Private Mortgage Loans Provide a Short-Term Financing Alternative
by Don Konipol
Private mortgage loans are made by private lenders instead of traditional
financing sources such as banks, lending institutions, or government agencies.
They usually are short-term (6 months to 3 years) hard money or asset-based
loans, and the decision to lend is based on the equity and value of the property
being put up as collateral, not on the borrower's credit.
These loans are a source of funding for professional real estate investors who
wish to acquire, rehabilitate, or cash out equity of income producing property,
and those who otherwise would not qualify for conventional financing. Private
mortgages also assist real estate investors who need immediate financing without
the financial documentation required by traditional institutional financiers.
Private mortgage loans are very secure because they represent a maximum of 65
percent to 70 percent of the appraised value of income producing property. On
non-income producing property, a maximum of 55 percent loan to value is lent.
Investors can expect to pay interest rates of 12 percent to 14 percent on first
liens and 16 percent to 18 percent on second liens in this current low interest
rate environment. Historically, first lien yield of six points over prime has
been obtainable.
Why Borrow Private Money?
When interest rates of 14 percent to 18 percent are added to four to eight
points, the borrower is paying more than 20 percent annually for a private
mortgage loan. This is a good deal for private mortgage lenders, but why would
borrowers want to pay these high rates when conventional mortgages range between
7 percent and 10 percent? Many reasons exist, but all fall into four categories.
Speed of Closing
Conventional mortgages usually take between 45 days and 90 days to fund, since
institutional lenders need to obtain an appraisal of the property's value,
perform a detailed examination of the borrower's credit history, and thoroughly
evaluate the borrower's current financial status. On the other hand, private
mortgage lenders usually can complete a transaction within seven to 10 days.
Since the property itself is the main criteria used to determine loan
eligibility, less information on the borrower is required, resulting in a much
quicker approval process.
The private mortgage lender is protected by lending at a significantly lower LTV
ratio: 65 percent vs. 80 percent to 90 percent for institutional lenders.
Further, the private mortgage lender can make a decision within 24 hours of
receiving information, whereas institutional mortgage money must be approved by
a loan committee that may meet only twice a month.
Easy Application Process
While a borrower's lack of up-to-date personal financial information would
negate or at least delay approval for an institutional mortgage, it should have
no effect on the ability to obtain a private mortgage loan. Private mortgage
lenders generally base their decisions on the asset used for collateral -- the
property. If the property value is high enough and the income being generated
from it is sufficient to pay the interest on the debt, the borrower's personal
financial situation should not affect the private mortgage lender's decision.
Other Money Resources Are Not Available
A borrower may not qualify for an institutional mortgage loan for reasons
ranging from low borrower credit scores or too much borrower debt. Further, the
property itself may not support the type of loan the borrower wants: Many
institutional lenders will not loan amounts under $500,000 and will not lend
second lien money even if there is significant equity in the property.
In these cases private mortgage lenders may be the only available resource.
Institutional lenders are concerned with both the appraised value of the
property and borrower and property credit; however, private mortgage lenders are
concerned only with the appraised value, as long as it represents a fair market
price. Hence, if a property is producing or can produce sufficient income to pay
the note and the value of the property will provide sufficient equity, the
borrower's credit is not an issue for the private mortgage lender.
More Funds Available
Since private mortgage lenders base loans on the appraised value of the
property, the borrower may be able to borrow more and therefore have less of its
own capital invested in the property. In these instances, the borrower is not
penalized for purchasing a property at a significant discount to market value.
Investment Parameters
The most important parameter private mortgage lenders consider when evaluating a
loan request is LTV ratio. They typically will lend up to 50 percent on raw land
or undeveloped property; 65 percent on commercial income producing property such
as office buildings, shopping centers, and warehouses; and 70 percent on
multifamily income property such as apartment complexes. The maximum amount
usually will be lent if all criteria are met; lower amounts may be lent if the
loan or borrower is considered less than ideal.
The second parameter is the type of properties to lend on, which often is
determined by the ease in disposing of the property in case of default.
Obviously, a single-use property that would take a year to sell is less
desirable than a multi-tenant, income producing office building.
The third investment parameter is the cash flow or income potential of the
property put up as collateral. Although many private mortgage lenders are
liberal in this area, the monthly interest payments must come from somewhere. If
the property is producing a cash flow after all expenses, the property income
alone may cover the monthly payments without the borrower having to come out of
pocket. This adds a great degree of safety to the note. Cash flow from other
income properties also can substitute for cash flow from the property being
placed as collateral.
The fourth major investment parameter the lender must consider is exit strategy,
or how the borrower plans to repay the loan. Since most private mortgage loans
are short-term, private mortgage lenders have a keen interest in analyzing
whether a particular exit strategy is viable. For example, if the exit strategy
is to refinance the property, the lender must determine if the credit score of
the borrower is high enough to qualify for a long-term mortgage, if the property
cash flow is sufficient to cover the debt payments, and if the property will
meet the general criteria set up by the mortgage lenders most likely to
refinance the property.
Bio:
Don H Konipol has a BS in Economics and an MBA in Finance from the University of Michigan and is a licensed Texas Real Estate Broker and Mortgage Broker. Mr. Konipol is General Partner of the Managed Mortgage Investment Fund LP, a private limited partnership that invests in short term, high yield private mortgage notes. He can be reached at 832.577.8838 or by email at dkonipol@yahoo.com.