What is a Private Money Loan?
Private money loans – or simply private money – is a term used to describe a loan that is given to an individual or company by a private organization or even a wealthy individual. The organization or the individual is known as a private money lender.
Private money is usually offered to borrowers without the traditional qualification guidelines required by a bank or lending institution. The major issue is that private money loans can sometimes be very risky, both for the borrower and for the lender. With less regulation, the borrower enjoys more freedom to use the loan for less than ideal purposes.
Most private money loans follow the current prevailing interest rates. However, they may be significantly more expensive. When the lender knows what the loan will be used for, it may charge a higher rate of interest if the risk level of the proposed enterprise is high.
- Private money loans are given to individuals or companies by a private organization or individual instead of a bank or other financial institution.
- Private money lenders must be diligent and discerning when offering private money to borrowers.
- Risks exist for both borrowers and lenders with private money loans.
Private Money Lenders
The mitigation of risk is paramount for a private lender because the goal is to make money. There are a number of factors that a private lender focuses on before offering a borrower a loan. Among the most important are:
- Borrower credit – A borrower’s credit score reveals how quickly and consistently the borrower has historically paid off his debts
- Pricing strategy – How can the lender ensure that the cost (to the borrower) of the loan is competitive with other lenders
- Exit strategy – The schedule for the borrower to settle the loan and how they plan to do it
It’s also wise for the lender to perform due diligence, verifying any information provided by the borrower in order to get the loan.
Regulation of Private Money Loans
All private lenders must follow federal and state usury laws, and they can be subjected to banking regulations as well. Still, not all routine regulations apply to private lenders and the loans they offer.
One of the most frustrating regulations for private money lenders is the fact that lenders are sometimes subject to limits on how many loans they can hand out if they lack a banking license. Most private lenders don’t need such a license because they aren’t a bank or some other type of financial or lending institution. Some states have established limits on the number of loans a lender can offer before they are required to get a banking license.
Risks with Private Money Loans
There are several risks associated with private money loans, both for the borrower and the lender.
A borrower may fail to fully check out the lender. It’s important to know where the money is coming from. Usually, it’s from a few independent investors who are looking for an investment return. Making sure that the money is good and that the loan won’t suddenly fall apart is important.
If the borrower begins the process of moving into a rental space and then their loan falls apart, they can find themselves in serious trouble. Borrowers may also fail to fully read or understand a loan agreement and end up with a loan they can’t pay back.
Lenders face risks also. That is why it is crucial for lenders to do their due diligence – to make certain that the borrower can be trusted to repay the loan. If a loan is given and the borrower uses it for a risky investment or on an opportunity that falls through, the borrower usually defaults on the loan. The lender must face the reality that they won’t see all of the loan repaid, even if they take legal action.
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