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How to Profit from Private Money Lending

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Hard money lending, or private loans, might sound like an exotic investment vehicle but given the emerging risks in the market, an increasing number of investors are starting to turn to these instruments as a way to beat the market. If this sounds like a good place for you to park some of your money, then here are some ideas on how to profit from private money lending.

What is Private Money Lending and How Does it Work?

As the name implies, private money loans are offered by investor groups other than banks. While the category includes money lent from one individual to another, the fastest growing area are investment groups which originate what are known as “hard money loans”.

According to private money lenders in NY, Gauntlet Funding, these loans help when a “real estate investor or property owner needs financing and traditional loans aren’t available.” From the perspective of an investor, the higher interest rates lead to higher returns, but this isn’t without risk. As such, getting into the private lending game is not for everyone.

How does private lending work? Generally, these loans are not long-term. In fact, most are no longer than 12-months in term with the longest-running up to 24-months. While some loans are interest-only, others are amortized over 30 years, with a balloon payment due at the end of the term.

This format allows buyers to get the funding they need quickly while keeping investors funds liquid. Another advantage is that the interest rates paid by investors are often much higher than bank loans. But in the case of flippers or developers, they just factor in the higher cost as part of doing business.

In addition, a borrower may be required to pay origination fees or points at closing. Points are used to buy down the interest rate and what this means for the lender is that they get more of their money upfront – thus, reducing risk.

How to Invest

For investors, the best way to invest is to find a money manager in their area who has built up a reputation as the go-to private money lender. While these groups will charge investors a fee to manage their money, their experience lending to high-risk borrowers will help to ensure that an investor will get their money back.

Granted, no investment is without risk, but an experienced private money lender will have the infrastructure in place to adequately originate and underwrite loans. Beyond this, they will have experience in managing the underlying fund including liquidity ratios needed to ensure they can continue to make loans.

Once you have found private money lender to invest in, you will want to conduct your due diligence. This includes evaluating the terms of the investment offering such as capital calls, the investment period, and how you will be paid back.

Beyond this, you will want to look at how the lender manages their processes as well as their track record. A key point here is that you probably don’t want to invest with a newly minted private lender – unless the principals have a track record of success managing a similar operation.

Lastly, have your lawyer review the offering memorandum as it will ensure you have a legal opinion on the offering. This might seem like a no-brainer, but some states regulate mortgage lenders and as such some the terms of the offering might not fit what the lender is able to meet.

How to Profit

When your first getting started, you need to find a lender who has a track record of success. But as you gain knowledge in how private money lending works, you can branch out to directly underwrite loans.

The advantage is two-fold. First, you know have experience about what works, what doesn't work, and may even have established relationships with qualified borrowers. Second, you won’t need to pay a management fee, which leads to a higher return on your investment.

Whether you decide to continue investing with the fund or to underwrite loans directly, one thing you will want to keep in mind is the need to perform your due diligence as there is no shortcut to profiting from hard money loans.

A key point to remember is to lose small and win small. Don’t try to swing for the fences on each loan. Instead, develop a head of steam by taking measured risks as this will ensure you win big in the long run.

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