After several years of experiencing low borrowing costs, many real estate investors have been shocked by the increase in interest rates which started in June 2022, but not all private lenders have increased their rates at the same pace. In this guide, I’ll explain why interest rates increased, why there is a big difference in rate increases among the private lending community, and how to find out the current interest rates charged by private lending companies, which are also known as hard money lenders or bridge lenders.
The reason many private lenders increased interest rates is because their cost of capital went up when the Federal Reserve started to increase the fed funds rate in mid-2022, in an effort to fight inflation. Before explaining what I mean by cost of capital, I have to first explain the various business models used by private lenders, as it relates to their capital structure for short-term loans. That will help you understand why some private lenders have lower rates than others, and why some lenders move their rates faster than others.
Selling Loans to the Secondary Market
The most popular business model in private lending today is for private lenders to fund a loan and sell it to the institutional secondary market, which includes loan aggregators, private equity, hedge funds and other investment firms. For simplicity’s sake, I’ll just refer to the secondary market as “Wall Street.” So the lender has the money on their balance sheet to fund the loan, but shortly after closing, they sell the loan to Wall Street, make a profit, and recoup their capital so they can fund more loans.
The interest that lenders charge is based on the rate that Wall Street will buy at. Prior to mid-2022, Wall Street was buying short-term private mortgages for around 6% to 7%, and lenders typically mark that up by 1% to 2%. When the fed funds rate went up, it caused Wall Street to increase their buy rate, and lenders were forced to increase the interest rates charged to real estate investors, due to the increase in their cost of capital.
Mortgage Funds
The second most popular capital structure in private lending is to manage a mortgage fund. The lender pools money from many individual accredited investors, and they hold the loans for the entire term. The interest charged to real estate investors is distributed to the fund investors minus a management fee or performance split. Most mortgage funds are not directly affected by the federal funds rate and are not forced to increase their interest rates. Fund managers will likely only take action when they see that most of their competitors have increased their rates, and/or when their fund investors demand higher yields. Some fund managers won’t make any changes to rates, and some have always had higher rates than the Wall Street backed lenders.
Balance Sheet Lending
The next most popular capital structure in private lending is to use a bank credit line, or a warehouse line, and hold the loans for the entire term. The lender borrows money from a bank or other institution, and makes a spread on the interest rate charged to real estate investors. Lenders using this model won’t be forced to increase their interest rates until the bank increases the rate on the credit line, which could take years since many credit line rates are locked for a period of time. However, there is a possibility of a credit line getting cut off.
Table Funding
Another capital structure in private lending is table funding, where the lender doesn’t use their own balance sheet to close the loans. They underwrite the loans and present to a wealthy individual investor who wires the funds at closing and collects the interest payments. Lenders using this model may not increase their interest rates unless their mortgage investors demand a higher yield. Now some lenders get table funding from a private equity firm that relies on Wall Street money. In those cases, their rates are moving according to the fed funds rate.
Sell to Individual Investors
The fifth and final private lending capital structure I’ll mention is similar to the Wall Street model, but the loan buyers are individual investors. The lender will use their own balance sheet to fund the loan and shortly after closing, they sell the loan to an individual investor, make a profit, and recapitalize so they can fund more loans. The rate movement with this structure is similar to mortgage funds and table funding; it likely won’t change unless the individual investors demand a higher yield. And this may not happen until there are other alternative investments available to them which offer a higher yield and a similar risk profile.
Conclusion
By sharing all of this information, I’m not suggesting that you ask lenders about their capital sources. The complicated part of all this is many private lending companies use multiple capital sources, financing structures, and business models. Some lenders sell their loans to Wall Street and also manage a mortgage fund. A lender could sell half of their loans to Wall Street and sell the other half to individual investors, while also managing a fund. Some lenders use all the capital structures mentioned, and most lenders have a credit line.
The point is just to understand why there is a disparity in the interest rates you see offered by various private lending firms. That said, the interest rate disparity in private lending has existed since 2015 when Wall Street entered the space and provided the capital for lenders to fund the majority of real estate investors deals throughout the country. The cheap capital caused by low interest rates enabled Wall Street to offer a lower cost of capital which pushed private lending interest rates down, and most of the lenders with other capital structures were forced to lower their rates in order to compete. Since Wall Street capital is getting more expensive, it may provide other types of capital the opportunity to increase rates and get a higher yield.
How to Find Out Current Private Lending Interest Rates
If you want to keep up with private lending interest rates, use our website as a resource. All the private lending companies listed have a detailed profile which shows their minimum and maximum interest rate. In some cases the range is skewed by lenders that offer long-term rental loans, but most of the lenders only offer short-term financing up to 2 years. 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.