Given the volatility and uncertainty in the stock market, as well as low returns on bonds and CDs, many investors are starting to consider the option of private lending. Private lending involves making cash loans to real estate investors to provide them with an alternative to bank loans. For the investor, these hard money loans can provide returns ranging from 6 to 15 percent. Private loans provide an income stream similar to that of a bond in that the investor receives monthly interest payments and then the return of the principal at the maturity of the loan. These loans can either be short term with a maturity of six months, or longer term loans that can three or more years to mature.
While private lending appears to be a very attractive investment opportunity, it is not without risk. In order to minimize the risk of making hard money loans, it is important to pay attention to the following aspects of private lending:
* Private loans have limited liquidity. When making a private loan, it is not the same as buying a stock that can be sold if one needs cash or a Certificate of Deposit that a person can redeem with a penalty if cash is needed. While this is not a factor with short term loans, it is something to consider on more long term investments. The money invested in a private loan will not be accessible until the maturity of the loan in the majority of cases. If the possibility exists that an investor will need the access to the cash he or she has invested, then private lending is not a good option.
* When making a hard money loan, it is essential to get an accurate valuation of the collateral used to secure the loan. Given the issues with exaggerated appraisals of real estate that occurred prior to the real estate market crash in 2008, it is essential that the property that is going to be used as collateral is appraised by a trustworthy and experienced real estate appraiser that is either licensed or certified by the state. Additionally, the appraisal should include the fair market value of the property as well as an opinion as to the amount of income the property can generate.
* Private lenders need to have title insurance on the properties that borrowers use for collateral. For the next several years, title issues are likely to plague the real estate market because of the high incidence of robo-signing. Title insurance can help protect the investors from title issues, especially those related to fraud.
* Private lenders must be aware that there is the risk that they might have to foreclose on a property. Even with the most careful screening of borrowers, circumstances arise where a borrower will default on the loan and the lender will have to foreclose. While it is not as much of an issue with the short term loans, it can be with loans that have longer maturities. The foreclosure process can be both complicated and time-consuming.
The best option for someone who wants to act as a private lender is to work with an experienced lender who can help minimize risk and optimize the returns on investments. These pages provide reviews of those lenders so you can see what past borrowers have experienced.
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