Many real estate investors visit our platform hoping to find wealthy individuals who will lend them money for their investment property deals. However, this is not a realistic approach for several reasons. First, these individuals don’t typically advertise online. Secondly, conducting business with an individual instead of a professional lending firm can lead to various challenges. In this guide, I’ll explain the drawbacks of borrowing from individual investors, and I’ll make a case for why I believe it’s always safer to get funding from private lending companies, which are also known as hard money lenders or bridge lenders.
Wealthy Individual Investors Lending Their Own Funds
We’ve heard a variety of reasons why real estate investors prefer to seek individual private lenders:
- They offer 100% financing.
- They don’t charge points.
- They don’t care about my credit score or personal finances.
- They don’t require appraisals.
- They offer gap funding and junior liens.
Some of these things may be true, but every individual lender is different. Some lenders have little to no experience with private mortgage lending and most have likely never experienced a default and foreclosure. Perhaps they just assume they can easily take over the property if you don’t perform, but the reality is far more complicated. Foreclosures can be prolonged and expensive.
It seems like most real estate investors only find wealthy individual investors in their local area, and the relationship started by a referral or recommendation or a networking event. Borrowing from individuals outside of your local area is more likely when it’s a referral from an individual investor you’re already doing business with. It’s all done by local networking.
Wealthy individual investors/lenders don’t advertise, so you’re wasting your time searching online thinking you’ll find an individual to lend you tens or hundreds of thousands of dollars. If you find an advertisement online offering private money loans at a low rate, it’s most likely a scam in which you respond, pay an application or underwriting fee and never hear from that person again.
The Downsides of Borrowing from Individual Investors
If you can find an individual investor/lender to finance your project, that’s great, but here are several drawbacks worth considering.
- Individuals generally have limited funds. At some point, they will run out of capital, and then you’ll have to find other investors.
- Unreliability. You may be trying to close a deal and can’t get the funds because your individual investor is on vacation.
- Their lack of experience with private lending can lead to legal action if anything goes wrong.
- The pricing may not be lower than what you’d pay to a professional private lending company. Some individual investors have unrealistic yield expectations.
- Individual investors don’t have a public reputation to maintain, so there is a higher risk of unethical behavior such as price gouging, bait & switch, or loan-to-own.
Private Lending Companies
While there may be some benefits to borrowing from individual private lenders, there are lots of advantages to borrowing from professional lenders which are small to mid-sized companies. Many real estate investors and brokers refer to them as “hard money lenders,” but “hard money” is no longer a popular term within the lending industry. While some companies embrace the term, most hard money lenders call themselves “private lenders.” To be more clear, I prefer to use the term “private lending companies.”
Lending Companies Don’t Run Out of Capital
Unlike individual lenders, private lending companies seldom run out of capital. Since they are in the business of lending, they are constantly recycling funds by one of several business models:
- Fund and sell to institutions
- Fund and sell to individual investors
- Manage a mortgage fund (pools money from multiple passive investors)
- Use a bank warehouse credit line
- Syndicate each loan to multiple individual investors
- Table funded by individual investors
Ironically, some private lending companies use individual investors to fund their loans, which can be considered brokering. This is a popular model in California and Arizona. Most of those individual investors would not work directly with borrowers because they prefer to have a license private mortgage professional underwrite and process the loans they invest in.
Advantages to Borrowing from Private Lending Companies
One major advantage of working with such companies is that they have a public reputation to uphold, which tends to discourage unethical practices.
Since private lending companies have staff and a lending operation, their customer service is typically better than individual lenders. Someone is always available to respond to calls and emails.
Private lending companies can be a great resource. If you plan to refinance into a long-term loan, they can refer you to a lender or arrange (broker) the refinance loan for you. For rehab and construction projects, private lending companies can refer you to contractors if needed and provide advice. Many private lending firms are owned by former real estate investors who have lots of experience.
The reputation of private lending companies is a significant reason why I recommend them over individual investors. Many private lending companies belong to a private lending trade association that mandates its members to follow a code of ethics. Our industry has 4 trade associations:
- American Association of Private Lenders
- National Private Lenders Association
- California Mortgage Association
- Arizona Private Lender Association
In California, Arizona and Nevada, individual investors cannot make loans directly to borrowers without a license. There are a few exceptions, but generally in these states your loan has to be arranged or funded by a licensed lender (or broker).
How to Find Private Lending Companies
If you’re seeking a private lender for an investment property deal, use PrivateLenderLink.com as a resource. All the companies listed on the site have a very detailed profile that shows their lending guidelines and trade association memberships. There are two options for using our platform.
Option 1: Browse Lenders
Search on our site for direct lenders. All lenders have a very detailed profile with information about their lending guidelines, rates, fees and much more. Make contact with each out directly by email, phone call, or visit their websites. First select a loan type, then enter the state where the property is located.
Option 2: Create a Loan Request
Fill out a questionnaire with information about your financing needs. You can then browse lenders and invite a few of them to view your deal. Or ask us for recommendations; we’ll review it and invite a few select lenders that we feel may be a good fit.
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