Understanding when to work with certain types of lenders saves project time and money.

As a real estate investor for more than 20 years, I have had the pleasure of working with both “private lenders” as well as “private investors.” It is important to develop relationships with both types of lenders, because different projects have different needs.

Working with Private Lenders

My experience with private lenders is they are more structured in their investment criteria and require more information to evaluate your loan request. There are pros and cons to working with private lenders.

One of the pros is they generally have more money to lend at any given time. Because they pool money from other investors or have a fund they invest from, they can be very helpful for larger projects or multiple projects. They usually underwrite the property based on the property itself and the numbers you provide. Many do not require financials such as tax returns, credit checks, etc., so they are investor friendly.

Some of the drawbacks to working with private lenders? They generally cost more than private investors. They will usually charge points up front, doc prep fees, loan fees, etc., as well as 10%-14% annual returns.

They also require a borrower to put down some amount of the loan amount. This could be as little as 5% or as much as 20%. Although that may not be much on a single house flip, it adds up when you are scaling and working on five or 10 projects at one time. Also, private money loans are based on internal requirements rather than on your personal relationship with the lender. Notably, their internal requirements can (and do) change without any notice to their borrowers.

For example, recently I worked with a private lender on a package of nine properties I acquired. The total loan amount I needed was $745,000. Because it was such a large loan amount, I chose to finance it through a private lender.

I had a “rate sheet” from the private lender showing what my total costs would be for each loan. I submitted the nine-property portfolio to the private lender based on the rate sheet I had. The request was then sent to underwriting for review. Little did I know, the private lender had updated their rates.

The underwriter came back with terms that were not as favorable to me as I had expected. I thought I was going to have to bring little or no money to the closing table and ended up having to bring $70,000 to close. Because it was so close to the closing date, I did not have time to find another lender. The fact that I had developed a relationship with this private lender did allow them to give me some concessions on the points upfront, but it still cost me quite a bit more than I expected. They also held back a portion of the rehab funds, so I will have to pay for the rehab and then get reimbursed after completion of the project.

All told, I will likely be into the properties for more than $100,000 out of my pocket. However, they did approve the loans and did not require me to jump through all the hoops a traditional lender would require.

Working with Private Investors

A private investor, on the other hand, is a person who knows you and your business and trusts you. A private investor will negotiate terms with you, which can be more favorable than a private lender’s terms.

Private investors usually do not charge points up front and will also give you the full purchase price and all the rehab money needed. They usually even loan enough to cover closing costs as well. They do not charge the additional “junk fees” (document prep fees, title transfer fees, flood certification fees, etc.) that private lenders do.

A private investor will usually wire money within two or three days, and they don’t require all the paperwork and supporting documentation traditional lenders or private lenders require.

The downside is that private investors do not typically have as large of a fund to loan out, so they are limited to the number of deals and size of deals they can loan on.

A loan I recently completed was with a private investor who is a personal friend. He was loaning money to me out of his 401(k), or from his personal savings account. I spoke to him by phone and explained the property and the opportunity. Because he knows me and trusts me, he was willing to do the loan. He asked me to send an email explaining what I needed, along with a picture of the house. He then wired me the total $85,000 I needed to purchase the property ($80,000 purchase price, plus $5,000 in closing costs). It took less than 24 hours to get the money from the private investor, and I was not required to show any documentation.

The deal was based solely on our personal relationship. I knew what to expect going into the deal, and he did not change any of the terms on me. He did not require me to put any money down, and he loaned me enough to buy the property, including closing costs and rehab funds. Also, if I need to extend the loan payoff date, he is flexible as long as our agreed-upon rate and terms still apply.

Assess Your Situation

As you can see from these loan examples, a private investor is much easier to work with than a typical private lender. A private investor allows you to keep more money in your pocket because you don’t need to put money down or pay points and “junk fees.”

But, many of my investor friends flip 200–300 houses a year. Because of their volume, they work with private lenders, private investors, and institutional lenders.

As a smaller “newbie” investor, it would be beneficial to develop relationships with both private investors and private lenders. As your business grows, you will want to establish a relationship with a traditional lender such as a local or regional bank. They typically have much lower rates, but they do require more financial information, tax returns, etc. before they will approve your loan.

From an investor’s point of view, the perfect scenario would be to have a lender who has the capacity to loan on bigger projects or multiple projects at one time but also operates more like a private investor, with a focus on the personal relationship. Perhaps after a few deals together, a larger lender would loan the full purchase price and rehab costs with no money out of pocket? Lower points up front would be preferred as well!

In the recent real estate market, lenders have had plenty of money to lend, and the competition has been fierce. Some lenders have been willing to work with their borrowers “outside of the box” and base their terms more on their history and personal relationship with a borrower.

However, now with the market at its peak, lenders are beginning to pull back for fear of the next downturn. Rates have crept up, requirements for down payments have risen, and points are tacked back onto the closing. Values of properties have escalated so fast that larger lenders are hedging their bets. Private investors are still active and still maintain favorable terms, but there aren’t as many of them out there. And it takes more time to develop a personal relationship with them once you do find them.

The property stands as collateral for the loan in either case, so both types of lenders are protected. A private lender, though, would rather have the property at 75% of after repair value plus 20% of the loan out of a borrower’s pocket in case they do end up taking the property back.

Perhaps one day we will once again get to experience “relationship banking” from larger institutional lenders—with terms that make sense to the lender but are also favorable to the borrower and allow small businesses to scale and grow.