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Low Risk and High Reward

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Private money lending has the potential to be lucrative for investors who are anxious to reap a high return with relatively low risk. Private money loans, more commonly known as hard money loans, are used by businesses and individuals who are in need of fast capital. People who choose to become hard money lenders typically fund more high risk companies, which are otherwise often rejected by various banks. However, private money lenders are able to charge a much higher interest rate, primarily because they are among the borrower’s only options for obtaining fast capital.
Private money lenders also provide businesses and/or individuals with short term loans, which are commonly referred to as bridge loans. The interest rates on bridge loans are usually between 11 and 13 percent for real estate hard money loans, which is considerably higher than the average bank. As a general rule, hard money loans are property driven, which means a relatively quick turnaround. This can be very beneficial for the investor because not only is the investor able to charge a higher interest rate, they typically don’t have to wait long to reap the financial return.
Private money loans are beneficial not only to the investor, but also to the business that is borrowing the money. In the absence of private money lenders, businesses that don’t have established credit, or have poor credit, would have no way to obtain the funds necessary to proceed with their project. In addition, businesses are able to get the funds much faster than if they were waiting for a bank to process and then close on the loan.
However, potential private lenders need to make sure to use caution and good judgment before extending a loan to a business or individual. This can be done through careful research. If the company has a history of problems, it would be a good idea to personally meet with them, which gives them the opportunity to explain any mistakes. Also, investors should make certain that there is a solid business plan in place, which includes a specific strategy addressing how the funds will be paid back. Even though private money lenders have the opportunity to gain a significant return on their investment, they still need to be discerning about distributing the funds.
In general, private money lenders distribute funds when one of several criteria is present. First, when the amount of the loan is $500,000 to $20,000,000 per transaction on the same project. Second, when there is up to 75 percent loan-to-value (LTV) on improved structures and up to 55 percent LTV on raw land. Third, when it is a commercial property purchase, construction or refinancing. Fourth, when bank workouts, bankruptcies, and foreclosures are common. Finally, when there are loans on commercial buildings or vacant land.
Another advantage to becoming involved in private money lending is that generally speaking, the LTV ratio is relatively low, which means that there is a greater opportunity for reward even though there is less of a risk. The LTV ratio of a property is the percentage of the property’s value that has been mortgaged. The LTV can be found by dividing the mortgage amount of a property by the lesser of either the appraised value or the selling price. For example, if a home is appraised for $300,000 and there is a $240,000 mortgage on the property, then the loan to value ratio is .80, or 80 percent.
For private money lenders, the lower the LTV, the better. Lenders typically see loans with high LTVs as more risky than those that present significant down payments or have larger amounts of equity. The reasoning is that borrowers who have less money invested in a property have less to lose by defaulting on a loan than a person who has put down a large down payment or has a good deal of equity in a property. For those who choose to become private lenders, decisions must be made about the LTV that will be required from potential borrowers. Becoming a private money lender is a potentially lucrative endeavor (one with low risk and high reward) as long as you do your research. When you are prepared and know specifically what the terms of your loan will be, you are going to be in a much better position.

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