Private Money Loan vs. Traditional Loan: Which is Right for You?
Understanding the differences between Private Money and Traditional Loans
In real estate, 2 primary sources of funding emerge as the frontrunners.
•The 2 most known sources are traditional lenders, including banks and mortgage companies.
•The second source and least known, are private money lenders.
Each source has its own advantages and constraints, making the choice between them fairly easy depending on the situation. This article explains the critical differences between private money loans and traditional loans. This should help guide you in making the right choice between using one source over the other, depending on your future circumstances.
Maybe right now you believe you could never need a private money loan, but think again. In this short article, you may find out a private money loan may be best for your needs, now or in the future.
Table of Key Takeaways between Private Money Lenders and Traditional Lenders
|Private Money Lenders
|Loan Processing Speed
|More flexible, no min credit scores
|Strict credit requirements in most cases
|Focus is on asset
|Comprehensive asset and borrower analysis
|Standardized, long terms
|None or shorter
|Fast funding, shorter term
|Slower funding scenarios, longer loan terms, lowest rates
The Speed of Loan Processing between Private Money and Tradition Lenders
Private Money Lenders: Renowned for their speed, private money lenders leave traditional lenders in the dust when it comes to closing loans quickly. Private money lenders are often the go-to choice for time-sensitive real estate purchases, or other situations where a fast loan closing is the top priority. Private money lenders gather documentation quickly that’s required to close a loan, usually in a matter of days.
This means you, as the borrower of a private money loan, must be ready to put everything on hold in order to provide documentation quickly during loan processing. A private money lender’s processing time is almost always constrained by the speed of the borrower in providing the requested documentation. Here are some of the most important items that every private money lender will need to process your loan quickly.
Traditional Lenders: In contrast, traditional lenders are much slower in processing their loans. Typically a loan processor for a bank or mortgage company is juggling a number of different loans simultaneously so response time is much slower.
And it’s not unusual for the list of documentation to grow either. Just when you think you’ve provided everything on the list to the loan processor, more and more documents are requested!
It’s the slow processing times of banks and mortgage companies which make them a poor choice for time-sensitive real estate purchases, or other situations where a fast loan closing is the biggest need.
Credit Flexibility and Minimum Credit Score Requirement
Private Money Lenders: Generally more lenient with bad credit histories of borrowers, private money lenders focus more on the asset and its value. In fact, there are many private money lenders that do not require a minimum credit score.
Getting a loan from a private money lender is particularly beneficial for those who might not have perfect credit scores.
Traditional Lenders: Banks and mortgage companies have strict credit criteria and this can pose challenges for those who have less-than-ideal credit histories.
However if a bank or mortgage company offers FHA, or other government backed loans, these loans allow for a low, min credit score of 580 (at the time of this article’s date of publishing).
Ironically it’s both private lenders and the U.S. taxpayers who take on the highest credit risks, but that’s a separate topic.
Private Money Lenders: The primary concern of private lenders is the loan’s collateral, specifically the property characteristics and value. In this context, real estate is the asset that is being put up as the collateral for the loan.
The location, age, condition, and property use are just some of the characteristics of a property that a private lender looks at. Private lenders also look carefully at property value, usually assigning a more conservative value to a property than a traditional lender would.
If the collateral is acceptable to a private money lender, and the loan to value ratio is low, a private lender will typically issue a loan approval without a minimum credit score or income requirement. This is particularly useful for real estate investors who don’t always have perfect credit histories.
Traditional Lenders: The loan collateral is also a primary concern for banks and mortgage companies, particularly the collateral value which is often determined by an appraisal. Traditional lenders generally place as much, if not more emphasis on the borrower’s income, assets, and credit history. More requirements for loan approval eliminate a lot of borrowers right out of the gates because most people don’t meet all of these requirements.
Loan Terms Flexibility
Private Money Lenders: With private lenders, you can often customize the loan term to fit shorter term needs. For example, a private lender may offer a 12 month loan when all a borrower requires is 9 months. A private lender can often modify the typical loan term of 12 months to the 9 month loan term preference of the borrower.
Traditional Lenders: Banks and mortgage companies usually offer loans with standard, specific loan terms that are non negotiable. They are suited for borrowers requiring longer loan terms, from 5 to 30 years.
Private Money Lenders: Prepayment penalties are deadly for borrowers who have short term loan needs. This is because if you pay the loan off early, you may owe a stiff penalty for doing so.
Because private money loans tend to be short term, usually between 6 months to 3 years, they usually do not have prepayment penalties. For example, a real estate investor who uses a fast funding, private money loan to purchase a rental property but quickly refinances with a long term, 30 year loan.
Or a homeowner who knows she will only live in a home for less than 2 years because of an inevitable job relocation. These are just two examples where a private money loan could be better than traditional financing because of no prepayment penalties. And if private money loans do have prepayment penalties, they are typically shorter, no more than 4 to 6 months.
Traditional Lenders: Almost all loans from banks and mortgage companies (at the time of this article’s publishing) come with prepayment penalties. Most with prepayment penalties of between 3 to 5 years. This means if you pay the loan off anytime before 3 to 5 years, you will have to pay a stiff penalty. Prepayment penalties are one of the most commonly overlooked items by borrowers when getting traditional type loans from banks, credit unions, or mortgage companies. Always ask about the prepayment penalty on any loan program you apply for, before you even apply. If you think you may need a loan for a shorter term than the prepayment period, then do not apply for that specific loan.
Ideal Scenarios for Each Lending Type
Private Money Lenders: They are particularly well-suited for quick processing and funding, as well as for other short-term real estate needs where no prepayment penalty is important. Private money loans are also known for credit score flexibility with approvals based more on the property than the credit score of the borrower.
Traditional Lenders: Traditional loans from banks, credit unions, and mortgage companies are better for long-term loans from 5 years to 30 years. Borrowers who want loans at the lowest possible interest rate for the longest possible term are looking for traditional loans. But in order to get approved for these loans, they demand good credit, high enough income, and a lot of heavy documentation.
In conclusion, understanding the differences between private money loans and traditional loans is crucial in knowing what type of loan is best for a specific situation. Just remember, the next time you find yourself needing a loan, ask yourself which type of loan would be most appropriate for the situation and use this guide to help you choose.
The choice between private money lenders and traditional lenders depends heavily on your specific needs in any given situation. And trust me, the situation will always dictate which source of funding you choose.
If you liked this post, please share it with someone you feel could benefit from it. Curious why people use private money loans? Check out some more reasons why people use private money loans on our blog. Think private money loans could be a fit for your situation? Contact us and get preapproved for a private money loan, we make it super easy, and fast!
Corey Ann Dutton, MBA, PLM, Private Money Lender