Understanding Private Money Interest Rates

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Understanding Private Money Interest Rates

Taylor Johnson
Real Estate Agent · Detroit, MI · Member since 2017 · 48 posts · 32 votes

Last night I attended my local REI meeting and the topic was about private lending. This seminar was so helpful and got my wheels turning about prospective family and close family friends who could potentially be a private lender for flipping projects. Based on the speakers examples and recommendation, he said interest rates are between 6-8% (located in Metro Detroit Area) and I could have the option to pay monthly at a lower interest or pay a higher interest rate if I get paid when the lender gets paid, meaning after the property is sold.

I was too embarrassed to ask, but is the interest rate calculated monthly or based on the contract's deadline? Also, if I were to reach out to a family member what would those who've used private money recommend as a "realistic" timeline for a beginner? He mentioned 5 years or until property is sold. I was thinking 3 years, but I wouldn't want to scare them off if that's too long of a time for me to return their money.

Open to different thoughts and perspectives. Thanks!

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George DespotopoulosBusiness Member
Lender · New York, NY · Member since 2016 · 936 posts · 287 votes
8y

Interest rates should always be calculated on an annualized basis. If they quoted you 6% - 8%, that's your annualized rate, and typically you make a monthly payment on that. If it's an interest only loan, then you would make a monthly payment that is 1/12th of that.  Example: $100,000, 12% rate, you owe $12,000 in interest, which means $1,000 a month.

If this was offered, it typically means that the lender is offering to roll the interest rate (and monthly payment) into your total balance owed to the lender. You would then pay the interest charged on the loan at the end when you sell the house. While this gives you the option of not having to pay monthly, if they're offering that the lender is usually charging you a higher rate because every month, they charge interest and roll it into your principal loan amount. That increases your overall balance. The next month they charge you that same interest rate, but now it's on the higher principal loan amount (which increased by the interest payment of the previous month). So your effective rate is higher than 6% - 8% in such a scenario.

This is really up to you and your family. I don't know what your object is either; are you going to refinance with a traditional lender to pull some cash out after sometime? Also, you can always make monthly payments to them of interest or interest and principal and pay them off fully when you refi or sell the property. I would think the longer the better. 

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  • Andrew Kerr
    Rental Property Investor · Everywhere, USA · Member since 2012 · 689 posts · 525 votes
    8y

    @Taylor Johnson - typically when I have used private money, we just do interest only payments. Just plug the amount you want to borrow into a I/O loan calculator to get the payment. If it is a longer term hold I found people want to be paid monthly. If it is a flip, it is easier to have all the interest paid when the sale happens, this lowers your carry costs, but not every private lender is willing to do this.

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  • Aaron K.
    Specialist · Riverside, CA · Member since 2015 · 6k+ posts · 3k+ votes
    8y

    If your question is whether the interest is per month or per year it is per year so 8% is 8% per year or 8% divided by 12 per month.  Terms are whatever you and your lender are comfortable with, there really is no "standard" as every situation is different.

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  • George DespotopoulosBusiness Member
    Lender · New York, NY · Member since 2016 · 936 posts · 287 votes
    8y

    Interest rates should always be calculated on an annualized basis. If they quoted you 6% - 8%, that's your annualized rate, and typically you make a monthly payment on that. If it's an interest only loan, then you would make a monthly payment that is 1/12th of that.  Example: $100,000, 12% rate, you owe $12,000 in interest, which means $1,000 a month.

    If this was offered, it typically means that the lender is offering to roll the interest rate (and monthly payment) into your total balance owed to the lender. You would then pay the interest charged on the loan at the end when you sell the house. While this gives you the option of not having to pay monthly, if they're offering that the lender is usually charging you a higher rate because every month, they charge interest and roll it into your principal loan amount. That increases your overall balance. The next month they charge you that same interest rate, but now it's on the higher principal loan amount (which increased by the interest payment of the previous month). So your effective rate is higher than 6% - 8% in such a scenario.

    This is really up to you and your family. I don't know what your object is either; are you going to refinance with a traditional lender to pull some cash out after sometime? Also, you can always make monthly payments to them of interest or interest and principal and pay them off fully when you refi or sell the property. I would think the longer the better. 

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  • Bob Green
    Lender · Mokena, IL · Member since 2014 · 1k+ posts · 261 votes
    8y

    Taylor,

    Grab your calculator and plug in the loan amount X 8% and divide by 12. This is your interest only payment.

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  • Jonathan StreufertPro Member
    Rental Property Investor · Redford, MI · Member since 2016 · 34 posts · 18 votes
    8y

    @Taylor Johnson I was at the MREI meeting as well and had some of the same questions you listed here. Thanks for putting some of them into words! I understand that private money is completely negotiable, and depends on the private lender's goals and what they want as a return, but I had been under the impression that most private lenders (at least for newbie investors) would want something more like 8-12% as security against their lack of experience instead of 6-8%. Did you think that a 6-8% interest rate for an inexperienced investor was a bit low as well?

    @George Despotopoulos Thank you for that explanation! I was not sure how that accruing interest owed worked, whether the interest rate applies to only the initial loan amount, or is reassessed each month or year as more and more is owed to the lender. Is there a minimum length of time you want to set the balloon payment for the private lender just so you have enough of a cushion in case it takes longer to to sell the house or refinance it, like a year? 

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  • Taylor Johnson
    OP
    Real Estate Agent · Detroit, MI · Member since 2017 · 48 posts · 32 votes
    8y

    Thank you all for your feedback. This has been really helpful and now know how to structure my private lending.

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  • Taylor Johnson
    OP
    Real Estate Agent · Detroit, MI · Member since 2017 · 48 posts · 32 votes
    8y

    @Jonathan Streufert we'll have meet in person at the next meeting. I agree I thought 6-8% was low for a beginning, but I think that range can work if you're paying it back within 3-6 months. Any time longer I'd expect a higher rate as a beginner.

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  • George DespotopoulosBusiness Member
    Lender · New York, NY · Member since 2016 · 936 posts · 287 votes
    8y

    @Jonathan Streufert - as for the length in time, most non-bank lenders will do 10, 15, or 30 year terms. If you're doing hard money or bridge loans it's usually 12 months, with a fee to extend. For straight private money, it's really up to that individual lender and the borrower. Standard is 12 months, but pushing it out to 24 or 36 is not unheard of.

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