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. Of particular interest, however, 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. Investing in private mortgages for real estate offers the same type of underlying security and profit potential as rehabbing or wholesaling, but without getting your hands dirty.
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. At the end of the day, private money lending allows you to secure a loan with real estate that is worth much more than the loan. In some ways, this process can be less risky than owning real estate. That’s why it’s important 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 to the real estate investment industry. In fact, its presence makes it more possible for the average investor to run and maintain a sustainable career.
In case you were unaware, there are several benefits involved for those who choose to lend private money as well. If done correctly, offering alternative real estate financing options can mitigate risk while simultaneously establishing wealth. Of course, this is not a path for everyone. 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.
You may want to consider private money lending if one of the following applies to you:
- 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:
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,
someone doing the lending, 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, there are several key differences. 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. 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. Money, like it is in every other industry, is the lifeblood of an investor. Real estate investors need to actively work on bringing in private money loans to fund their deals. More often than not, the average investor isn’t capable of funding 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 an increased likelihood of them needing private money assistance. Instead of having to pool money or stretch every dollar, investors are given more options to grow their business with the use of private money.
Perhaps even more importantly, is the speed and efficiency in which private money may be obtained. The speed of implementation is critical to an investor, and can mean the difference between closing on a deal and losing one. Having the money in a timely manner can make it that much easier to close on 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.
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 borrowers 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.
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.
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.
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 viability of the deal. 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 in our series.
Content thanks to Than Merrill, Fortunebuilders