Private VS Hard Money?

Question

Hello all! This may sound like an ignorant question, and it is!, but I'm wondering your thoughts.

What is the benefit of using private money (say grandma's money) as opposed to hard money, if I am still paying the same interest rate (say 10%)? I understand Hard Money is usually interest only, and has to be paid back in 6-12 months usually, but are there any other benefits to private money that I'm missing? I keep hearing people talk about private money but my problem is, every person I know that has lots of money (who could potentially be a private money lender) has other avenues of investing where they can make more than 10% on their money (or they are already deploying their money somewhere else and are not interested).

Jason Hopkins · Answer

Normally hard money has more terms and hoops to go through.  Most often the terms are set in stone.  For example you pay 10%-12% interest and you have 1-3 points.  When I do fix in flips I used a hard money loan at 12% for 90 days and 2 points.  Private money has more room to negotiate terms so I would always suggest to go that route.  If you use private money just be sure to get the terms clearly documented.

Jeff S. · Answer

Whenever I see this, I always think the wrong question is being asked. Private/hard money lenders run the gamut from being almost indistinguishable from conventional lenders to terms much closer to your grandmother, @Aaron Lietz.  The first question you should ask any potential lender is not what they charge, which is what everyone asks, but where do they get their money. The answer will tell you a lot.

Those lenders who run with money from Wall Street, or the larger syndicated pools, will structure their terms to attract investors and meet their expectations.  Not surprisingly, most investors only understand the conventional loans they used to buy their residences. The results are private loans requiring credit reports, tax returns, one or multiple appraisals, maybe W-2's, and few competitive advantages other than perhaps competing on interest rates.

Many lenders rely on brokers and affiliates to bring business in and who really have no underwriting or decision-making authority.  They represent the lender, and in the case of brokers, also represent the borrower.  There’s nothing wrong with that as long as you know who is representing whom, which is why you need to ask.  Some lenders offer white label loan docs where their rep uses their name and makes you think you’re borrowing from them.  Legal, I guess in some states, but this always seemed weirdly unethical to me.  What do I know?

Smaller lenders, i.e. most lenders, can be nimbler and offer varied competitive advantages.  These could include deferred payments, internal valuations, minimal paperwork, quicker turnarounds, and even competitive rates.  You have to ask around and not assume everyone is the same.  These are often direct lenders who loan their own money or those with smaller syndicated pools.

One thing included when you use any private lender is an evaluation of your property and an evaluation of your ability and wherewithal to make money and pay your loan back.  You should take heed when an experienced lender warns you away from a deal. Lenders don’t do this because they love you.  They don’t want to loan on a bad deal and risk losing their money any more than you do.  With Grandma, you’re on your own.

I don’t care how big they are, at no time should you think that any lender will be 100% reliable.  Many borrowers found this out as recently as last April and May when Wall Street got cold feet and bailed on some mega-gigantic HML’s, leaving many borrowers in the dark.  Others of any size can overleverage and overpromise.  Some simply run out of money.  I’m curious what will happen during the next real estate downturn.  Don’t think there won’t be another downturn.

Grandma might be able to fund a deal or two, but once you start growing, you’ll need a greater volume of money.  It might be easy to convince your grandmother to loan to you, but when you’re just starting out and don’t know what you’re doing, this is backward and unfair in my view.  Better to risk the money of a private/hard money lender (and if you couldn’t figure it out already, there is no legal difference), and use grandma’s money to backfill when you get your feet on the ground.  I bet she would appreciate an above-average return.

Either way, you’d be wise to follow @Derek Dombeck’s excellent advice above and make sure Grandma is protected legally with paperwork and insurance exactly as any professional lender protects themself. No cutting corners at her expense.

Good luck to you, Aaron.

Jim Thorpe · Answer

The problem I had with trying to find private money  was trying to explain to them the process. I have found it easier to work with HM lenders, they understand the process and the property and no emotions are involved. The best thing about HM is the money gets cheaper the more you work with them. Find a good lender and stay with them.

Aaron Lietz · Answer

@Derek Dombeck & @Brandon Martinez, awesome tips! Thank you guys!

Derek Dombeck · Answer

My entire Hard Money business is funded by private money.  I pay my investors an interest rate on their investment and secure it with the 1st position mortgages from each new loan. Establishing a track record and taking care of relationships is the start to finding private money. It takes time, but the sooner you start, the better. I would let EVERY person you come in contact with daily know what you do. My best investors were people who did not appear to be wealthy, so don't pre-judge anyone.

Brandon Martinez · Answer

Hello @Aaron Lietz, when seeking private lending it is always easier to convince someone to loan you money when you can show them a few successful deals completed. I don't know if you've completed any deals but if not, fund a few with traditional loans and your own money, then go back to your potential private money sources and show them your track record and how they could have been the recipients of that interest. I can see them giving you those excuses that you stated simply because they don't have enough "business" trust built with you to give you their money. I haven't used private money for real estate but I have used private money for building companies and getting the money has always been about creating a sense of trust and comfort with the person giving the money.

Michael Kinsella · Answer

Hi Aaron,

I agree with what @Jason Hopkins said above.

The primary advantage of working with an individual private lender is the flexibility.

Oftentimes, hard money lenders will be restricted by certain underwriting criteria, and won't have much latitude beyond that.

An example of this is that private lenders can do things like forego an appraisal if they are very familiar with a certain location.

Best,

Michael

Derek Dombeck · Answer

My caution with using private money is to still protect them as if they are an institution. You are going to hate yourself if you lose Grandma's nest egg. Make sure you draft a promissory note and mortgage, provide lenders title insurance, and list them as the lender on your property insurance.

Hard Money lenders can be an incredible asset because during the underwriting process, we may catch something you missed. I can't tell you how many times we talk our clients into renegotiating their contract or walk away because they were going to potentially lose on a deal.

No matter what your choice is, always do you research on the individual or the hard money lender before you move forward.

Aaron Lietz · Answer

Thank you for the insights! Has anyone had success with private money? If so, what was experience and how did you go about structuring things? Perhaps more importantly, how did you find those lenders (friends, family, co-workers, etc.)? In this competitive market (here in the greater Phoenix, AZ area) my goal is to find some good private lenders for my flips and/or holds.

Stephanie P. · Answer

"The worst part about private lenders is they run out of money at the absolute worst time."  Stephanie  You can quote me on it.

Private VS Hard Money?

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