Advantages and disadvantages of financing investment property with private mortgages
Rental real estate can be very lucrative, and it’s the kind of passive income that can give you a massive return on your investment. And for those who want to invest, look to mortgage lenders to secure property. But those who are new to this kind of business may want to first assess their options regarding financing and where to get it. Is it better with banks or private lenders? Here are the pros and cons of these lenders.
Benefits of a private mortgage
- Faster approval
The wait for loan approval can take a long time depending on the type of lender, but a private mortgage has been known to release cash loans faster than banks. The latter requires documents and various procedures which are tedious and time consuming. Some application processes take a long time due to loan amount and paperwork. The application can be approved in just a few hours if you speak to a licensed mortgage broker – private mortgage as soon as possible if you have a deadline to meet.
- Possibility of lower rates
Private mortgage lenders also apply to family members or relatives that you can turn to for money. Some immediate family members may have the financial capacity to help you. If they trust you enough, you can get a lower interest rate from private institutions. But remember, the IRS rules still apply when you keep rates lower. It must meet the applicable federal rate (AFR), or you may pay more taxes. Anyone with enough money can choose to lend their money and earn more by lending it privately to someone they trust.
- Excellent choice for top fixators
Private mortgages have shorter payment periods, but those with flipping properties don’t mind the limited time frame. They also may not dwell on the qualification of traditional lenders because lenders frown on homes that require major renovations, even if you have a good credit report.
The reason is that it may need more money to repair. Vacant homes are likely to have broken windows, vandalized walls, and plumbing that requires major work. A private lender may want to try their luck by financing renovations that you can sell or rent.
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Disadvantages of a private mortgage
- Short term payment plans
If you are considering taking out a private mortgage, you need to plan how you can pay it off. Traditional lenders have longer payment terms. During this time, private lenders can give time to repay what you owe for up to three years. The standard payment terms of banks and other institutions are provided for 15 years and 30 years.
That is why, when you go for a private mortgage, you need to know how much interest you will have to pay monthly. Since you only have a few years to repay the loan, the amount is bound to be larger with interest. Make sure you can work within your budget. You also choose to get a mortgage foreclosure rate which will help keep rates from going up.
- Risk of vacancy
When you expect larger payouts and a shorter payout period, you would want to weigh it against the possibility of extended vacancies. The property can remain vacant for a long time. If you have no other income, you will pay for his mortgage, insurance, taxes, and maintenance expenses.
Do a math and assume the property will be vacant for a month. Find out if the return on investment is acceptable for you if the property will not make money for a while. Make adjustments in the calculations if the property remains vacant for more than a month. You will save yourself trouble the sooner you know whether the loan is worth it or not.
- Requires higher credit scores
Whether you are buying a home for personal or investment purposes, the private mortgage lender often demands high credit scores. High credit scores prove your ability to pay off what you owe. Private lenders need you to have a good track record with a score between 500 and above.
Also consider that lenders have raised minimum credit scores due to the economic pressure caused by the pandemic. If you need information, you can consult a few mortgage lenders and compare interest rates and quotes to determine how much you could potentially repay if you give the loan.
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Funding from private mortgage lenders has both advantages and disadvantages. You may find that you can get approvals faster, even for those in need of major renovations. But you will also be faced with short payment terms and the possibility of not making any money as soon as you want. Before applying for a loan, it is best to do your research first.
Reagan Reane is an investment specialist. He has been in the industry for 15 years. He shares his knowledge of investing by hosting webinars, writing guest posts and blog posts to inspire budding investors. Reagan enjoys biking and hiking in his spare time.