A private money lender offers financing outside of traditional lending institutions and is typically used to assist in the purchase or refinance of a real estate investment. There are various types of lenders, such as friends and family, hard money lenders, mortgage companies, and other private lending firms. Utilizing these lenders offers financing opportunities that may be otherwise inaccessible to small businesses with limited resources or credit history.
How Private Money Lenders Work
Private money lenders include high net worth individuals and private organizations that offer what are typically short-term loans to provide funding opportunities for borrowers needing quick access to capital. Loans associated with these lenders aren’t subject to the same regulations otherwise required by licensed lending institutions, such as banks and credit unions. Therefore, they are typically easier to qualify for and are accessible to borrowers with limited capital or credit history.
Most commonly, private money loans are associated with financing real estate investments and can apply to:
- Purchasing or refinancing a property
- Constructing or renovating an asset
- Flipping a property
Borrowers can take advantage of flexible rates and terms that would otherwise be unavailable to them via a traditional lender. Notably, since regulations differ, approval and disbursement usually have a streamlined process, which can be valuable when competing with cash offers and requiring funds on short notice.
As an example, say a borrower wants to utilize a private lender for a hard money loan since they’re looking to acquire a real estate property and fix and flip it for a return. However, they lack the financial resources to cover the cost of the purchase and renovations upfront. The borrower can use the proceeds provided by the private lender and pay off the loan with the return in a short period instead of seeking long-term financing from a traditional bank.
Rates & Terms of Private Money Loans
| Rates and Terms | Average Private Money Loan |
|---|---|
| Maximum Loan Amount | Generally 90% LTV, 80% ARV |
| Interest Rate | Varies; generally 6% to 20% |
| Loan Term | Generally 12 to 24 months |
| LTV Ratio | Up to 90% |
| Closing Costs | 2% to 5% of the loan amount |
| Minimum Down Payment | 10% to 20% of purchase price |
| Closing Timeline | 30 to 90 days |
Rates and terms can vary vastly between lenders. Maximum loan amounts depend on the value of the asset (based on its LTV if it’s in good standing condition) or its after-repair-value (ARV) (applicable to property in poor condition and in need of repair).
It’s common for loans offered by private money lenders to have higher interest rates and fees. Those account for the risk that lenders take on when providing funding to borrowers with less-than-ideal creditworthiness.
Most loans offered are short-term, mainly because loan funds support rehabilitation, construction, or flipping projects. These projects can be done in a limited period and don’t require long-term financing. However, they can be extended up to five years in some cases.
You’ll likely come across various fees included with the closing process, alongside a required down payment for the asset. Closing costs and timelines will vary per lender, but generally, funds can be received within a few days to a few months.
Pros & Cons of Private Money Loans
| Pros | Cons |
|---|---|
| Available to borrowers with limited resources or credit history | Shorter repayment terms compared to traditional loans |
| Less rigorous qualification standards compared to traditional banks | Higher fees often applicable to utilizing private lenders |
| Approval and disbursement often have a quick turnaround | Higher interest rates usually tied to private loans |
Who Private Money Lenders Are Right For
Using a private money lender has its risks and should be used only by businesses in need and equipped to demonstrate adequate returns to the lender. It may be an option if you are:
- A business looking to make a real estate investment: Whether it be an acquisition of a property or renovation project of an existing asset, you can use a private money lender to help you finance a real estate property. Real estate flippers commonly use this method and take advantage of the short-term financing options typically available.
- A business with bad or limited credit history: If you have a bad credit score or are a new business with limited credit history, private lenders offer loans with less rigorous qualification requirements than are standard with traditional banking practices. While you may pay higher interest rates and fees, private money loans are an option for those who need financing and have limited resources to obtain it.
- An existing real estate owner looking to refinance: If you’re currently locked into a loan offered by a traditional lending institution, you may be looking for more favorable rates and terms. Depending on the private lender you use, you can refinance your existing loan and alleviate your debt obligations.
Qualifying for a Private Money Loan
Depending on the lender you choose, you’ll likely have to meet certain qualifying criteria to obtain a private money loan. While requirements will vary, here are some general factors to consider.
- Credit score: Private money lenders often cater to borrowers with limited credit history and therefore typically have lower credit score requirements necessary for approval. In general, a credit score of 600 and above will increase your chances of obtaining a loan.
- Business finances: Whether you are a new or established business, be prepared to furnish financial documents that outline the current financial status of your business. These documents can include cash flow statements, balance sheets, tax returns, and P&L statements.
- Personal finances: If you plan on obtaining a loan via your personal credit, lenders will consider your personal income and credit history. Be ready to provide your personal tax returns and net worth statements or other documentation requested by the lender.
- Value of real estate: More often than not, the loan provided is secured by the asset being acquired. Your loan amount will also depend on the value of the asset, so keep this in mind when applying.
- Business plan: If applicable, a lender may want to see a drafted business plan outlining the use of the funds and your ability to repay the loan. If you need assistance, see our guide on how to write a business plan.
- Required documents: You may have to present certain documents detailing the legitimacy of your business and other closing documents. These can include a purchase and sale agreement, contractor bids, appraisals, proof of down payment, or even a list of your past projects documenting at least one to three years of investment experience.
How to Find a Private Money Lender
You can’t get a private money loan from a traditional lending institution, such as a bank or credit union, so you’ll have to consult a lender accessible to you. This can include loans from:
- Friends and family
- High net worth individuals
- Online lenders
- Mortgage companies
- Private equity firms
Our partner Kiavi offers real estate investment loans with quick access to funds. It offers loan amounts of up to $3 million and loan terms of up to 24 months. It can provide funding to both first-time and experienced flippers, with access to funds in as little as seven days.
Alternatives to Private Money Lenders
If you think using a private money lender may be too risky or are just exploring all of your financing options, you should consider the following:
- Commercial real estate loan: There are multiple commercial real estate loan options available for a variety of uses. These are typically traditional financing opportunities that can help to facilitate the purchase, renovation, or refinancing of commercial real estate assets.
- Business line of credit: A business line of credit can provide access to funds on an as-needed basis, where loan funds can be used for virtually any business expense and be repaid over some time.
- Personal loan: If you are a new small business with limited resources or credit history, you can obtain a personal loan, which is tied to your personal credit. While loan amounts are generally smaller than most small business loans, it’s a viable option for business owners needing access to funds quickly. For our recommendations, see our roundup of the best personal loans for business funding.
- Home Equity Line of Credit (HELOC): A HELOC is available to qualifying homeowners with sufficient equity. The line is a revolving credit facility that can be used to finance purchases with limited restrictions, and the balance is repaid over some time. See our article on using a HELOC to fund your business for guidance.
- Venture capital: For businesses seeking investors, raising venture capital can be a way to obtain funding without the obligation of repayment. Instead, a business can offer equity stakes to investors as a return.
Frequently Asked Questions (FAQs)
There are various types of private money lenders, all catering to different needs, rates, and terms. Most commonly, they include hard money lenders, friends and family, mortgage companies, and other private lending companies.
In most cases, yes. Most private money lenders are used to help finance a real estate asset, which usually requires a down payment, applicable closing fees, and collateral (usually secured by the asset).
Yes. As long as you comply with federal and state laws, you can utilize a private money lender.
Bottom Line
Now that you know how private money lending works, you can determine if it’s suitable for your business. While it can be challenging to secure a lender, there are multiple routes you can take to find the right fit. If you have a real estate investment that you’re looking to finance, private money lenders can assist you and provide short-term financing opportunities to help support your business ventures.
