When it comes time to plan your next investment, you can choose between several lending options such as private lenders (also called hard money lenders), or conventional financing (mortgage companies and banks).

There can be some confusion when it comes to what these terms really mean. Let’s look at some of the pros and cons of each type of financing option to help make it easier for you to find the one that best suits your needs.

What is Private Money (or Hard Money) Lending

Private money lending has become increasingly popular in recent years, particularly in real estate investing. Many real estate investors and developers turn to private money lenders to finance their projects, as private lenders are often more flexible and offer faster financing than traditional lenders.

Private money lending, also known as hard money lending, is a form of lending in which borrowers obtain loans from private investors or companies. These loans are typically secured by collateral, such as real estate or other valuable assets. Private money lenders are able to provide financing quickly, often in a matter of days, as the decision to lend is based on the value of the asset and the experience of the borrower.

These loans are short-term secured by the asset and tend to extend for between 6 to 12 months. Also known as bridge loans, the borrower is typically looking to sell the property quickly once the asset has been stabilized and does not need the financing for a long period of time. In some cases, a lender will offer extended terms such as 5, 7, or 10/1 ARMs (Adjustable Rate Mortgages) giving investors an opportunity to hold a rental property and get it cash flowing.

Another advantage of private money lending is that it is often more flexible than traditional lending. Private money lenders can tailor loan terms to the specific needs of the borrower, which can be particularly useful for borrowers who need financing quickly or who have unique financial situations. For example, private money lenders may be willing to provide financing for properties that need significant repairs or renovations, whereas traditional lenders may be less willing to do so.

So how much money can private lenders actually lend to the borrowers you might ask?  That amount is primarily based on the subject property’s value. This is where the term “Loan-to-Value” aka LTV comes into play. This is the outstanding debt on a real property divided by the fair market property value. Most hard money lenders will finance anywhere from 65-80% LTV. Here’s an example:

Let’s say you have a property with the following details:

• Fair Market Value: $500,000
• Investor is putting down: $100,000
• Outstanding debt now:  $400,000

In this situation, if the lender is providing $400,000 on this $500,000 property, they are  lending 80% LTV.

Private money lenders are also typically less concerned with the debt-to-income ratio of the borrower than traditional lenders. This financing is for business purposes and so the lenders are more focused on the value of the collateral being offered. Don’t get us wrong: credit is still important, but it’s not weighted as much in this case as people think. To give an example, borrowers who’ve gone through a recent short sale or foreclosure and can’t obtain conventional financing can still get a private money loan if the property that’s being used as collateral has enough equity.

Overall, private money lending is ideal for real estate investors who need to close quickly on a property, have multiple properties or have have unique financial situations. Private money lenders are able to meet these needs and provide financing quickly, with more flexible terms than conventional banks and lenders.

Conventional Financing

Conventional financing is a mortgage used by individuals and businesses to purchase or refinance real estate, and are offered by independent mortgage lenders, banks and credit unions. The most popular conventional mortgages are for buying a primary residence, rental property or vacation home.

The main advantage of a conventional mortgage is that it generally offers lower interest rates and longer repayment terms than other types of financing. This is because conventional lenders have stricter underwriting guidelines, such as a higher credit score (FICO), debt to income ratio (DTI) requirements, long-term, stable employment and salary history. In a nutshell, the bank is lending money based on the borrower’s creditworthiness whereas private money lenders focus primarily on the value of the asset.

The terms of a conventional real estate loan can vary, but they typically offer fixed interest rates and a set repayment schedule.  Although some conventional loans offer interest only payments for some portion of the loan, generally each monthly payment will include some principal and interest. 

There are also some disadvantages to conventional real estate financing. One drawback is that it can be a time-consuming process, as borrowers will need to provide extensive documentation and go through a rigorous underwriting process. Borrowers with poor credit scores or limited financial resources may struggle to qualify for conventional loans, which can limit their options. This type of loan may not be suitable for short-term investments or projects that require quick access to cash. This is because the underwriting process can take several weeks or even months, which may not be feasible for borrowers who need to move quickly.

Overall, conventional real estate financing is a reliable and accessible way for individuals and businesses to finance real estate purchases. It offers lower interest rates and more flexible repayment terms than other types of financing, but also requires a larger down payment and a rigorous underwriting process. As with any type of financing, it’s important to carefully consider your financial situation and goals before committing to a conventional real estate loan.