Private lending is too risky
Private lenders like Ignite Funding, which are not associated with a bank, conduct their borrower due diligence with a more investment-focused approach. With an underwriting process tailored to real estate-backed loans, typically in the form of short-term bridge loans or construction financing, private lenders will assess the amount of risk and try to mitigate it diligently.
Private lending due diligence on the borrower identity & background checks
First, private lenders like Ignite Funding will analyze the borrower’s individual and business track record to confirm their identity in the industry. They will assess the borrower’s track record to see what notable projects they have done in the past and what their overall real estate track record is like. Although they will check credit worthiness, they may not rely heavily on credit scores but instead will focus on payment histories, bankruptcies filed, judgements, and tax liens. Private lenders also check liabilities, as well as debt loads.
Private lenders evaluate collateral & loan security for private lender loans
Rather than the borrower’s credit score, private lenders will focus more on the collateral quality, since they are focused on asset-based lending. They will use various methods to determine the value of the property that may include an appraisal, market analysis, broker price opinion, or an independent valuation to make sure the property value to amount lent meets the standards to get the loan. They will then pull a preliminary title report to assess a thorough lien and title search on the property. If there are issues, they will be discussed with the borrower to ensure they can be overcome prior to the funding of the loan.
To mitigate future risk, private lenders will maintain their loan-to-value (LTV) ratio below 60 to 70%. They want the borrower to have significant equity in the deal so that if a borrower default arises and the property is foreclosed on, there is a mitigated risk of investor capital being loss. Low LTVs ensure greater protection when there are market fluctuations, and the assets would be easier to liquidate shall a default occur. It also ensures that the borrower has skin in the game by committing a great stake of their own money in the loan.
They will also look at the loan-to-cost (LTC) value and evaluate it thoroughly. This compares the loan amount to the total cost of the project rather than just the property’s appraised value. Loan-to-cost value focuses on the actual cost of the project. Not only does it evaluate borrower risk, but it also ensures financial commitment and manages investor exposure. Private lenders want to protect themselves from overleveraged borrowers setting LTC limits between 65 to75% to ensure the borrower has reserves. Also, LTC accounts for construction and renovation risks as it factors in rehab/construction costs and unexpected overruns. Private lenders will require the minimum equity contribution anywhere from 25-35% of the cost of the project is standard. Private lenders will reduce the risk by having construction draw schedules, releasing funds in phases, rather than providing the full amount upfront. This way, borrowers need to reach specific milestones in their project before the lenders release more money. To ensure projects are realistic they will conduct independent cost verifications and seek out third party feasibility reviews on them because a project with underestimated costs may require a higher borrower equity injection.
When applicable, private lenders will also conduct debt service coverage ratio (DSCR) analysis to see if the project can generate enough revenue to cover debt. A DSCR is the value of the net operating income divided by the loan payments and private lenders usually will want a score that is greater than 1.2. Private lenders will evaluate the property conditions and do inspections. They will evaluate the property conditions for any risks and structural soundness. They want to also know how the borrower plans to repay by assessing their exit strategy. Will they have a property sale or refinance? Or they will want to know how they will spend their operational revenue. These are all important questions they will ask the borrower before continuing to lend.
For fix-and-flip or new construction loans, project specific considerations are questioned. To ensure that costs align with market rates, they will want to know the scope of the work and its associated budget. They will review the contracting work and the contractor’s building experience as well as assess the project’s timeline. What is the project’s timeline? Will it get completed within those timelines?
Other financial review
Private lenders will evaluate any cash reserves to show that the borrower can cover interest payments, construction overruns, and cover the market itself in case there is a downturn. They will look at past loan performance to see past payments and the history of those repayments. This is if they have had loans with the private lender they are borrowing from prior to this loan. Any DSCRs will also be evaluated especially for rental projects to ensure that their income will cover any debt associated with the project.
Some private lenders may seek legal and compliance checks by outside counsel, while others will utilize legally maintain loan agreement software. Due diligence on loan agreements will be reviewed for enforceability of terms and conditions, default provisions, and personal guarantees. Regulatory compliance will be enforced so that the borrower meets the laws specific to that state. Insurance requirements might also be mandated by the private lender to require general liability or property insurance.
Private lenders will also take additional precautions with their borrowers to ensure the project and its viability. They will conduct an investor suitability match to align deals with investors’ expectations. These investors will be given risk disclosures so that they are informed about the potential that a borrower may default. Also, a foreclosure risk plan is also taken into consideration so that in case there is a default with the borrower, the lenders are prepared to take over and sell the collateral.
So, when it comes to risk, let’s look at the upside. You will receive higher yields. Ignite Funding investment garners a 10 to 12% annualized return. All loans are secured by real estate that are shorter terms from 9 to 27 months at most. Risks you may have to weigh against are loan defaults, market fluctuations and investments being illiquid. They may not be as liquid as stocks or a REIT investment. Consider the pros and cons when you think it is too risky and do your research to make sure you feel comfortable about your options.
Private Lender Loans Investing is only for the wealthy
Private lenders like Ignite Funding offer real estate-backed loan investments, meaning investors fund loans secured by property. Examples of investments include trust deed investing and are accessible to anyone who meets the following criteria:
If you have a household net worth that exceeds $250,000, excluding any equity in your primary residence. You can also qualify if your household's net annual income meets or exceeds $70,000 for each of the previous two tax years, with a reasonable expectation of maintaining this income level for the current year.
Ignite Funding requires a minimum investment of $10,000 per trust deed investment. That’s it! Practically everyone can invest with these criteria. The low investment entry makes it accessible to many individual investors.
Also, many investors use Self-Directed IRAs (SDIRAs) to invest in trust deeds, making private lending a viable option for retirement accounts.
If a borrower defaults, I lose all my money
In case of default, the lender has recourse because the loans are backed by real estate or first position trust deed. Unlike stocks or unsecured loans, the investment is tied to real estate which is a tangible asset. Also, since you are in the first position trust deed, you will be the first to recover funds in case the borrower defaults. Also, the lender can initiate foreclosure to recover the property and repay investors if the borrower cannot repay. Private lenders like Ignite Funding manage the foreclosure and liquidation process for investors. Because the LTV is typically 60 to70%, the property is often worth more than the loan balance, ensuring investors recover principal and interest. So, this is a myth, and you do not lose all your money.
Another fact is that investors can reduce risk by diversifying across multiple trust deeds instead of putting all their money into one loan. For example, if one borrower defaults, you still earn returns from the other four loans. You can do this by investing $100,000 spread it across five loans in $20,000 increments, not only reducing risk but providing diversification in different properties.
Even when a borrower misses payments or defaults, investors still earn money. The private lender will typically charge the borrower a higher default interest rate. This means if the borrower defaults, they often owe higher interest penalties. There may also be late fees charged so that can increase the investor’s overall return. And finally, the interest continues accumulating during the default period and should the borrower cure the loan prior to foreclosure, you will receive the deferred interest.
Conclusion: The Truth About Private Lending Investments
Private lending, especially with firms like Ignite Funding, offers a compelling alternative to traditional investing, yet many myths create unnecessary hesitation. While some perceive it as too risky, the reality is that private lenders implement extensive due diligence, secure loans with real estate, and maintain low loan-to-value ratios to mitigate risk.
Additionally, private lending isn’t reserved for the wealthy - with a minimum investment of $10,000 and clear financial suitability requirements, a broad range of investors can participate. Furthermore, the fear of losing all your money due to borrower defaults is largely unfounded, as these loans are secured by first-position trust deeds and backed by tangible assets, offering investors multiple layers of protection.
While no investment is without risk, the structured safeguards of private lending, such as foreclosure rights, loan diversification, and investor protections, ensure that capital preservation remains a priority. By understanding the facts rather than believing in myths, investors can make informed decisions about whether trust deed investing aligns with their financial goals.
If you're considering private lending investments, research your options, understand the risks and rewards, and diversify your portfolio for long-term success. With proper due diligence, private lending can be a powerful tool for earning passive income while maintaining control over your investment strategy.