Private money lending has become a popular option for real estate investment but poses some very significant risks. Private money loans usually come from a friend, family member, or individual investor who has money to lend and wants to get a high interest rate. The terms are typically negotiated between the borrower and lender, and are generally flexible. Using a private money loan needs to be considered very carefully, especially if you are borrowing from someone who is providing you with their own loan documents.
This article examines private money lending from the Borrower's Perspective. We'll have a follow up article that will explore private money lending from the Lender's Perspective in a second installment.
PRO: Convenience and Speed for Borrowers
One of the biggest advantages of private money ending is the convenience and speed of the loan approval process. Private money lenders are not subject to the same strict requirements as traditional lenders, which means they can process loans faster and with less paperwork. This is especially helpful for individuals and businesses that need cash quickly for emergencies or time-sensitive investments. Additionally, private lenders may be more flexible with repayment terms than traditional lenders, allowing borrowers to customize their loans to fit their needs. Some private lenders are even people in the community who have excess cash to lend out, and take a security interest in the property - meaning, if you stop payment, the property becomes theirs.
CON: Borrowers Pay High Interest Rates
One large downside of private money lending is that it often comes with higher interest rates than traditional loans. Private lenders take on more risk by lending to individuals and businesses that may not qualify for traditional loans. To compensate for this risk, private lenders charge higher interest rates. While this may be acceptable to borrowers who need cash quickly, those who can wait may want to explore other options that offer lower interest rates. In the event you are using private money lending for a construction, if your project is delayed, you will still be responsible for paying interest on the loan.
PRO: Less Stringent Requirements for Borrowers
Unlike traditional lenders, private lenders have fewer requirements when it comes to creditworthiness and collateral. This means that individuals or businesses with less-than-perfect credit scores or non-traditional forms of collateral, such as real estate or artwork, may still be eligible for a loan from a private lender. Additionally, private lenders may be more willing to work with borrowers who have unique financial situations, making this option more accessible to a wider range of individuals.
CON: Lack of Regulation
One of the cons of private money lending is that this industry is not regulated to the same extent as the traditional lending market. This means there are no standardized documents that are vetted by any trade group, state or federal agency. While this may seem like an advantage, every document could be drastically different, so you should review all of these documents with your attorney. There are fewer default protections in place for borrowers, which means borrowers are often times vulnerable to fraud or other unethical practices. To avoid these risks, it is essential to thoroughly research any private lender you are considering and ensure they have a reputable track record in the industry and to consult an attorney to review the loan documents before you sign.
Overall, private money lending can be an attractive option for individuals and businesses in need of a short-term loan for a project, or flexible repayment terms. However, it is important to weigh the pros and cons of this option before deciding if it is right for you. Ultimately, informed decision-making is crucial to ensuring a positive lending experience and avoiding potential risks.