Real estate investors should consider using a private mortgage loan when they are buying properties. A private lender has a different set of criteria that makes the process more streamlined and flexible. The criteria for one of these private mortgage loans is less strict than a more traditional counterpart. Having all the information can help investors make a good decision about when these are appropriate choices.
Introduction to Private Mortgage Loans and Investment Properties
Private mortgage loans come from private or alternative lenders. These individuals and or entities work apart from federally regulated options like banks and credit unions. Private mortgage loans have a more streamlined application process and different acceptance criteria than more traditional loans.
Private mortgages focus on equity and the loan-to-value (LTV) ratio, as opposed to credit scores and strict income verification from more traditional institutions. The LTV calculation incorporates all of the requested mortgages and any existing ones divided by the property’s appraised market value. Most private lenders work with a maximum LTV of 75%.
Investment properties are ones that are bought to generate income through appreciation over time or rental revenue. These aren’t usually a primary residence.
There are several other excellent reasons why these alternative loans are a good choice for this type of investment.
Why Choose a Private Mortgage Loan for Investment Property?
A private mortgage through an alternative lender has several big benefits over a more traditional loan, including:
Customized Loan Terms
Private loans can line up with investors’ strategies. These alternative lenders offer shorter-term loans than more traditional banks and credit unions. They are interest-only options that can reduce monthly payments when investors are renovating a property they intend to flip after it’s upgraded.
The Application Criteria are Flexible
Private lenders accept what would be considered unconventional income sources apart from traditional banks and credit unions. For example, these alternative lenders will look at the income made from sole proprietorships and contract work as well as freelance endeavours. They also take on what would be considered bad credit mortgages by a bank.
A real estate investor might be looking to move quickly on an investment property. They can get a second mortgage through a private lender, taking advantage of these flexible income requirements.
The Application Process is Faster
Real estate investors will also be happy to know that the application process for a private mortgage is faster than its traditional counterpart. Markets are usually competitive, and getting a mortgage quickly can give them an advantage in any attractive deal.
A private lender can approve an application in one to seven days, depending on how complicated the loan is and the documentation and equity that gets provided. Traditional banks usually take 30 to 60 days because of their strict requirements.
The Rewards of Using a Private Mortgage Loan
There are some other bonuses to using an alternative lender for an investment property.
- Applying for a private mortgage means a faster approval time and the ability to jump on a good deal quickly.
- A private mortgage loan is easier for an investor to qualify for because alternative lenders put a big emphasis on the value and equity of a property. That means if an investor has been in business for any length of time, they have equity built up, which is the amount of any property that’s being paid off.
- Private mortgage loans use more flexible criteria. That means a real estate investor can consider risky properties that banks would pass over. Those might include houses or other buildings that are in poor condition or ones in underdeveloped or urban areas. Remember, the loan-to-value (LTV) ratio allows investors to borrow money up against a property’s value.
Any investment property carries a certain amount of risk. The same can be said for a private mortgage loan that can finance the deal.
The Risks Involved
The biggest risk involved with one of these loans is the higher interest rates. The most recent numbers as of September 2024 are between 8% and 12% for most of these private lenders. It’s important for real estate investors to keep in mind these rates depend on the requested mortgage and how close it is to the maximum LTV ratio.
Here’s an example. A requested mortgage with a 30% LTV will get a low interest rate. The same is true in reverse if the requested mortgage is close to the maximum LTV ratio.
The risks involved also include higher fees which can include legal, broker and lender fees. These combined usually sit in a range from 4% to 8% of the total loan amount.
Investors also need to keep in mind the loan terms are shorter. They are usually only 1 year, so an investor has less wiggle room to juggle finances. These less forgiving terms mean there’s a bigger risk for a power of sale or foreclosure if the terms of the mortgage agreement are broken.
Working with a Private Lender: What to Expect
Overall, real estate investors can expect a more streamlined, quicker process when they deal with a private lender. There are no strict income verification requirements like with a regular bank, and the emphasis isn’t on credit scores and debt-to-income ratios.
These differences give investors the chance to act quickly when a deal is time-sensitive. Working with a private lender also usually requires a clear exit strategy. Because the terms are short, these alternative lenders want some extra reassurance they will get their money back.
