by Jake Wengroff
Traditional mortgages don’t often work for construction, development or fix and flip projects. Such projects are short-term, with capital required to see a project through to completion, which is generally less than two years. Additional capital may also be needed at different times throughout the duration of the project to ensure success.
Further, conventional loans require a lengthy approval process, strict adherence to approval criteria, and significant down payments that can leave investors strapped for cash once they have acquired the property and construction or renovations begin.
Private money lenders offering “hard money” loans address this gap in the lending market.
What Is a Private Money Lender?
Hard money loans are a way to borrow without using traditional mortgage lenders. Loans come from individuals or investors who lend money based largely on the property used as collateral.
When deciding to move ahead with a loan, the private money lender generally relies on the potential value of the underlying property and the track record of the borrower or developer.
Private money loans are perfect for short term loans. For example, a construction project is nearing completion, and additional capital is needed. Or, a fix and flip investor needs to own a property just long enough to rehab it and sell it. Neither of these situations would fit a traditional mortgage scenario.
Why Choose a Private Money Lender?
Because the lender is more focused on collateral than on the borrower’s financial position, loans from private money lenders tend to close more quickly than traditional mortgages.
According to the Home Buying Institute, the average time to close on a mortgage loan was 46 days toward the end of 2018. This length of time is most likely too long for some borrowers and developers, especially those who operate in hot real estate markets where there are multiple offers.
Private money lenders do not follow the standard underwriting practices used by a traditional bank or mortgage company. Each deal is evaluated individually. This is perfect for projects like construction, which are complex and often require customized loan solutions. Instead, the previous experience of a borrower or developer is factored heavily during the loan approval process.
For further flexibility, when choosing a private money lender, a borrower should verify that the loan is serviced by the lender. Most private lenders do not service their own loans; instead, they farm them out to third parties. This results in a poor experience for their borrowers and little autonomy should troubling situations arise during a construction, development or rehab project.
Private money lenders hold deep expertise in the local real estate markets in which they operate. Traditional banks and mortgage lenders are most likely national (or even international) and must follow strict guidelines when funding loans. As such, for borrowers with experience building, developing, buying and selling in the local real estate market, private money lenders are an attractive option.
Jake Wengroff writes about enterprise software and financial services. A former technology reporter for CBS Radio, Jake covers such topics as blockchain, security and IoT.