The Private Money lending space has been one of the hottest topics in the real estate finance industry for 2017. What was once a very specialized and sleepy industry where mom and pop lenders with wealthy investor friends dominated the “hard money” industry, has now ballooned into a $65 billion industry. Wall Street has taken note: Goldman Sachs recently purchased private money lender Genesis Capital to obtain direct access to these higher yielding, short-term loans. Many others are now purchasing private money loans as investments.
Background of Private Money Financing
Private money financing has always been around. It was thrown for a loop, however, when the Dodd/Frank Act passed in 2010. No longer were consumer loans a viable option for private money financing. Dodd-Frank basically eliminated balloon, equity-based loans as an option for homebuyers or homeowners. So, instead, private money lenders have focused on business purpose loans to continue to provide short term, equity-based loans. Business purpose loans for 1-4 unit residential properties are exempt from RESPA, TILA and some of the other state regulations enacted to protect consumers and homeowners.
What is a business purpose loan? It is the opposite of a consumer purpose loan. A consumer purpose loan is defined as a loan to a natural person on a residential property (1-4 residential units), when the purpose of the loan is to obtain funds for a personal, family or household purpose. A business purpose loan is a loan on residential property primarily for business, commercial or agricultural purpose (includes loan to acquire or improve rental property), NOT occupied by the borrower, OR 2.) Loan to business entity (i.e. Inc., or LLC) (Note: A Trust is NOT considered business entity.)
Private money loans are typically short-term, 1 to 3-year bridge loans, interest only, with interest rates around 7-12%, depending on the equity of the property and credit rating of the borrower. Little or no regard is paid to the borrower’s income when determining the approval of the loan. Equity is king. Loan to value ratios rarely exceed 70 or 75%.
Another factor that influenced the growth of the private money market were fix n flippers – entrepreneurs who purchased foreclosed and run-down homes for renovate and resale. These homes would typically not qualify for conventional financing because of the condition of the property or the need to purchase them very quickly to get the best price possible.
A second growth factor was the boom in 1-4 unit properties being rented out. Many people lost their homes during the 2008 financial crisis and many people do not qualify for homeownership financing because of the newer, stricter Dodd-Frank rules and rapid home price increases in many parts of the country.
Why borrowers choose Private Money Financing
Real estate investors choose private money for a variety of reasons. Often times, it’s a timing issue. If the close of escrow date is coming due and conventional financing fell through, investors will go to private money as a last resort. Other times investors might choose hard money because they need construction rehab financing and institutional lenders don’t have a lot of lending options for that. Finally, if the borrower’s credit rating or income do not meet institutional requirements they will choose to go the private money route.
Pros vs Cons of Private Money
Like most things in life, there are two sides to every option. Private money allows for a lot of great options like fast closings, little documentation, and looser credit standards. Downsides include larger downpayment or equity requirements, higher interest rates and the uncertainty of future financing, since these loans are typically 1-3 years in length.
Private Money Loan Options
Most private money lenders offer a wide variety of loan options. There are purchase loans which are especially well suited for real estate investors that are trying to obtain an under-market home and close as fast as an all-cash offer. These typically can range up to 75% of the purchase price. There are also the options for a cash-out refinance that allow borrowers to take equity out of their property in 10 days or less to use towards renovation of other rental property or other business purposes. These might have more conservative LTVs, usually around 65% for a good credit borrower. Finally, private money gives fix and flip developers the ability to leverage multiple projects at a time, since they can borrow most of the funds needed to purchase and remodel the home. These are typically up to 75% of the purchase price of the home and up to 100% of the rehabilitation dollars, as long as the after repaired value is under 70%.
This financing category is not for everyone. It is, however, something you should be knowledgeable about because you will have customers that fit these specialized uses. You will want to work with an experienced private money lender because they will know the ins and outs of this financing option. And what a great opportunity for conventional lenders. Borrowers who obtain private financing for the acquisition of rental property will need you for permanent financing for their rental properties.