As published in Scotsman Guide's Commercial Edition, July 2005.
Most brokers and borrowers distinguish between private money lenders and conventional institutional lenders based on two factors: speed and cost of capital. Private money lending has a high cost of capital but can move quickly, and conventional institutional lending has a low cost of capital and typically is much slower.
Although correct, this comparison is not truly indicative of the differences between private money lenders and conventional institutional lenders. Gaining a better understanding of just how different they are will enable you to prepare your loan-request package and moreover, prepare your client for borrowing from a private money lender. Here are a few other comparisons that show how private money lenders see things differently.
Real estate vs. banking expertise
First and foremost, private money lenders are real-estate people in the business of lending. They understand the business of real-estate investment, development and financing much better than they do securitization, swap rates and defeasance. They are more interested in your proposed business plan than with extensive financial modeling. Although the economics of a deal are important, these lenders see as equally important that your proposed plan is thorough, well-researched and above all, reasonable.
Loan ratios vs. overall risk analysis
Private money lenders generally have flexible parameters regarding loan-to-cost and loan-to-value ratios. They have the ability to structure a deal outside conventional lending parameters and spend more time analyzing risk than manipulating numbers to fit the necessary template for presentation to a loan committee. This does not necessarily mean they tolerate more risk than conventional lenders. It usually means they assess the risk differently and structure deals designed to mitigate those risks.
Credit vs. character and experience
By nature, short-term, opportunistic real estate deals are dynamic. For better and sometimes for worse, private money loans are subject to the same constant change as the real-estate deal itself. As such, it is important to private money lenders that borrowers are of good character (honest, reliable, responsible and accountable) and have the necessary experience to foresee change and adapt accordingly.
Private money lenders are not interested in borrowers’ FICO scores, nor are they overly concerned that borrowers’ recent tax returns might be on extension. They are more concerned about whether the borrowers are prudent businesspeople who make good decisions and have reasonable expectations.
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