Should you borrow from private mortgage lenders?

mortgage lenders

If you are having difficulty qualifying for a conventional mortgage loan, working with a private mortgage lender may be a good option. These lenders are not affiliated with a traditional financial institution like a bank or credit union, which means they are free to offer more flexible loan terms with less stringent requirements.

If you're wondering if you should work with a private mortgage lender, here's what you need to know.

What is a private mortgage lender?

A private mortgage lender is a private entity, such as a friend, family member, or business, that provides funds for a mortgage loan and earns a return on the investment by charging interest. Unlike traditional mortgage lenders who follow lending guidelines set by the federal government or government-sponsored entities, private mortgage lenders determine their own lending criteria and underwriting processes.

For example, a private lender might base loan approval and interest rate on the borrower's down payment and collateral rather than the credit history, debt-to-income (DTI) ratio, and employment status needed to qualify for a mortgage. typical. This might make it easier to get the loan approved, but it's also riskier for both parties involved.

It's also important to note that private lenders aren't regulated by the federal government in the same way that traditional banks and credit unions are, so you're losing some protections, but not all. Private lenders often have to register with the state authority where they operate.

If you get a mortgage from a private lender, the home loan works like a standard mortgage, which means you'll sign an agreement to pay off the loan, plus interest, within a certain period of time. It will likely also provide a down payment. The private lender may perform their own underwriting process, such as verifying your financial situation and conducting a title search. And just like with a traditional home loan, the home you buy will act as collateral and can be foreclosed on if you don't make your payments.

Who Should Consider Private Mortgage Lenders?

There are a few types of borrowers who could benefit from working with a private mortgage lender.

Borrowers who do not meet the typical requirements

Some borrowers may have difficulty meeting the requirements commonly set by traditional lenders. For example, if you are self-employed or do not have the necessary documentation or work history that a traditional lender requires. If you have bad credit or haven't yet established a credit history, it may be difficult to meet the credit requirements for a conventional loan.

Because private lenders create their own eligibility guidelines, these types of borrowers will have an easier time qualifying for a mortgage.

Real estate investors

During the underwriting process, a traditional lender will review the property to ensure they are making a good investment and may resell the property to recoup their losses if the borrower defaults. If you are an investor looking to sell distressed properties, you may have difficulty meeting the lender's requirements.

Instead, you might consider a mortgage from a private lender with less stringent qualifications.

Offer Finders

In some cases, you may simply be able to take advantage of better loan terms from a private party than you would from a traditional lender. For example, a friend or family member might offer a lower interest rate and a longer-term loan.

Keep in mind that the private lender will need to make sure that they follow IRS rules. If the interest rate is less than the "applicable federal rate," the minimum rate the IRS allows for private loans, there may be tax implications.

How to find a private mortgage lender

The best private mortgage lenders are the ones that offer the type of loan you need along with flexible qualifications. For example, a friend or family member could act as a private mortgage lender, or you could find local or national companies that specialize in providing these types of loans.

Friends or family

If a friend or family member has the cash on hand, getting a mortgage from them could help you buy a home if you don't qualify elsewhere. However, this could also have an impact on your relationship, especially if you don't keep up with your payments and put that person in a difficult position where they have to enforce a payment schedule or take a loss.

Be sure to clearly state the terms of the loan and treat it like a business transaction to avoid awkward situations later. It's also a good idea to have an attorney or real estate professional draft the mortgage agreement to make sure you and the lender are complying with local laws and agreeing on a realistic plan. They can also look into tax implications and help you complete the necessary paperwork, which will include:

  • A promissory note (or mortgage note): This shows that you agree to repay the loan before its due date. This should include the loan balance, monthly payment, payment term, interest rate, amortization schedule, and any fees that may apply, such as late payments or loan default.
  • A deed of trust (or mortgage): This establishes that the lender owns the property and holds title until the borrower pays off the loan in full. This is a contract that places a lien on the property, which means the lender can foreclose on your home if you don't pay.

Companies offering private mortgages

Companies that offer private mortgages may specialize in different types of borrowers, such as investors, business entities, or people buying or building a new home. The mortgage loans provided by these lenders are often non-standard mortgages, which can have high-cost loan amounts and long payment terms.

If you want to work with one of these companies, consider asking family and friends for recommendations. You can also contact a real estate agent or other industry professionals for suggestions. As you shop around and compare your options from different lenders, be sure to check company websites, online reviews, and any complaints a company has received through resources like the Better Business Bureau.

You'll want a lender that has a history of positive feedback and offers low interest rates, an easy application, fast closing times, and the loan terms you need. Ask the lender to provide a quote on the interest rate, loan term, fees, and closing costs so you know all the details before you apply.

Private Mortgage Lenders vs. Traditional Mortgage Lenders

If you're considering a private mortgage lender versus a traditional mortgage lender, there are several important points to keep in mind.

Private mortgage lenders Traditional mortgage lenders
Requirements Create their own lending guidelines, so you might qualify even with poor credit, a high DTI ratio or a nontraditional work history Follow specific criteria to ensure a borrower’s ability to repay, meaning you must fit lending guidelines set by government agencies or government-sponsored entities (good credit, low DTI ratio, sufficient income, etc.)
Risk involved Can be riskier because the lender doesn't have to follow established lending guidelines, leaving both the borrower and lender with fewer protections Can be less risky because the lender must verify your ability to repay, which means a lower likelihood of default
Open to negotiation? Yes, might negotiate with borrowers on some terms, such as interest rate, mortgage insurance, size of down payment, closing costs and term length Yes, might negotiate with a borrower on interest rate or closing costs, mainly if you have good credit or have an offer from another lender
Process Should conduct a title search and sign a promissory note and deed of trust As part of the traditional underwriting process, lender will conduct a title search and you’ll sign a promissory note and deed of trust
Repayment Terms Terms are usually shorter than typical 15- or 30-year mortgage 10 to 30 years

Alternatives to a Private Mortgage

While a private mortgage may be easier to qualify for, it also comes with risks. For example, if you get one of these loans from a friend or family member, it could damage your relationship if you can't keep up with your payments.

If a private mortgage doesn't seem right for you but you can't qualify for a conventional loan, here are a couple of alternatives to consider:

  • Government-sponsored loans. Loans backed by the Federal Housing Administration (FHA), the US Department of Agriculture (USDA), and the Department of Veterans Affairs (VA) have less stringent qualifications and lower down payment requirements (or none at all) compared to conventional mortgages.
  • Renovation loans. Some loans, like the FHA 203(k) loan and the Fannie Mae HomeStyle Renovation loan, are designed to cover the purchase of a home plus repair costs.
  • Refinance or home equity options. If you already own a home, you might consider tapping into your home equity with a cash-out refinance, home equity loan, or home equity line of credit (HELOC) to help you renew a home. existing property.

Ultimately, if you're having difficulty qualifying for a mortgage, you'd be wise to postpone applying for a mortgage while you focus on the issues causing the problems. For example, you could work on building a less than stellar credit score by paying all your bills on time. Or if you can't afford the down payment, research down payment assistance programs you might qualify for.

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