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   ARTICLE   |   From Scotsman Guide Residential Edition   |   April 2008

A Private Avenue

More borrowers are turning to private lenders to fund their deals

Today’s sluggish economy brings an ironic twist to real estate financing. Despite relatively low interest rates and an abundance of foreclosures on the market, homebuyers are experiencing difficulty qualifying for traditional financing. In fact, the economic slowdown has forced conventional lenders to tighten their underwriting guidelines, making it difficult for buyers and investors to obtain traditional financing.

Private lenders are filling the gap and becoming a viable financing alternative for many. Private loans are funded by a variety of sources. These can include high-net-worth individuals, some of whom are the founders of lending companies. In general, such investors offer higher rates and fees than conventional lenders.

Despite elevated costs, many real estate buyers are increasingly turning to private lenders for sound business reasons and key advantages unmatched by most conventional lenders. Such advantages include:

  • Flexible loan structures. Most conventional lenders stick to specific lending programs, but private lenders structure deals for each borrower and property. The importance of flexibility often comes into play when a buyer finds a good deal that does not fit into a conventional loan program.

    Most conventional lenders also won’t finance deals that don’t fit their lending mind-set. For example, properties with less-than-perfect maintenance often run into financing roadblocks. Buyers who wish to purchase such properties to improve them and profit in a market that continues to price high are turning to private lenders for flexibility.

  • Quick response. Whereas conventional lenders can take as long as 60 to 90 days to commit to a deal, private lenders often can close a loan in less than a month -- typically one to three weeks. This speed is possible because private lenders focus on the project’s viability and the borrower’s experience. They also place less scrutiny on the underwriting process. The lack of federal auditors and large management boards also allows private lenders to act quickly.

  • Credit flexibility. Buyers turning to private lenders for credit reasons do so more for lack of adaptation than for lack of credit. A real estate investor’s net worth is typically in real estate. Yet, conventional lenders often consider liquidity as the borrower’s main financial strength. This disparity causes conventional lenders to reject many reputable borrowers. Depending on the nature of the transaction, private lenders are not as concerned with substantial liquidity. An interest reserve or deferred maintenance account can be escrowed (if there is room in a lender’s loan-to-value ratio) to ensure a buyer has enough capital to be successful.

  • Greater leverage. While most conventional lenders base their loan value on the cost of the project, typically 50 percent to 80 percent, private lenders lend based on the property’s future value, usually lending about 50 percent to 70 percent. Whether buying property below market value or taking steps to increase the value, buyers can enhance their leverage with a private lender.

Not all private lenders operate with the same standards, and the best solution is to use the same precautions as in any other business deal when searching for a reputable lender. Mortgage brokers should advise buyers to always request and check lender references. Brokers should also help review agreements and determine whether a private lender will require upfront fees to cover third-party expenses.

As the current economy forces borrowers to seek loan programs that are more adaptable to their individual circumstances, the advantages of using a private lender should be viewed strategically. After all, performance often counts more than price in real estate.  


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