Beyond the Banks: Why More Investors Are Turning to Private Lending

A deep dive into why borrowers bypass traditional banks for lending to fund their projects.

Reasons for Private Money Lending

This is happening to traditional lenders primarily because of three factors: speed, flexibility, and access to capital.

What is a Private Lender?

A private or hard money lender is an individual or organization that lends money outside of traditional banking. They often offer loans to individuals, homebuilders, and developers seeking faster funding. Ignite Funding is an example. Read about why Borrowers and Investors choose us.

Private Lenders and Hard Money Lending

Private money lenders and private lending companies have an advantage without all the red tape in approving and funding loans based on the merit of the real estate collateralized by the loan, making it easier to fund quickly. Quick access to funds is critical. The company’s internal underwriting process and decision-making criteria are the only red tape, unlike regular banks with a much more rigid underwriting process that can take months to process and fund. With hard money lenders, the processing time could be as short as a few days. Now remember, there is a difference between private money lending and bank lending. Private moneylending usually comes with higher rates and short-term loan durations.

Not only can private money lenders approve loans quickly, but they are also typically much more flexible with the loan structure, catering to the borrowers’ financing needs. Some of the terms that can be approved of are:

• Interest-only payments - a type of financing where the borrower is only required to pay the interest on the loan for a set period (typically 6 months to 5 years) without reducing the principal. Once this period ends, the borrower refinances the loan, sells the property, or begins making the entire principal and interest payments. This is an excellent option if you want to keep a cash reserve to pay for renovations, unexpected expenses, or any additional investments. Here is an interest-only calculator if you want to see how it works.

• Balloon payments - a large, lump-sum payment due at the end of a loan term. Instead of gradually paying down the principal over the life of the loan (like with traditional amortized loans), borrowers make smaller monthly payments (often interest-only) and then pay off the remaining balance in full at the end of the term. They are commonly found in short-term real estate loans, private money loans, bridge loans, and commercial mortgages.

Some tremendous creative financing includes cross-collateralization, bridge funding or taking an equity position in a loan.

• First Lien Position - A first lien position in private lending refers to the lender’s legal claim to a borrower's asset (typically real estate) that takes precedence over any other claims. If the borrower defaults, the lender in the first lien position has the primary right to be repaid from the sale or foreclosure of the asset before any other creditors or lienholders. It matters because this position gets paid before anyone else if there is a foreclosure. It is, therefore, more attractive because of the lower risk for lenders and is in stronger collateral protection because it is often secured with a Deed of Trust or mortgage. If the borrower defaults, the lender has the legal right to foreclose and sell the property.
• Cross-Collateralization - Cross-collateralization is a financing strategy where a lender uses multiple properties (or assets) as collateral for a single loan. Let’s take a real estate investment project, for example. Instead of securing a loan with just one property, a lender ties multiple properties together, reducing risk to investors and allowing borrowers to access more capital or better loan terms. In this case, the private lender can seize any assets named in the cross collateral upon default. These are used more for bridge loans and large real estate deals.
• Bridge Financing - Bridge financing is often used for short-term needs to bridge the gap between the available capital and the total capital needed for the project. It helps borrowers cover costs when traditional financing, private loans, or personal funds aren’t enough. Bridge financing is often used for projects such as fix-and-flips or while a borrower creates value, adding to an increased sales price of the asset.
• Equity Position Loans – An equity position or second position on a property behind an existing first lien allows a borrower to bridge funding gaps, increase leverage, and preserve remaining liquidity without refinancing their first mortgage. If the borrower defaults, the first-position lender gets repaid first, and the equity position only gets paid after if there are remaining funds.

Another fact about private moneylending is that terms or requirements are more lenient regarding credit and income requirements. Private lenders focus on the asset's value (for example, on the physical property or land) and its potential upon completion. The most significant difference between banks and private money lenders is that with private lenders, banks evaluate borrower creditworthiness first. In contrast, the property is first assessed by private money lenders. Banks require strong credit scores, income verification, and extensive documentation to illustrate these facts. They also have much red tape and stricter compliance guidelines regarding underwriting, as mentioned earlier. What sets private money lenders apart when comparing the two is that fewer restrictions and more lenient guidelines are offered.

What about the ratio of loan to value? Banks are rigid, as their rules are determined by guidelines set by governmental agencies that must be followed. Meanwhile, private money lenders can work with borrowers, allowing them to put less cash up front and leverage their capital more effectively. This could allow for higher loan-to-value ratios to cover the interest reserve for the loan. That advantage alone opens investing up for many who do not have a lot of cash reserves.

What about the fact that private lenders are more open-minded about their willingness to finance non-traditional properties? This includes areas that banks avoid, such as unique commercial deals, distressed assets, and fix-and-flips. Private money lenders love financing short-term investments, renovations, and value-added projects.

Banks are cookie-cutter and shy away from complex real estate transactions, multiple property collateralization, and high debt-to-income ratios. Financial history is the top priority for banks, and they are assessed and evaluated with care for approval. Meanwhile, a private money lender goes beyond these financial histories and looks at the project's full potential and can envision the future of a project because they think like developers.

Private money lenders also build lasting relationships, leading to loyal repeat borrowers with loyalty perks. When a borrower sees the potential of speed to financing and the flexibility to provide creative financing, the emphasis on personal relationships is a great reason why private money lenders are being chosen over banks. This also illustrates that private money lenders can adapt to different types of borrowers and their criteria.

Due to the short-term nature of their lending timeframes, private money lenders are more flexible in their ability to adapt to economic market conditions. What happens when the economy tightens up for banks? Banks will pull back on their lending, regardless of the type of project, funding needed, or borrower, and may possibly have stricter requirements to meet. Yikes!

To conclude, borrowers increasingly turn to private money lending over traditional banks due to speed, flexibility, and easier access to capital. Private money lenders can approve and fund loans quickly, offering customized financing options, and provide competitive loan-to-value ratios, making it easier for borrowers to scale their companies. With creative financing solutions like interest-only payments, balloon payments, cross-collateralization, and private equity positions, private money lenders cater to the unique needs of borrowers. Unlike banks, which rely on rigid underwriting and strict credit requirements, private lenders focus on project value “as is” or “as completed” rather than just the borrower’s financial history. Additionally, the relationship-driven approach of private lending fosters repeat business and long-term success. As banks tighten lending policies, private lenders maintain an adaptable and strategic funding source for real estate borrowers and investors looking to maximize their opportunities.