From REI Academy
Private mortgage loans are made by private lenders instead of
traditional financing sources such as banks, lending
institutions, or government agencies. They usually are
short-term (6 months to 3 years) hard money or asset-based
loans, and the decision to lend is based on the equity and value
of the property being put up as collateral, not on the
borrower's credit.
These loans are a source of funding for professional real
estate investors who wish to acquire, rehabilitate, or cash out
equity of income producing property, and those who otherwise
would not qualify for conventional financing. Private mortgages
also assist real estate investors who need immediate financing
without the financial documentation required by traditional
institutional financiers.
Private mortgage loans are very secure because they represent
a maximum of 65 percent to 70 percent of the appraised value of
income producing property. On non-income producing property, a
maximum of 55 percent loan to value is lent. Investors can
expect to pay interest rates of 12 percent to 14 percent on
first liens and 16 percent to 18 percent on second liens in this
current low interest rate environment. Historically, first lien
yield of six points over prime has been obtainable.
Why Borrow Private Money?
When interest rates of 14 percent to 18 percent are added to
four to eight points, the borrower is paying more than 20
percent annually for a private mortgage loan. This is a good
deal for private mortgage lenders, but why would borrowers want
to pay these high rates when conventional mortgages range
between 7 percent and 10 percent? Many reasons exist, but all
fall into four categories.
Speed of Closing
Conventional mortgages usually take between 45 days and 90
days to fund, since institutional lenders need to obtain an
appraisal of the property's value, perform a detailed
examination of the borrower's credit history, and thoroughly
evaluate the borrower's current financial status. On the other
hand, private mortgage lenders usually can complete a
transaction within seven to 10 days. Since the property itself
is the main criteria used to determine loan eligibility, less
information on the borrower is required, resulting in a much
quicker approval process.
The private mortgage lender is protected by lending at a
significantly lower LTV ratio: 65 percent vs. 80 percent to 90
percent for institutional lenders. Further, the private mortgage
lender can make a decision within 24 hours of receiving
information, whereas institutional mortgage money must be
approved by a loan committee that may meet only twice a month.
Easy Application Process
While a borrower's lack of up-to-date personal financial
information would negate or at least delay approval for an
institutional mortgage, it should have no effect on the ability
to obtain a private mortgage loan. Private mortgage lenders
generally base their decisions on the asset used for collateral
-- the property. If the property value is high enough and the
income being generated from it is sufficient to pay the interest
on the debt, the borrower's personal financial situation should
not affect the private mortgage lender's decision.
Other Money Resources Are Not Available
A borrower may not qualify for an institutional mortgage loan
for reasons ranging from low borrower credit scores or too much
borrower debt. Further, the property itself may not support the
type of loan the borrower wants: Many institutional lenders will
not loan amounts under $500,000 and will not lend second lien
money even if there is significant equity in the property.
In these cases private mortgage lenders may be the only
available resource. Institutional lenders are concerned with
both the appraised value of the property and borrower and
property credit; however, private mortgage lenders are concerned
only with the appraised value, as long as it represents a fair
market price. Hence, if a property is producing or can produce
sufficient income to pay the note and the value of the property
will provide sufficient equity, the borrower's credit is not an
issue for the private mortgage lender.
More Funds Available
Since private mortgage lenders base loans on the appraised
value of the property, the borrower may be able to borrow more
and therefore have less of its own capital invested in the
property. In these instances, the borrower is not penalized for
purchasing a property at a significant discount to market value.
Investment Parameters
The most important parameter private mortgage lenders
consider when evaluating a loan request is LTV ratio. They
typically will lend up to 50 percent on raw land or undeveloped
property; 65 percent on commercial income producing property
such as office buildings, shopping centers, and warehouses; and
70 percent on multifamily income property such as apartment
complexes. The maximum amount usually will be lent if all
criteria are met; lower amounts may be lent if the loan or
borrower is considered less than ideal.
The second parameter is the type of properties to lend on,
which often is determined by the ease in disposing of the
property in case of default. Obviously, a single-use property
that would take a year to sell is less desirable than a
multi-tenant, income producing office building.
The third investment parameter is the cash flow or income
potential of the property put up as collateral. Although many
private mortgage lenders are liberal in this area, the monthly
interest payments must come from somewhere. If the property is
producing a cash flow after all expenses, the property income
alone may cover the monthly payments without the borrower having
to come out of pocket. This adds a great degree of safety to the
note. Cash flow from other income properties also can substitute
for cash flow from the property being placed as collateral.
The fourth major investment parameter the lender must
consider is exit strategy, or how the borrower plans to repay
the loan. Since most private mortgage loans are short-term,
private mortgage lenders have a keen interest in analyzing
whether a particular exit strategy is viable. For example, if
the exit strategy is to refinance the property, the lender must
determine if the credit score of the borrower is high enough to
qualify for a long-term mortgage, if the property cash flow is
sufficient to cover the debt payments, and if the property will
meet the general criteria set up by the mortgage lenders most
likely to refinance the property.
Don Konipol
Don H Konipol has a BS in Economics and an MBA in Finance
from the University of Michigan and is a licensed Texas Real
Estate Broker and Mortgage Broker. Mr. Konipol is General
Partner of the Managed Mortgage Investment Fund LP, a private
limited partnership that invests in short term, high yield
private mortgage notes. He can be reached at 832.577.8838 or by
email at dkonipol@yahoo.com.
