What Is a Private Mortgage Lender?

How private mortgage lending works

Just like with traditional mortgages, you’ll need to go through a loan application and approval process to get a private mortgage. Here are the key steps you’ll follow:

• Application and approval: You’ll start by filling out an application with a mortgage broker or the lender directly. In the case of investor groups or hard money lenders, you’ll often provide an application to a mortgage broker. You’ll then wait for approval, which might be as simple as a family member agreeing to lend you money or as formal as a hard money lender reviewing your assets and income.
• Loan proposal: Investor groups and other formal lenders will provide a document to sign that includes the amount borrowed, the loan term and the interest rate.
• Additional documentation: If needed, you may have to show proof of down payment funds and provide a property appraisal.
• Approval and closing: Once your loan is approved, your lender will release the funds, and you can move forward with the purchase.

The terms and conditions of a private mortgage can vary widely. For individual investors or groups of investors, you’ll usually have strict repayment terms and loan durations, and the interest rate can be based on a wide variety of factors like income, the loan-to-value (LTV) ratio and more.

The interest rate for private mortgages is also capped based on state regulations. If a friend or family member is performing the duties of a loan originator, repayment terms are often more flexible and interest rates are lower because of your relationship.

Pros and cons of private mortgage lenders

The majority of homebuyers go through a traditional mortgage lender, but there are some upsides to private mortgage lending worth considering.

Pros of private mortgage lenders

Private mortgage lenders aren’t restricted by the same regulations that institutional lenders are. That means you could get financing through a private lender even if you wouldn’t normally qualify for a mortgage due to nontraditional income, like if you’re a freelancer or a business owner who pays themselves irregularly. Private lenders may also consider income from stock dividends, capital gains and more, while traditional banking institutions often don’t view these as eligible income sources.

Private mortgage lenders work best for freelancers, self-employed buyers or those using income from stocks to secure a loan.

Private mortgages face less scrutiny, so approval can happen immediately, while traditional lenders often take weeks. You’ll usually have to provide less documentation for private mortgages, too, since lenders focus more on asset value than your finances.

Finally, some private mortgages can come with far more favorable terms than you’d get from a traditional lenders, especially if a family member or friend is providing the loan.

Cons of private mortgage lenders

Of course, there are some drawbacks to consider, too. First and foremost, a private lender often takes more risk than institutional lenders. A private lender doesn’t have to follow the same regulations for lending and can create a more customized approach to lending — but more risk often means higher interest rates.

Many private mortgage lenders intend their loans to be more for short-term use, so you may not get the same 30-year repayment term you’d see from a traditional home finance company. You could see a much higher monthly mortgage payment if you go with a private loan.

Understand the tradeoffs

Private mortgages are riskier, and in financing, added risk often comes with higher interest rates and shorter terms.

Since private mortgages don’t face as much regulation as traditional mortgages, you also may not have the same borrower protections. For example, disclosure requirements can be more lax, and foreclosure actions can be faster and more aggressive with private mortgages.

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Differences between private lenders and direct lenders

Private mortgage lenders differ from direct lenders or traditional mortgage lenders in a few key ways.

First, private lenders have more freedom in how they loan money. They have to abide by state usury laws that can limit interest rates, but they aren’t subject to federal regulations that may leave some buyers unable to finance altogether. Private lenders take a more personalized approach to lending rather than using general guidelines that may exclude some buyers.

To that same end, private lenders usually focus mostly on asset value and LTV ratios to determine loan eligibility, which means your property value and down payment can largely drive your terms and eligibility. Direct lenders look at your income, credit score and general financial history, which can alienate certain homebuyers.

Finally, private lenders can provide funding more quickly because they have fewer regulations, but they also offer fewer consumer protections due to the lower regulation.

In a nutshell, getting a mortgage from a traditional mortgage lender or a bank will usually mean a lower interest rate but longer approval timelines and a stricter approval process. Getting a mortgage from a private lender often comes with higher interest rates, but the approval process is faster and significantly more flexible.

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Key terms in private mortgage lending

If you’re considering getting a mortgage from a private lender, familiarize yourself with the following terms that can help you understand your loan product a bit better.

• LTV ratio: This compares your loan amount to the value of the property. Private mortgages focus more on asset value and loan amounts than on buyer qualifications, so LTV is a crucial aspect of private lending and can often make or break financing.
• Balloon payment: A balloon payment is a large payment that the buyer must make at the end of the loan term. Balloon payments were more common in traditional mortgages prior to the 2008 financial crisis, but they’re still prevalent in some private loans. They’re popular for buyers who want to make low monthly payments and then refinance or sell before the final payment comes due.
• Asset depletion: Asset depletion is a unique way of qualifying a buyer for a mortgage based on liquid assets rather than proven annual income. Mortgages that consider asset depletion are convenient for retired individuals, business owners with significant company stock and buyers who have a large amount in savings but minimal income.
• Origination fee: An origination fee is an up-front payment to your lender for establishing the loan. These are common in both private and traditional mortgages, but private lenders may charge higher fees for the additional risk they take on.
• Broker fee: A broker fee is a fee you’d pay to a mortgage broker for establishing the relationship between you as the buyer and your lender. Private mortgages more often have these fees because they involve a broker in more cases.