How does private lending work?

Question

I'm really thinking about using Private lending (or HM lending) for my real estate deals, so,

#1, Im asking if someone could explain to me the structure and purpose of Private lending? I don't get the gist of it and all I know is it funds your deals like a bank loan.

#2.What’s the best way to apply this PL strategy when funding deals?

#3. Could someone explain to me the different possible loan terms of private lending? Is it based on which lender it is?

I'm really interested in purchasing REO's and flipping them with PL, so basically I want to know how this type of lending works (Feel free to explain HM if you'd like). Any advice concerning this strategy?

Dion DePaoli · Answer

A loan is a loan, if by any other name. (that was my Shakespeare reference for the day) A secured real estate loan is where you grant an interest in the real property by giving a mortgage to the a lender. The lender in term gives you money. The money and terms of repayment are evidenced by the promissory note which is held by the lender. The terms used to describe lenders have general meanings in conversation but they can, within their own ranks vary. For instance, private money and hard money lenders. Private has grown to imply the funds are from private investors seeking to put their own money to work for a rate of return. That is not to say hard money is really any different. All money comes from the same place, an investor. A hard money lender can charge more or less or the same as a private money lender per their own described designation. The idea of private money grew out of single investors who placed their own capital at risk in the market place opposed to using a hard money lender to get their money out. Thus, the idea and term "private". Where a hard money lender tends to be more along the lines of "public". The hard money lender is "open for business" as a lender. A private money lender may make a loan this week and not do another one for 10 years. Since a hard money lender tends to be in the business, they need to have capital to work with on an on-going basis, otherwise there is no point of being open for business since without the money no business takes place. As far as legal definitions between these ideas, there is a legal difference between you privately using your funds and someone else using your funds. We will leave that idea at that for this thread. Much of the distinctions between the two are simply window dressing. As Jon points out, due to the nature of the how the money is put to work, additional fees stack on top of the money. If you give me your money to put to work, I will charge a fee to do so which may make the loan cost more to the borrower. The opposite happens (well, is supposed) where if I privately place my money in the market, the fees are my own. So if I only need 10%, I charge 10%. If I use a lender to put my money out, they will want say 2%, so now we have a loan for 12%. That said, it can certainly go any which way depending on the parties who particpate. In regards to different loan terms. There are many. Any lender can offer any terms (subject to license and usury and other laws). So just because we say Private Lender does not mean the rate, for example, will be 10%. Maybe they only want 5%. (buy that guy lunch!) The possible varience is usually greater in Private Lending settings opposed to Hard Money settings since often times hard money has a capital structure behind it. There is a fund somewhere that investor puts his money into, controlled by the hard money lender which is used. When the investor invests, there is a structure to how it will all fall into place. Again, investor wants 10% return, lender wants 2% so we do not have much wiggle room for less than 12%. However, we have possibilities above that floor. So the hard money lender needs to earn 12% but that doesn't stop him from trying to earn 15%, which makes his investors happy by making everyone more money which also attracts other investors. When it comes to loan terms, they are pretty straight forward on their own merit. I would suggest you begin to simply learn those so you can understand how each idea affects a loan. This includes but is not limited to interest rate, loan term, amortization term and points and fees. That will start to lead you into some of the tangent ideas that go with each.

Jon Holdman · Answer

What @Dion DePaoli and I are both saying is that many "hard money lenders" take money from individual investors and then loan it out. I have money invested like that. The amount of interest I receive from the hard money lender is less than the borrower pays for the loan. The difference between what the borrower pays and what I get is what the hard money lender makes. Banks do exactly the same thing. They "borrow" money by selling CD's to depositors at 2% interest. Then they loan that money out at 4-5% or more. An old saying is banker's work using the 3-6-3 rule. Borrow at 3% (i.e., pay 3% on deposits), lend at 6%, be on the golf course by 3:00. As a borrower, none of this really affects you. The point what HMLs call themselves "private lenders" because the money comes from individuals. You just care about what you have to pay. Often when someone writes "I'll looking for a private lender" what they mean is "I want the sort of terms a hard money lender will give, but at a lower interest rate."

Jon Holdman · Answer

What do you mean by "flipping"? Wholesaling or rehabbing. If you're wholesaling you don't need private or hard money. Rehabbing is a good use of hard or private money, though you will still need significant cash of your own. Private money is someone you know and who will invest in you. You find them by talking about what you're doing with everyone you know and everyone you meet. Hard money lenders are easier to find, but rates are going to be higher. Many HMLs refer to themselves as private money because their cash comes from individuals. Rates for hard money are in the 12-18% plus 2-6 points. Higher rates often have lower points. Some require specific down payments, some don't. Private money should be somewhat cheaper. Depends on the lender. If they're a savvy RE lender their rates are probably on the lower end of hard money. They know what their money is worth. If its an individual who's not as familiar with this market they may be willing to do high single digits. Really up to what you can negotiate. Term is going to be long enough to sell or refi the property. Some private lenders might go a few years.

Bryce Y. · Answer

Most HMLs have LTV and LTC (loan to cost) limits so even if you can get all in for less than 70% LTV, you will still need to bring some money of your own. The whole point of this to make sure the borrower has skin in the game. I can tell you right now that 3500 is not enough, unless you can find a partner with cash. You will need around 20% of the loan amount in cash as a general rule. This is to fund closing costs, points (some HMLs will roll them into the loan or allow you to pay on the exit), and to get the rehab started. Good luck.

Brandon Gamblin · Answer

No. I have absolutely no experience doing this. And I don't have cash as of right now but the most I could probably come up with would be anywhere from $2500 to $3500. So according to the example you just gave me, If the ARV is $100,000, the total of the purchase price and rehab costs the lender would give is $70,000? So youre saying I would need to add $15,000 to whatever the down payment is?

Brandon Gamblin · Answer

Question #1. So basically you’re saying that the terms “private” and “hard money” really have no full influence (maybe partial?) on how these lenders lend? Basically you’re saying that they lend on their own terms and when they want to, despite the term in front of lenders? "As Jon points out, due to the nature of the how the money is put to work, additional fees stack on top of the money. If you give me your money to put to work, I will charge a fee to do so which may make the loan cost more to the borrower. The opposite happens (well, is supposed) where if I privately place my money in the market, the fees are my own. So if I only need 10%, I charge 10%. If I use a lender to put my money out, they will want say 2%, so now we have a loan for 12%. That said, it can certainly go any which way depending on the parties who particpate." Question #2. So If I give you my money to put to work, then I'm the lender right? If that’s the case, how can you charge me a fee? Wouldn't I, the lender, charge you the fee’s? And what do you mean when you say “privately place my money in the market”? What doe sit mean to privately place it? And what market are you putting it in? And are those percentages you’re giving me interest rate percentages? What do they refer to? "The possible varience is usually greater in Private Lending settings opposed to Hard Money settings since often times hard money has a capital structure behind it. There is a fund somewhere that investor puts his money into, controlled by the hard money lender which is used. When the investor invests, there is a structure to how it will all fall into place." Question #3: a. What is this "capital structure" referring to? What is it? What does that mean? b. What is the relevance of the fund that comes into play? How and why would the HML control that aspect of it? c. And what is the structure that’s already in place when he invests? Does he build that structure or is it automatic/organic/natural? Is this refferring to the HML or the PL?

Jon Holdman · Answer

Do you have experience doing this? Do you have some cash to contribute into the deal? My math is that if your purchase price plus rehab cost is 70% of ARV (ARV meaning the price you conservatively think you will get when you sell) and your lender will loan you 100% of the purchase plus rehab then you will need about 15% of ARV of your own cash at a minimum. Many HMLs won't go 100% of purchase and rehab, so if they require some down payment, add that amount to the 15%.

Brandon Gamblin · Answer

I mean by rehabbing. I want to rehab REO's, and they just dont have to be REO's but that is a priority. it can be from a seller in foreclosure but I want to be able to know how it works (from a PL and HM standpoint) because I've heard stories of people using this kind of lending, they end up messing up the deal and they have to give the property back as collateral to the lender. I'm just being really careful and I want to know how to approach this properly. I feel as if I need to know every side from the lending part, REO agents, contractors part, etc. But I know the most important thing is to address the lending part right?