directly into the borrower's bank account.

Is private lending the same as hard money? ›

A hard money loan uses the "hard" asset of the actual real estate, whereas a private money loan analyzes both the property and borrower financial strength.

Does private lending show up on credit report? ›

In general, hard money lenders and private lenders do not report to the credit bureaus. Any organization, like banks and lenders, wishing to report customers' payment records to the bureaus has to pay each bureau for the reporting.

Are private loans hard to get? ›

Unlike federal student loans, private student loans require an established credit history. Lenders determine your eligibility, terms and student loan interest rate based in part on your credit score. This also means that all borrowers on the loan will need to submit to a hard credit inquiry.

How much can you borrow from a private loan? ›

Lenders' maximum aggregate limits often range from $75,000 to $120,000 for undergraduate students and $150,000 to $300,000 for graduate or professional students. The aggregate limits consider how much you've already taken out in federal and private student loans.

What are private loans and how do they work? ›

A private loan is made by a private organization such as a bank, credit union, or state-based or state-affiliated organization, and has terms and conditions that are set by the lender. Learn about the differences between federal loans and private loans.

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