Many of us have heard about private money, hard money, and other types of non-traditional funding sources for real estate transactions. It sounds good but you may not be fully aware of all of the benefits that private lending offers to you and your business. With that in mind, I would like to outline the top ten benefits of using private money in your own real estate investment pursuits.
Benefit #1: You are in control!!
The first benefit of private money that I'll mention is probably the one that is the most important. Private lending gives you far more control over the buying process than afforded by either traditional lenders or even hard money lenders. How often do you get to negotiate things like interest rate with a traditional lender? These rates are generally predetermined and are dictated by your financial strength and/or credit score. Furthermore, the terms of repayment for traditional or hard money loans are rarely negotiable. They know they're in the driver's seat (because they're the ones lending the money and they have clients willing to accept their terms if you choose not to) and pass along that knowledge to you via terms that they dictate. With private lenders, you negotiate the terms of the loan. Granted, the private lender has a say in it but you are in a stronger negotiating position because you are offering an opportunity they might not be able to find elsewhere.
Benefit #2: There is no limit to how much private money you can use on one project.
One of the greatest frustrations in traditional or hard money lending is that of the Loan to Value (LTV). With great credit and a solid income/asset portfolio, you may be able to borrow 100% of the purchase price for a piece of real estate. But what if you have less than perfect credit, limited or "hard to document" income, or desire to purchase land or a commercial property? In these cases, lenders want to see 10, 20, or even as much as 30% down to loan you the balance. This limits your ability to grow your business, even if you've found a tremendous bargain that is a sure winner.
Private money does not present the same rigid obstacles. Once again, remember you have the flexibility to negotiate the terms with your lender(s). This means you may borrow enough to fund the entire purchase price of the property if so desired. A private lender will likely want to see how good the investment is first before they will loan this high of a percentage. That is natural and you should be selecting quality investments for your private lenders in the first place. That being said, how cool is it that you can fund 100% of your projects, including repair costs, just by establishing the right relationships with your private lenders?
Benefit #3: Private money is less expensive to borrow.
While interest rates with private lenders may be comparable or slightly higher than with traditional lenders, the absence of third party involvement can dramatically reduce or even eliminate the closing costs and other fees that are normally associated with traditional loans. Furthermore, most private money loans have fixed interest rates and/or are based upon simple interest amortization so you don't have to worry about floating adjustable interest rates or interest heavy payments in the early stages of a loan. It is also worthwhile to point out that many private lenders will willingly accept either a portion of the profit from the sale of a property or a fixed rate of return upon the sale, effectively eliminating any out of pocket costs during the loan. How many traditional lenders that you are aware of would defer interest payments until you sold a property for a profit?
Benefit #4: Private money is faster than going through banks.
One of the common complaints about traditional lending is that the process proceeds at the lender's pace. This can mean as much as 30-60 days to close a loan, even if you are in compliance with all the lender's requests. This amount of time may not seem like a lot but it may mean the difference between securing the deal of the year and not doing so, just by not being able to close quickly enough. In these cases, both you and the seller want to move quickly but traditional lenders will still operate at their own pace, regardless of the urgency at hand. Private lenders can often lend immediately because they have direct access to their own lending capital and thus dictate both when it is used and for what purpose. Once you have established a relationship with a private lender or lenders, you can act on these great bargains and know for sure how quickly you can close, without having to wait on the bank. Remember that a great real estate bargain will look as attractive to a private lender as it does to you so they have incentive to make things happen quickly to cash in on those opportunities you present to them.
Benefit #5: Having a source of cash allows greater flexibility for buying properties at a discount.
You've all heard the phrase "Cash is king." Real estate is a perfect example of this, with the frequency of advertising that offers cash for houses, quick closings, etc. True, cash is a powerful leveraging tool with a seller, particularly one who is highly motivated and needs to sell very quickly. By definition, a cash offer only means that there is not a financing contingency in the contract. It doesn't mean you have to have the money available yourself. Private money is a perfect example of a readily available source of outside funds. When you have this available to you, you have the confidence and the means to offer cash for some or all of your purchases. Faster closing times and cash purchases should translate into more attractive purchase prices if the seller is properly motivated. Lower purchase prices mean better bargains so this benefit of private money is huge, given its impact on your profit margin for each transaction for which you are able to offer cash.
Benefit #6: There are no lender "seasoning" issues or restrictions on loan amounts with private money.
Many investors are not familiar with lender seasoning issues and the effects these can have on successfully closing transactions. In a nutshell, many lenders will look at a recent purchase and see a sale within a short period of time as a red flag, questioning the ability of the property to have increased in value so quickly. When you offer cash and use private money to fund the purchase, there are no appraisals required, no recent loans issued to compare to, and therefore a bargain remains just what it should be, a bargain. Another lender issue concerns the amount borrowed. Many lenders disallow loans less than a certain amount and you may not be qualified for purchases above a certain amount. Both circumstances can limit you if you are using traditional lending sources or even hard money. The use of private lending removes these issues because the lender is more interested in the rate of return and the quality of the transaction than these other issues.
Benefit #7: Using private money preserves your credit and buying power.
Many investors have solid financial strength and can purchase properties through traditional lending channels. This is true up to a point. Once you purchase a certain number of properties, it can become increasingly difficult to purchase more, even if they all have good equity and are producing monthly positive cash flow. If you plan to purchase many properties, the use of private lenders becomes all the more critical so you don't hit a wall with your own personal buying power. Another issue to consider on this theme is the impact of multiple purchases on your own personal credit. If you are buying 20 houses per year conventionally, you will have at least 20 credit inquiries, which will reduce your FICO score, even if the impact is brief. Private money requires no credit check and thus removes the proverbial restraints on your purchasing power.
Benefit #8: Using private money makes it easier to run your investment business through your entities.
You've probably heard that it is better to run your real estate investments through corporations, LLCs, or other legal entities. This is highly advisable and is all well and good in theory, until traditional lenders and even hard money lenders want to see credit backing a loan. Many lenders are hesitant to issue loans to entities, even if you sign personally as a guarantor on the loan. Since many entities are too new to have a credit rating to back them, most investors must take title to a property personally if they use a traditional funding source. Private money all but eliminates this obstacle and also improves the asset protection aspect of your business. Private money backing means you can offer cash for a property and therefore take title to it any way that you wish. This allows you to keep your investments out of your personal name, which makes more sense for both asset protection and for tax purposes. Additionally, use of an entity like an LLC to purchase a property is a way to secure your private lender's contribution to the project .
Benefit #9: Private loans require less paperwork!
While the use of private lenders may require some paperwork to make everyone feel secure about the investment opportunity you are presenting, the quantity of paperwork is far less than if you went with another funding route. Cast your mind back to the last time you closed on a traditional mortgage or even a loan through a hard money lender. How many trees were required to produce the stack of paperwork that you had to go through and sign? A small forest, perhaps? These large volumes of paperwork are a necessary evil in the lending business, designed to protect all relevant parties, disclose any number of minute points of interest, etc. etc. The point is that traditional lenders are required by law to have you jump through these hoops. Private lending is not subject to these kinds of laws and restrictions so that means less paperwork for you and your prospective lenders!
Benefit #10: Securing private money gets you in that negotiating frame of mind.
I've heard the phrase many times, 'You don't get what you deserve, you get what you negotiate.' This is particularly true in business and especially true when working with private lenders. Negotiation is something of a lost art to many American consumers, as we are socially conditioned to not bargain for things in the same fashion as in other cultures. Think about that. My point here is not to suggest that you are a poor negotiator. Quite the contrary. Negotiation, like any other tool in running a business, is one that can be developed and improved with a little bit of effort. What I'd like to suggest is that you take the time to develop the skills that I know you already possess but maybe just don't use as often as you could be.
