On the surface, real estate investing might seem fairly simple and straightforward. You buy a house, find a renter, and make some money. But what few on the outside consider is the financing portion of the investment process. Unless you have hundreds of thousands of dollars in cash lying around, you can’t exactly buy lots of property on your own. And because banks aren’t always keen on lending to people who already have a mortgage or two to their names, traditional lenders aren’t always an option. It’s in these situations that private money becomes highly attractive.
What is Private Money?
“Private Money Lenders are non-institutional lenders that issue short-term loans for the purchase of, and sometimes the renovation, an investment property. They’re commonly known as ‘hard money lenders,’” real estate investor Allison Bethell explains. “These private money lenders offer private money loans to short-term fix-and-flippers as well as long-term investors looking for a rehab project, quick funding, or cash-out refinancing.”
Private money is ideal in numerous situations, but is most commonly used when:
- You’re investing in a short-term deal where there are benefits of being an all-cash
- A traditional lender won’t finance a real estate deal for you.
- You want to buy a property and renovate a property before you can get a competitive loan package from a conventional mortgage provider.
By definition, a private lender can set any terms he or she prefers. It’s their money and they can use it as they see fit. However, in most cases, a hard money lender will require you to put at least 10 to 20 percent down on the deal. In other words, they’ll ask you to fork over $20,000 to $40,000 of your own money on a $200,000 investment. Then they’ll provide the rest.
Because of the convenience and risk, private lenders generally charge much higher interest rates – perhaps in the 7 to 12 percent range – and require you to return the investment in one to five years. However, there are exceptions. If you’re making a long-term investment, for example, the rate could be lower and the loan term lengthier.
Finding and Using Private Money
Money doesn’t grow on trees – and private money is no exception. However, it’s more readily available than you realize. In a booming economy, there are plenty of people looking for ways to put their money to work. Here’s some advice on how you can find these people and use their money strategically so that it benefits everyone:
1. Know the Three Circles
Private money is all around you, but it’s easiest to organize it into three degrees or categories. They include:
- Primary Circle: Family and Friends. You should always start by tapping into your closest connections. Whether it’s a parent, aunt or uncle, best friend, or sibling, your best chance of obtaining private money is to look to those who trust and know you.
- Secondary Circle: Colleagues and Acquaintances. If you don’t have someone in your inner circle that’s able to lend money – or if you’re unwilling to put them on the spot – you can move to your secondary circle. This includes colleagues, acquaintances, and professional connections. In other words, these are people that you have an “in” with.
- Tertiary Circle: Accredited Investors. If you can’t find someone in your secondary circle, then you need to cast your net even wider. It’s at this point that you look to investment clubs, accredited investors, and hard money lenders that lend money as a primary form of investing.
The hope is that you can source private money from one of the first two circles, but don’t be afraid of dipping your toes into the third one. As long as you can get money with favorable terms, it doesn’t really matter where it comes from.
2. Focus on the Deal
Private money lenders typically don’t care much about your credit score or financial statements. They care about the deal and want to know if the numbers work. They’re far more interested in whether you have a track record of successful investments than if you have an 820 credit score.
Keeping this in mind, don’t try to sell yourself to a private money lender. Instead, sell the deal. View the deal as a product and the lender as an investor. How can you convince them the product will provide a strong return on investment? While you play a role in this, you aren’t the primary selling point.
3. Understand the Risks
Private money isn’t free money. Familiarize yourself with the unique risks and challenges that this sort of financing model presents.
As previously mentioned, the biggest downside of hard money is that it features much higher interest. This may not be a big deal if you’re holding onto a loan for six months, but it becomes problematic when the loan is active for years at a time.
It’s also important to know that you can still lose the property in a privately financed deal. If you can’t pay back the loan, you give up the underlying asset. In other words, you can still go into foreclosure.
4. Be an Excellent Communicator
When working with an individual investor, you should always be thinking about your relationship with that person. Aside from making sure they get a positive return on their investment, you should also be cognizant of how you’re communicating with them.
Good communication puts an investor at ease and makes it more likely that they’ll offer you another loan in the future. Don’t forget about this side of the equation.
Contact Green Residential Today
When you invest in real estate, you want your time and money to work for you. At Green Residential, we understand how precious these resources are; we’re committed to providing Houston-area landlords with premier property management services. From rent collection and monthly accounting to maintenance coordination and property inspections, we do it all. Please contact us today for a complimentary property analysis!