Private lenders function similarly to hard money lenders. They provide short-term loans for house flippers and make money on interests.
If you stay in real estate long enough, you’ll likely work with a private money lender eventually. But, for new investors, it’s not always clear what private lenders do. More precisely, how do private lenders make money?
Private lenders function similarly to hard money lenders. They provide alternative financing to real estate investors. Typically, they offer short-term loans to house flippers. Private lenders make money in two ways: 1) origination fees and 2) interest on the loan balances.
To explain how private lenders make money, I first need to outline what a private lender does. In basic terms, private lenders are individuals who A) have extra cash and B) want to lend that cash to other investors and make money on the interest. Private lenders serve as an alternative financing source for real estate investors. In situations where conventional lenders (e.g., banks and credit unions) won’t issue a loan, private lenders often will.
While private lenders provide a variety of loans, they typically lend to real estate investors—frequently fix & flip investors. With a conventional mortgage, you generally cannot purchase a distressed property needing repairs. This means that traditional mortgages don’t work for house flippers, as they inherently buy properties in need of repair.
On the other hand, private lenders base their loans on what a property will become. Rather than establishing a loan on a property’s “as-is” value—like a conventional mortgage—private lenders loan against a property’s appraised after-rehab value, or ARV.
Private lenders provide real estate investors with three primary advantages:
Before issuing a loan, private lenders typically want to see equity in the property. This demonstrates that the investor has some “skin in the game” and will complete the renovation. Related to this, private lenders generally require borrowers to have actual real estate investing experience. They don’t want to lend to a first-time house flipper who may or may not successfully renovate and sell a property.
Broadly speaking, private lenders make money in two ways:
Related to interest, private loans also tend to have shorter terms. They exist to finance fix & flip deals—not long-term investment property purchases. Most private loan terms range from one- to three years, depending on the particular deal. This shorter time horizon also justifies the higher interest rate private lenders charge. They have less time to earn income, so they need to charge higher interest rates to justify the risk.
If you know anything about hard money lenders, the description of private lenders likely sounded familiar. They provide alternative financing to real estate investors, frequently for house flip deals. Both lenders make money through loan origination fees and loan interest.
Private lenders differ from hard money lenders in terms of organizational structure. Private
lenders are individuals. On the other hand, hard money lenders have established companies.
These organizational differences lead to some key advantages for hard money lenders over private lenders:
Advantages exist to private lending. You profit from real estate deals without the hassle of fix & flip work. You screen borrowers, lend money, sit back, and make money.
Before diving into private lending, you’ll need:
But, if you meet these criteria, private lending can be a great way to make money. Check out The Investor's Edge to learn more about becoming a hard money lender now!