When it comes to real estate investment strategy, there are many opportunities to receive funding for a project. Two of the most common sources for investment property financing are private lenders and traditional bank loans, also known as a mortgage. Before choosing which type of real estate lending works best for your project, it’s important to understand the differences between a private lender and a bank mortgage.
Private Lending vs Bank Lending
While each provides money, a smart real estate investor should know the differences between the two. Banks are traditionally less expensive, but they are harder to work with and more difficult to get a loan approved with. Private lenders tend to be more flexible and responsive, but they are also more expensive.
What is a Bank Lender?
Banks are in the business of taking in funds from depositors, paying them a very low interest rate (if any) and lending money out to borrowers at slightly higher rates and making a profit from the spread between what they are paying and what they are collecting in interest.
When needed, federally chartered banks can borrow money from the federal government, at a very low rate. Again, the bank can lend these funds out at a higher rate and derive income from the funds.
What is a Private Lender?
Private lenders are generally funded by investors, or by banks, or both. Private lenders are in the business of taking funds from private investors and making private business purpose loans with those funds.
The investors expect a decent return from their investments, and interest rate from money borrowed from banks is significantly higher than thebanks are being charged for the funds. These factors raise the private lender’s expenses, which is then passed on to the ultimate borrower.
Private Lender vs Bank Mortgage Comparison
Banks are frequently harder to deal with than private lenders. Banks are subject to significant state and federal regulations, as well as programs set forth by governmental and quasi-governmental agencies such as Fannie Mae, Freddie Mac, the Veterans Administration, and the Department of Housing and Urban Development. These regulations often dictate what businesses a bank can lend to and what borrow profiles should look like.
Private lenders, while still subject to state and federal laws, are significantly less regulated and can be more flexible in the types of loans they make and who their customers are.
Accordingly, it is generally easier to get approved by a private lender than a traditional bank, as private lenders are able to customize each loan based on a set of internally set criteria, such as credit scores, loan to value ratio and debt to income levels.
Bank approvals are program or computer driven with little discretion available to the lender. Private lenders generally take a more common sense approach to understanding issues and overcoming them.
In addition, banks tend to look at financial histories and credit through easily traceable and documented income sources, making it very difficult for self-employed borrowers to qualify for bank loans.
Private lenders will be more creative and investigative in qualifying income and may be willing to overlook background flaws upon explanation.
FAQs
Bottom line, banks are a great option if you have a simple, straightforward property to finance. However, a private real estate lender is more likely to finance a loan on a challenging property, in a shorter period of time.
Is it better to go through a lender or bank? ›
Mortgage Lenders
Agencies like Freddie Mac and Rocket Mortgage can sometimes offer more flexibility than banks when it comes to in-house approval requirements. However, a major downside to mortgage lenders is that there is often a lack of brick and mortar stores.
Is it better to get a personal loan from a bank or lending company? ›
When evaluating personal loan lenders, you can choose from traditional banks and private online lenders. 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.
Should I go with a private lender? ›
The loan process for a private loan is often faster, with no income verification, and the terms are more flexible, allowing borrowers to seize timely investment opportunities. However, these advantages come with a cost — private loans usually carry higher interest rates than bank mortgages.
What are the risks to private lenders? ›
The main risk associated with private lending is the risk of borrower's default (i.e. inability to make their scheduled mortgage payments).
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.
What should you not say to a lender? ›
10 Things Not To Say To Your Mortgage Broker | Loan Approval
- 1) Anything untruthful.
- 2) What's the most I can borrow?
- 3) I forgot to pay that bill again.
- 4) Check out my new credit cards.
- 5) Which credit card ISN'T maxed out?
- 6) Changing jobs annually is my specialty.
Many individuals prefer to work with a broker regardless of their situation because it gets them access to lenders they wouldn't think to look for. Mortgage brokers may also be able to help loan seekers qualify for a lower interest rate than most of the commercial loans offer.
Is it better to go direct with the lender or a broker? ›
A mortgage broker can offer a wider array of options and streamline the mortgage process, but working directly with a bank gives you more control and costs less. Kate Wood joined NerdWallet in 2019 as a writer on the homes and mortgages team.
What are the disadvantages of a money lender? ›
In addition to the risks of fraud and high interest rates, taking out a loan from a money lender can also have serious consequences for your credit score. Money lenders typically do not report your payments to the credit bureaus, so your credit score will not improve if you make all of your payments on time.
Because private lending is more flexible, the process is often faster. If you have a nontraditional work history, bad credit or no credit history, a private lender may fund your loan based on other factors, such as your education or income. Private lenders often charge higher interest rates.
Why private loans are better? ›
Federal student loans are generally recommended due to fixed interest rates, repayment flexibility and forgiveness options. However, if you require more funds than federal limits allow or have excellent credit, private loans might be more favorable with potentially lower rates or higher borrowing amounts.
What is the benefit of a private lender? ›
Benefits to the Private Lender:
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.
Is private lending a good investment? ›
Private lenders often see value where other lenders do not, and are more willing to take on the risk. A private lender loan could be a great option if you're a real estate investor looking for reliable access to capital to put towards your next investment purchase.
How do private lenders make money? ›
Private Lending Companies
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.
Is it better to use a local lender or bank? ›
You'll get more personalized service.
When you work with a large bank or online lender, you're just another number. But when you work with a local lender, they'll get to know you and your needs. They'll be invested in helping you find the right home and getting you the best loan possible.
Do private lenders have higher interest rates? ›
You may pay higher interest rates.
While family might be willing to extend a loan at a low rate, a private lender who has no personal connection to you will likely charge you higher-than-average rates and/or require a large down payment in order to offset their risk.
Why a mortgage broker is better than a bank? ›
Mortgage brokers work with a variety of lenders, which gives them access to many mortgage products at many price points. That means you can go to one mortgage broker and compare multiple loan programs.
Private Lender vs Bank Mortgage Comparison
