6 Misconceptions About Private Loans
Recent modifications to Canada’s mortgage regulations have forced homeowners to borrow from alternative lenders, often at higher interest rates than they can obtain through a bank.
There are several misconceptions about private lending that lead some developers and investors to avoid it. Private lending has a reputation for being slow, costly, and inflexible. Since several lenders entered the market without the resources to deliver on their promises in the past few years, many of these misconceptions have grown.
Many of these new lenders have exited the market in recent months, leaving the way open for experienced lending businesses to benefit. To secure funding from this sector, you are going to have to take the right approach. Private lending is much faster than banks when it is handled correctly.
Banks typically pigeonhole each transaction based on its credit policy, and don’t evaluate each on its merits as do private lenders. Private lenders aren’t controlled by banking policy.
Private lending is perceived as being more expensive because of the flexibility of approvals. However, faster project funding is possible through private lending, and is essential in some cases where the slow approval processes by banks can cause developers to lose out on great opportunities.
In spite of the higher interest rates, you may increase your profits at the backend of the transaction by being the first to market as you start your project earlier in the cycle. In addition, it is usually a short-term loan (at 6-24 months), so the effect of higher interest rates (that are more competitive now than ever before) is not as dramatic.
It’s not uncommon to use private lending as a bridge to bank financing. A direct approval system is another benefit of private lending—you are dealing directly with the people making the decisions.
The non-commercial approach used by banks overcomplicates transactions, and does not provide the transparency expected by developers. On the other hand, you have certainty of outcome with private lending and the contract is fixed.
Buying Your First Home
How do private lenders work?
A private lender may be a corporation that pools investors’ capital or an individual lending their own money.
Unlike banks and credit unions, private lenders do not take deposits, so they are not subject to the stricter regulations that govern the way they lend. This enables private lenders to make riskier loans.
Investing in properties is a great idea if you have access to private money lenders. Borrowers view investment properties in the same way that private money lenders do: as an investment.
Private Loans: 6 Misconceptions and Truths
Misconception 1: A private lender is unethical and offers loans illegally
Truth: The borrower’s property as collateral secures your investment. Loans secured by real estate must be originated by licensed mortgage brokers. Provincial lending regulations apply to private lenders. There are rules that private lenders must follow despite not being regulated as strictly as banks. The process of obtaining a private loan is managed by a lawyer. Mortgage Commitment letters drafted by lawyers are required to be signed by the borrower and lender.
Misconception 2: Taking out private loans is the last resort for desperate borrowers
Truth: It’s likely that this misconception arises since private lenders look at a property’s marketability and overall value rather than the borrower’s credit history. When the equity in a deal is sufficient, private lenders are less concerned about other shortcomings. The majority of private loan borrowers are successful and knowledgeable individuals or businesses who happen to have financial circumstances or investment opportunities that do not meet the strict criteria of conventional lenders.
Borrowers Choose Private Loans for Many Reasons:
A prime lender or bank isn’t willing to finance an unconventional property you want to purchase.
An approval process that takes a long time is inconvenient for you.
Conventional lenders refuse to lend to you due to your poor credit history.
The loan only needs to be for the short term.
You cannot get a traditional mortgage because your income is not verified.
Misconception 3: Lenders in the private sector are just loan sharks
Truth: Business professionals who are successful and experienced are private lenders who are willing to invest their own money in loans that they believe will provide the highest possible return on investment. Having control of their funds, they can choose how to use the loans. Since private lenders are usually small companies, they rely heavily on referrals, word-of-mouth, and their reputation to attract customers. As a result, it is easy to distinguish honest private lenders from the dishonest ones as long as you do your homework.
Misconception 4: A private loan is too expensive
Truth: Obtaining funding quickly enough (for example, to take advantage of a discounted purchase price or to dissolve a partnership that needs fast cash) often cancels out the higher borrowing costs of private loans. In order to determine whether a private loan would be beneficial to your deal, you must consider all the lending factors.
Misconception 5: Private lenders give risky loans
Because private lenders do not lend someone else’s money (as opposed to employees of institutional lenders), they are less likely to approve truly risky loans.
Truth: Typically, a private lender will only approve a loan against a property whose value can be determined with a reasonable amount of confidence, regardless of how financially savvy or experienced the borrower appears to be, or how strong his or her track record may be. Nevertheless, private lenders may be perceived as risky because they understand local markets well and may approve loans that other lenders may deem too risky.
Misconception 6: Lenders in the private sector try to beat banks
Truth: There is no competition between private lenders and banks, nor are they intended to replace them. It is likely that a private lender can assist you if you cannot get the funds you need from a bank. When your credit rating is less than stellar, the stress test cannot be passed, or you need flexibility in the loan structure, then private loans are especially worth considering if you own your own property.