Understanding Private Money Interest Rates

[Taylor Johnson]

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!

[George Despotopoulos]

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.