Who wants to have more money? I’m sure you wouldn’t say no. How often have you stopped in front of a real estate project and had to give up for lack of funding? One often-overlooked method of financing is to approach private lenders. It looks dangerous! Isn’t that your first reaction when you see the word, private lender? It must be loan sharks or people who made their money with drugs and contraband… Don’t worry! It’s not about that (at least for those I deal with).
Who is the private lender?
Private lenders are simply people like you and me who have money to lend to people who want to invest in real estate. These people prefer to invest their money in real estate loans than in 1% GICs, or even in Mutual Funds whose capital or return is often not guaranteed.
Where does their money come from?
As Mr. Luc Audet, a lawyer specializing in real estate, teaches in training “Becoming a private lender.” The money comes from the equity in their home ( house value – difference from the mortgage ), inheritance, cash, sale of their business, money acquired inside their business or saved over the years, etc.
How does the loan work?
The purpose of the loan is to finance either real estate or, very occasionally, a business. However, some equity must be available on the building to protect these lenders. Therefore, the lender will not agree to finance a loan at 100%. The loan is legal, notarized, and registered with the government (Land Registry). The interest rates are naturally a little higher than those of the banks due to the higher risk incurred by the lender. The term can be very flexible: repay interest only, a minimum period of 3 months or more; there is often no penalty like in banks if the loan is repaid before the end of the term. All these advantages make it possible to move quickly and safely with such a type of loan.
A mortgage loan made by a private lender is a contract between two parties that do not involve the participation of any financial institution. One party agrees to lend money to the other in exchange for repayment of interest. The private lender always reserves a hand as collateral on the borrower’s property. It is by no means mandatory that it is precisely the building for which the loan is made. This private lender could be a professional company, one or more people, friends, or family members.
This type of arrangement has pros and cons for lenders and borrowers, but many potential downsides can be avoided with careful monitoring, planning, and precise documentation. This is why I recommend always using the services of a notary to draft a good, complete and secure document.
1. Private mortgages have advantages for the borrower
The main advantage of private mortgages for home buyers is that they can get a loan from anyone who wants to grow their money, including a family member. Thus, a buyer does not have to meet bank requirements and qualify for a traditional mortgage; the terms of the agreement can be very flexible.
Also, lenders who lend to family members often prefer this arrangement because it allows them to keep all the money involved within the family. Additionally, getting a private loan with the family means the borrower may not need to provide collateral. Even with a bad credit score, this offers him a chance to improve his situation as long as he meets his payments. It may also constitute a gain on an asset.
2. And also a financial advantage for private lenders
Private mortgage lenders can potentially make more profit this way than a bank would from a traditional mortgage because they can charge higher interest rates. It should be considered normal that these interest rates are higher since they take more risk in lending to people who often cannot qualify for traditional mortgages. Usually, private mortgage lenders work with people who have a “damaged” credit rating; they can also provide financial support for risky projects independent of credit, such as FLIPS, conversion to condos, new construction, etc.
3. A loan that can be flexible in repayments
One of the significant advantages of this type of loan is that the lender, not being governed by the rules of the banks, can be very flexible with the terms. For example, repayment of interest only, repayment at the end of the project only, no claim on the loan, but can participate in the profits or a mixture of both, etc.
4. You are using other people’s money!
You know that profitability is directly proportional to personal money invested in the project. If you invest $100,000 and the project earns you $10,000, that makes you 10%. That’s fine, but if you’ve used $50,000 and the project still earns you $10,000, you’ve just doubled your profitability, so 20%. However, it would help if you subtracted the lender’s costs. You will understand the principle, I am sure.