What is a private mortgage lender?
Key takeaways
- Private mortgage lenders are individuals or companies that offer real estate-secured loans outside traditional banks. They use their own funds or investor capital and offer flexible terms for borrowers with non-traditional incomes.
- Private mortgage loans require repayment with interest but allow alternative income sources, offer diverse financing options and may be securitized by investment firms.
- You’ll typically need at least a 20 percent down payment, an appraisal and proof of income, and you should be prepared to pay a higher interest rate and possible prepayment penalties.
What is a private mortgage lender?
A private mortgage lender is usually a private or public company or individual that offers mortgage loans secured by real estate. These lenders set their own guidelines and terms, offering financing outside of traditional institutions like banks and credit unions. Private lenders tend to use their own funds or capital from investors to provide financing.
Traditional mortgage lenders have strict lending guidelines and often require borrowers to complete a lot of paperwork. Many place a strong emphasis on your credit score, income, debt-to-income ratio and employment history.
“Private mortgage lenders take a different approach,” says Steven Glick, director of mortgage sales for real estate technology platform HomeAbroad. “They look at alternative income sources, such as bank statements instead of W-2s, current assets and income from rental property if you are an investor. They may have more flexible credit requirements. That means borrowers with non-traditional income or credit challenges have a better shot at securing financing.”
A private mortgage lender often provides a lifeline to borrowers who can’t get financing elsewhere.
“Think of them as a ‘Plan B’ when traditional banks or lenders say no,” says personal finance expert Andrew Lokenauth.
How private mortgage lending works
A private home loan works similarly to a traditional home loan: You repay what you borrow with interest over an agreed-upon term, such as 30 years, and the private lender uses the property as collateral. This means it has the right to foreclose on your home if you fail to make payments on the loan.
Private lenders can offer a variety of different financing options, including a 30-year fixed-rate mortgage loan for both primary residences and investment properties as well as fix-and-flip loans, construction loans and bridge loans.
“Larger private mortgage loans are securitized in capital markets by investment firms and Wall Street funds,” Glick continues. “These firms purchase pools of private mortgages, creating liquidity in the private lending space and enabling lenders to issue more loans while also distributing risk among investors — similar to traditional mortgage-backed securities.”
Key terms
There are several key terms and definitions to be aware of when seeking a private mortgage loan, including:
- Asset depletion: This is a method where a private lender calculates your ability to repay by dividing your total liquid assets over a set period.
- Balloon payment: Some private mortgages don’t last for 15 or 30 years like traditional loans. Instead, the loan may take the form of a balloon mortgage, which typically only lasts between five and 10 years. These loans require a big lump-sum payment, known as a balloon payment, at the end.
- Cash reserve requirements: This is the amount of liquid assets you must have after closing to cover mortgage payments for a certain number of months. They’re also referred to as mortgage reserves.
- Cross-collateralization: Some private lenders allow you to use multiple properties as security for a loan. This can help you borrow more money or get better terms, but if you default, you risk losing more than one property.
- Hard money loans: A hard money loan, also referred to as a bridge loan, is a type of mortgage, but it usually has a short term (a few months to a few years) and comes with a higher interest rate.
- Interest-only payments: Some private loans offer interest-only payment options for a certain period, which keeps payments low in the short term.
- Loan-to-value (LTV) ratio: Your LTV ratio is how much of your property’s value the private lender is willing to finance. For example, if the lender allows 70 percent LTV, they’ll lend you up to 70 percent of the property’s price, and you must cover the remaining 30 percent as a down payment.
- Prepayment penalty: Some private lenders charge a fee if you pay off the loan early.
Private mortgage requirements
As is true of a traditional mortgage loan, you’ll have to meet certain requirements to be eligible for a private mortgage loan. Here’s what you’ll typically need to qualify (although rules can vary from lender to lender):
- A down payment of 20 percent or more, depending on your credit and property type
- A professional appraisal to confirm the property’s market value
- A sufficient credit score — typically 620 or higher, although lower scores may be allowed with a higher down payment and/or higher interest rate
- Proof of income, including bank statements, 1099 forms, rental income records and asset statements, based on the mortgage program chosen
“Private lenders are often preoccupied with the value of the property and the exit strategy of the borrower rather than traditional metrics,” says Dennis Shirshikov, a professor of economics at City University of New York/Queens College. “But you will still need some documentation like a recent appraisal and proof of the value of the property as well as a plan for repaying the loan.”
Private mortgage lender pros and cons
A private loan has advantages and drawbacks. Here’s a breakdown of some of the most common:
Pros
- Accepts borrowers with alternative income sources and lower credit
- Less paperwork than traditional loans
- Customizable loan terms
- Faster approval
Cons
- Higher interest rates and down payment requirements than conventional loans
- Limited consumer protections
- More origination fees, processing fees and penalties
- Often shorter repayment terms
“In general, private lenders are usually more flexible in their guidelines, documentation needed and approval process. They tend to be faster to approve and close the loan as well,” says private money lender Jack Miller, president and CEO of Gelt Financial. “However, private loans are usually more expensive.”
Alternatives to private mortgage lenders
Getting a private mortgage loan isn’t your only option. If you have unique financial circumstances, consider exploring:
- Government-backed financing like an FHA loan, USDA loan or VA loan. These types of loans require little to no down payment.
- A portfolio loan, which may offer more flexible terms than a traditional mortgage. You can typically find these at banks or a portfolio lender.
- Owner financing, in which the home seller offers to fund your purchase directly.
- A hard money loan, typically a short-term loan that can be funded quickly but comes with a higher interest rate.
What borrowers should know about private mortgage lending today
Private money lending is best for self-employed borrowers, including small business owners and freelancers who lack consistent income or proof of W-2s. Those with credit challenges, including low credit scores, a previous bankruptcy or high DTI ratios, are worthy candidates, too. If you’re seeking to invest in a property as a home flipper, this option could also be ideal. And if you need a quick closing, a private loan could be just the ticket.
“But remember, these loans come with higher interest rates, so having a clear exit or refinance strategy is crucial,” says Glick. “Always check the APR — annual percentage rate — to understand the true costs of borrowing, not just the interest rate alone. Be especially cautious of large upfront fees, as well. And watch out for hidden charges, vague repayment terms and aggressive prepayment penalties.”
Keep in mind that private loans are mostly unregulated, so proceed with caution.
“You only want to deal with well-established companies, and be sure to fully understand all of their terms,” suggests Miller.
How to get a private mortgage loan
Ready to pursue private financing? Here are some of the steps involved:
- Determine your needs and exit plan. Figure out how much you need to borrow, the down payment you can afford and how you’ll repay the debt — either via refinancing, selling the property or another strategy before the loan term ends.
- Gather financial documentation. Collect recent W-2s, bank and financial account statements, profit and loss statements, tax returns and any other paperwork that can help your cause.
- Compare and research potential lenders. Hunt online and ask friends, real estate agents or investors for referrals. Shop among several different lender options. Vet each lender carefully by reading online reviews from customers and the Better Business Bureau and checking for proper NMLS licensing.
- Choose a lender and apply for a loan. Prepare to submit the requested documentation. Having everything organized before you apply will help streamline the application process.
- Appraise and inspect the property. The lender will order an independent appraisal for the property and may also conduct a title search. Paying for a professional home inspection is optional but highly recommended.
- Await an underwriting decision. The lender will review your financial documentation and the property details over the next week or two. Avoid opening any new lines of credit or making major purchases during this time.
- Review the loan offer. If approved, carefully review the loan offer, terms and rate.
- Close on the home. At closing, you’ll finalize the loan by signing several legal documents and paying your down payment and closing costs. Due to the unique characteristics and limited regulations associated with private mortgages, strongly consider hiring a real estate attorney for the closing process to protect your interests.
