When seeking a loan to finance an investment property, there are two main options available to most real estate investors: Private Loans and Traditional Loans. In this article we will dive into the characteristics of each and why they may or may not be suitable for your next investment.
Sometimes referred to as “conventional loans,” these types of mortgage loans are generally issued by banks and then sold to third party institutions like Fannie Mae and Freddie Mac. The fact that they are sold off to third party agencies is important because it means that the lender has very little control over the guidelines for underwriting the loans. The agencies purchasing the loans on the secondary market provide guidelines that the lender must follow very closely in order to sell the loan after origination. These types of loans are attractive for most borrowers because of their lower rates, but can also be time consuming to apply for and can take as long as 60 days (or more) to get completed.
Traditional mortgage lenders make money in fees when they issue the loan and again when selling the same loan to a buyer in the secondary market. Once a traditional loan is approved, the mortgage lender taps into its line of credit to fund the loan. If the loan was approved using the set guidelines the loan can be sold, the credit line replenished and the lender is once again in a position to make even more mortgage loans.
Characteristics of a Conventional Loan
- Offer lower mortgage rates in the market
- Requirements for traditional loans lower the risk of default of a borrower
- Traditional loans can be long-term, up to over two decades or more
Private lending involves the issuing of private loans that are not underwritten using third-party guidelines by a mortgage lender. These loans generally have a different loan process and therefore cannot be sold on the secondary market to one of the traditional agencies. A private lender comes in handy when the property being financed does not meet the conventional lending guidelines or if the investor buying the property needs to close fast and cannot wait for the typical 30-60 days for a traditional lender. A private loan can be acquired for the purchase and rehabilitation of the property to a point it meets the lending guidelines, and a borrower can subsequently refinance the property with a conventional loan.
Characteristics of a Private Loan
- No set of specific lending guidelines, generally more flexible
- Typically faster and less complex than traditional mortgages
- Available to borrowers who may otherwise not be able to qualify for conventional financing
Both private lending and traditional lending have their unique features and any investor should choose the financing option that best meets their investment needs. Most of the major loan types: commercial loans, residential loans, fix and flip loans, bridge loans, and even 30 year loans, are available under both scenarios. The wrong decision can cost valuable time and money for any project, so it is worth understanding the pros and cons of each scenario.