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.
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Investment Parameters
Loan To Value (LTV) Ratio: 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.
Property Type: 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.
Income Potential Of The Property: 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.
Exit Strategy: 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.
