Real estate investors are always on the look out to make deals every day. However, in funding their real estate investments money is needed to complete deals. This brings out the next big question, is it better to borrow from private money lenders or a bank when investing in real estate? This is a frequently asked question among individuals today. In finding out, which is better, below is a concise comparison between the bank and private lenders. When borrowing money from either of the two bodies there always benefits and drawbacks that come with it. The best thing about making the best decisions for a real estate investment is by first being fully equipped with enough knowledge on the loan borrowing process and the choices available.
A private money lender is either a company or a non-institutional individual that credits out money, secured by a deed of trust and a note in funding a real estate transaction. Private money lenders put their priority on the deal more than the credit score of the realtor. They always ask for protection through the first deed of trust on the property. Thus, the security of their money is a hard asset. A bank, on the other hand, is a direct lender, where a borrower applies for the desired loan. Employees further review the application, but it has first to pass the Automated Underwriting Software, that gives the final decision.
Differences between hardmoney lender and private lender
People very often confuse private money lenders and hard money lenders. The private money lenders are more relationship-based than the hard money lenders are. Hard money lenders are intermediaries that connect individuals with those people lending the money. These lenders put money where the interest rate is high with a low-risk possibility. Although both a private money lender and a hard money lender are backed more by a real estate purchase, a hard money lender is usually in a way licensed to loan money, unlike a private lender where an agreement is based on the parties. When it comes to hard money lenders, they often follow a criterion, where the loans have, for instance, defined durations, upfront points, and interest rates. When it comes to private moneylenders, there is flexibility in all the above points in issuing the loan since they put it in an open discussion
Whether you choose a bank or private money lender in financing a real estate investment, it is wise to have the approaches of both at hand. They both can be a good deal, depending on what you are planning to do.
Interest rates and origination fees
Predominantly, banks offer lower interest rates and origination fees than private lenders in real estate. When it comes to banks, their interest rates and origination fees are capped to match those offered by other banks in such safe deals. Thus due to the high competition between banks, the bank interest rates are relatively low. Also, banks offer high pre-payment fees to borrowers. As for the private lenders, the interest rates are quite high, due to the high risks they partake. With this, however, private money lenders always expect more compensation, that is, a high return on investment. The origination fees by private money lenders range from less to 1% of the total amount of the loan offered. Private money lenders are, therefore, more viable in real estate investments where the property is to be resold with higher returns. Bank loans, on the other hand, are viable in safer purchases such as personal residential houses where minimal returns are expected.
When purchasing a property, closing is usually the last step. Thus, it is very crucial to budget for the closing costs. The closing costs of bank loans range from 2%-5% of the overall amount of the cost of your property. The closing costs range from discount points, title insurance, attorney fees, recording fees and appraisal charges among others. Initial loan estimate received from money lenders contain how much your closing costs may be. However, less money is spent on fees and the closing costs of a loan, by private money lenders. These closing costs vary per the private money lender and depending on the amount of the loan. Usually, these costs vary between 3 to 8 points. In this case, a point is equivalent to one percent of the total mortgage amount
Private lenders will often close a deal within few weeks while others may close in a few days. With the private lenders, certainty is achieved very early since there is less personal information required for consideration. On the other hand, banks close a loan between 60 to 90 days while some may take less than 45 days, depending on the loan required. Banks do not offer certainty of approval until late in the process. In the case of a poor credit history by a borrower, the bank is likely to take ages to approve a loan request.
Loan to value
Private money lenders give out loans at 65% loan to value while banks give loans ranging from 65% and 80% loan to value of the property’s total value. Banks are known to lend depending on the current value of the property. On the other hand, private lenders lend after the repair of rehab properties. While putting this into consideration, the loan given by private lenders is more.
Preferred deal type
Private lenders make easy deals. They believe in offering loans if the real estate investment creates an opportunity for the borrower to make the most income out of it to pay back. Meanwhile, banks have different terms. They prefer to lend on safe deals that have stable incomes and values. Banks rely on a property’s debt service coverage ratio, which should portray that the income from the property should be more than mortgage payments. With the debt servicing ratios and the minimum income requirements, not everyone can qualify to get a loan from the banks.
When it comes to banks, credit scores are the primary factor in the loan approval. When dealing with a private money lender, credit scores are as well considered, but they do not form the basis of their loan approval. As for the bank loans, there are many qualifications to be met before the bank decides to offer you a loan. Every private lender has their way of determining the credit scores. Most private lenders, give more weight to the borrower’s ability to pay rather than on the credit scores.
Mortgage underwriting is the process that is used by money lenders to determine if the risks associated with offering a borrower, a loan fit the category of acceptability. This means that an underwriter either denies or approves your loan request depending on the criterion used. When offering bank loans, banks use Automated Underwriting Software decisions in offering loans. This means the bank personnel does not make the final decision in offering a borrower a loan. Nonetheless, when it comes to private money lenders, they base their decisions on the experiences of the private money lender by the type of loan collateral being offered. In the case of private money lenders, you can always agree with the borrower and the lender. Private lenders mainly major their decisions on personal judgments.
When looking into venture into a real estate investment, there is, need to consider looking for funds from a private money lender. Their fast loan approval process will allow you to acquire the property as soon as possible. Remember, many investors are considering purchasing the same property just as you are, thus, if money is availed urgently, you can beat the competition in acquiring it. When it comes to other standard properties such as a home, banks are quite a better option to get a loan from. This is because; private money lenders are way too expensive, whereas, banks are cheaper and offer flexible payment plans. However, when having the bank as an option, you should have a decent credit history to meet the bank’s criterion. Additionally, in the case of an individual having a poor credit history, then looking for a private money lender would be ideal.
Private lenders are the best option when looking to borrow money for a real estate investment because they have no constraints when it comes to lending limits. With their shorter loan-processing period and fast transactions, it means a borrower can access money quickly and invest. They focus on building a good relationship with the borrower and keep the borrower upfront with all the information on the fees to expect from the project. Through offering personalized customer service together with a broad range of loan products, it is suitable to meet individual circumstances and needs.
To sum it up all, both the bank and the private money lenders are good options, each one of them in their instances and distinct ways. Thus in planning to purchase conventional property bank loans would be ideal. On the other hand, private money lenders are ideal when it comes to real estate investments.
Finally, yet importantly, both banks and private lenders are a good option to finance a real estate investment. However, banks are more suitable for straightforward property that needs to be financed. On the other hand, private money lenders are most appropriate for those challenging properties. Challenging properties are those that have a promise of making the most money, benefiting both the borrower and the private money lender. Above, are the most fundamental differences that you need to know in making a decision which option is best suited for you. Concisely, from the above differences, a private lender is an ideal person or company to look up to if you have plans in investing in the real estate industry.
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