Private money lenders, also known as hard money lenders, provide loans to individuals and businesses in instances where the borrower cannot qualify for conventional financing. The private lender funds the loan out of personal wealth or through a company or organization that is backed by sources of private money. Due to the higher risks involved in making non-conventional loans, the lender charges an interest rate that is typically much higher than the rate for a conventional loan to a creditworthy borrower.
The private lender industry is typically made up of affluent people who are trying to make large returns on money they can afford to put at risk. Instead of making a lending decision based on the creditworthiness of the borrower, private money lenders look at the efficacy of the underlying transaction. These types of lenders most often provide funds for commercial real estate transactions where the property serves as the security for the loan, ensuring that the lender will receive either the interest expected or the asset to sell to recover the loan money. The private lender makes an assessment of how likely it is that the property can be made profitable in a short span of time to make the lending decision.
A real estate investor with poor credit who wants to buy and rehab property, to sell or lease is the typical hard money borrower. He approaches private money lenders with a property that he feels can be resold after some fixing up for much more than it would take to buy the property in its current condition. If the lender agrees with the investor's assessment, he makes a loan for the purchase price and for some part of the money needed to rehab the property.
Terms of a private money loan are designed to offset the high risks involved in the transaction. The loan is typically made for commercial purposes only, meaning that the investor must be acquiring the property to resell or to lease to others. He cannot live in the property himself, even if he has a problem selling the property at the back end and needs to cut personal expenses. The paperwork the investor signs for the loan ordinarily provides for expedited repossession of the property, which would not be legal in most jurisdictions in a loan for residential purposes.
The interest rate of a private money loan is typically so high that the loan cannot be carried by the borrower for an extended length of time. Private money lenders structure the transaction to be a short term funding solution, or a bridge loan. The borrower is expected to either resell the property within months, paying the lender out of the proceeds, or to arrange for permanent financing once the property is rehabbed and leased.
