What Is Private Lending?

Before learning how to become a private lender, let’s quickly walk through a commonly asked question: “What is private lending?”

Private money lending is a method for financing a real estate deal without a formal financial institution involved. One or more private investors – often high-net-worth individuals – provide the funds necessary for another party to purchase profitable real estate investment properties. 

Investors providing the funds benefit from such transactions since the origination fees and interest on the loan are paid directly to them. Most states have interest rate ceilings for private money lending. However, in general, this rate typically follows regular market trends. 

At the same time, real estate investors looking to purchase a physical property benefit from private lending since the approval and funding process is often faster than financing through a formal institution. When real estate investors aren’t able to secure a loan through a bank or need a loan quicker than a formal institution can provide, they may turn to private lending.

How Does Private Money Lending Work?

Private money lending works in two main ways. The first involves an individual with money to invest. They can form deals on their own with potential borrowers, using all of their own money to fund the loan. 

The second main private money lending method involves a group of private lenders pooling their money together. There is typically a representative from the partnership who handles the deals of the transaction. In some cases, companies – such as Revolution Realty Capital – will act as the middleman for these transactions and gather funds from investors. 

When working with a private lending company, your main responsibility is to supply the funds, this method allows for truly passive real estate investment income. 

No matter the funding method, terms of private loans can range from six to 24 months. They are secured by the physical real estate property and require a downpayment, although the exact amount varies.

Private Money vs. Hard Money

Private money and hard money lending are terms often used interchangeably. While they are very similar, some key differences do exist. However, private money vs. hard money pros and cons are generally the same for investors.

One aspect of learning how to become a private lender will require you to understand the key difference between private money and hard money. Using them interchangeably is okay, but be aware that private money isn’t synonymous with hard money 100% of the time.

Is Private Lending Right for You? 

Becoming a private lender can help you diversify your portfolio in an industry that has historically maintained profitable returns. However, if you don’t have much experience in the real estate world, you’ll want to work with a trusted company or create a partnership to start your private lending journey. 

Despite its profitability, private lending isn’t for everyone. Those that are best suited for this investment type include: 

• High-income earners (doctors, lawyers, etc.)
• Retirees with a high net worth 
• Lottery winners 
• Successful entrepreneurs
• Real estate professionals 

Although you don’t have to fit the above categories exactly, the key to becoming a private lender is having the money to loan out, and then some. 

One of the key benefits of investing with a company, like Revolution Realty Capital, is that you can choose how much you would like to invest (above a certain requirement). Every company and partnership is different. Some require a higher minimum amount than others. For retirees, this means you’ll want to do your research before committing to any organization or partnership, and you should never invest your entire nest egg. 

Retirees aren’t the only ones who should be wise about how much of their net worth to risk on an investment opportunity. Consider how much you’d be willing to lose if a deal goes south, and don’t invest more than that. Even though the goal is to make money from your investment, not lose it, you can’t predict the future and should thus still act with caution.

How To Become a Private Lender

One of the easiest ways to become a private lender is to form real estate partnerships or work with a trusted real estate lending company. You can also start your own private money lending business if you’re looking for deeper profits. 

Lending smaller sums of money to family and friends occasionally will also make you a private lender. However, if you go this route, ensure there’s nothing casual about the written agreement you make with the borrower. 

Read through the steps below to learn how to become a private lender, no matter your method of lending. 

1. Build wealth: There’s a reason most private lenders are individuals with deep pockets. Unless you’re pooling money with other investors, most deals will require you to have at least $100,000 to lend. Even if you are pooling your money, that may be the minimum requirement for any given deal. 
   
   The good news for high-net-worth retirees is that it’s possible to use funds from certain retirement accounts to become a private lender. If this appeals to you, never loan all of your retirement funds. Only commit the money you’d be okay losing if the borrower defaults.
   
   
2. Locate a potential borrower: If you’re lending to family or friends, they’ve likely approached you about borrowing your funds. However, if you’re looking to actively find potential borrowers, networking with real estate investors or working with a private lending company is key.
   
   
3. Evaluate potential borrower’s financial credentials: Understanding the full scope of the borrower’s financial situation can show you whether or not they are likely to default on the loan, or hold up their end of the agreement. 
   
   If you’re working with a company that pools investors’ funds, you very likely won’t be responsible for this or any of the following steps. 
   
   When working with a group of investors in a partnership, there is typically a designated role for each investor. Your role may or may not include this or any of the below steps. 
   
   
4. Evaluate the risks and rewards of investing in the agreed-upon property: Just as important as knowing the borrower’s financial history is knowing the proposed property’s history. This includes current and previous market value, any present liens, and how similar properties in the area have performed in recent years.
   
   Once you have the full financial landscape of the property, compare the risks of lending your funds to the rewards. Keep in mind that because private loans are typically short-term loans, the borrower won’t have time to recover from potential adverse market volatility.
   
   If this happens, the borrower may be at risk of failing to repay the entirety of the loan. This can be especially relevant for fix and flip deals, where the funds to repay the loan come from the increased value of the property.
   
   While real estate generally experiences less short-term volatility than other investment options, every market is different. Popular locations that regularly see flooding, hurricanes, wildfires, and other hazards can prove to be risky investments, particularly in certain seasons. Most property evaluations should also factor in these environmental conditions, as they can dramatically affect the property’s value.
   
   
5. Write a contract with the loan terms: This step is crucial no matter who you’re lending to. Some private lenders hire an attorney to develop the loan documents, while others choose automated loan software.

Some of these steps may come easy to you if you’ve had extensive experience in real estate. If not, it may be best to partner with other investors or a private money lending company for your first few deals. This will help you better understand the process before going it alone if you choose to.

How Do Private Lenders Make Money? 

It’s common to ask questions like, “How do private lenders make money?” 

Luckily, it’s a pretty easy answer. Consider all the fees and interest a borrower pays to a financial institution when approved for a loan. Private lenders essentially fill the role of a formal financial institution. This means the fees said institution usually charges, now go to the private lender. 

Closing Fees: Similar to most loans, closing fees account for anywhere from 2% to 5% of the loan amount. These include origination fees, legal fees, processing fees, and underwriting fees, among others. 

Interest Payments: Any interest a borrower would normally pay a financial institution now goes directly to your bank account. The exact interest rate varies by loan type and borrower qualifications. 

Points: To reduce the interest rate, borrowers may pay 1 point, or 1% of the loan value, at closing. This entails paying interest upfront. Since private money loans are typically short-term, paying points isn’t usual. 

If you want to scale your profit by increasing the number of loans you fund every year, you may consider creating your own private lending business. However, if you intend for your private lending to be a passive investment, or just want to help the people close to you, then forming an official business isn’t necessary.

How To Start a Private Lending Business

To know how to start a private lending business, you first have to understand how the private lending industry works. Your very first step is to conduct as much research as possible. 

Through this process, you may find that you’d rather take a more passive approach and work with a trusted company. Or, you may find that learning more about the industry has fuelled your desire to start your own private lending business. If you’re in the latter category, read on to learn the next steps you should take. 

1. Learn the private lending process through partnerships: Conducting research is one thing, but the process of doing is usually the best teacher. Form partnerships with other investors to dive further into the industry. Take note of what’s lacking in other private lending companies.  
   
   
2. Ensure access to your funds: Even the wealthiest investors wouldn’t be able to start a private lending business if all their assets were tied up in illiquid investments. Before moving forward, check in on the status of your funds and do what you can to gain access to a significant portion of them.  
   
   
3. Create a business plan and formally establish your company: Remember how we told you to take note of what’s lacking in the industry? Use your business plan to fill that gap so you can more easily attract investors to your business. 
   
   During this stage of the process, you also need to thoroughly research local private money regulations.
   
   
4. Consult with a trusted lawyer about your company: Now that you have an idea of how you want to form your business, have a lawyer look over your plans. They can help you identify where and how you can legally protect yourself and your money.
   
   
5. Identify potential borrowers: Identifying one or two specific types of borrowers can help you narrow down the hunt for potential investors. Are you more familiar with fix and flips or would you rather work with building developers? Are commercial properties more your thing? Whatever you decide, narrowing it down early can give your business a stronger start.
   
   
6. Create a website targeted to your ideal borrower: Creating a website is easier than ever these days. And if you don’t want to create one yourself, finding a skilled freelancer is easy on sites like Fiverr and Upwork.
   
   
7. Expand your network to land leads for new investments: Attending real estate conferences and asking friends for referrals are just two ways to land leads for your business. Put yourself out there and develop a strong elevator pitch – you never know when you’ll run into potential borrowers.
   
   
8. Evaluate proposed borrowers and investments: Not all potential borrowers or properties will be suited for your business. In the beginning, it can be tempting to lend money to almost everyone who comes knocking. But falling into this trap can hurt your business more than it can help it.
   
   Before lending money to anyone, evaluate the potential borrower’s credit history and past real estate ventures. You should also evaluate the potential return on investment on the proposed property and determine if it has any outstanding liens.
   
   
9. Rinse and repeat steps 7 and 8 to grow your business: As you scale your business, you may need to re-evaluate your company structure or the types of borrowers you lend to. But until then, continue expanding your network and increasing your knowledge of private money lending. 

Knowing how to start a private lending business and actually getting it started are two very different things. Private money lending can be intimidating, so don’t skip over step one. The more knowledge you gain in the industry and the more connections you make, the better off your business will be in the long run.

How To Become a Private Lender: 6 Pro Tips 

More and more investors are turning to private lenders instead of traditional bank loans. So how can you get your slice of the pie? The following tips give further advice for breaking into the private lending business. 

1. Learn the subject of your investments: If you choose to lend to fix and flippers, doing your own fixer-upper projects will enhance your knowledge base for evaluating potential investments. 
   
   
2. Start small: Start with partnership investments before going solo, then smaller deals before taking on large projects.
   
   
3. Find a lawyer you trust: A good lawyer can make a world of difference. Don’t be afraid to fire a few until you find one that suits you and your needs. 
   
   
4. Work locally: Becoming a private lender can be slightly simpler by starting locally and expanding to different regions once your business is more stable. 
   
   
5. Develop a sixth sense for calculating risk: If you don’t first know how risky a property or potential borrower is, you could lose big. 
   
   
6. Keep studying and learning: There’s always room for growth – never assume you know it all.  

As mentioned previously, knowing how to become a private lender and actually becoming one is very different. Private money lending can be incredibly profitable, but you’ll never know if you don’t take action. 

If you’re ready to break into the private lending business and make your money work harder for you, contact Revolution Realty Capital today.