What Are Private Mortgages?
We usually think of real estate financing in terms of loans from banks, mortgage brokers, mortgage banks, credit unions and insurance companies. In fact there’s another source of real estate financing, private mortgages.
Private mortgages can be alluring and in some cases financially dangerous. In the best case a private mortgage will provide a low rate with little down and fair terms, in the worst case you’ll have a hard-money loan with high interest and huge fees.
On the good side, one can get a mortgage — it’s just a loan — from a friend or a relative. In fact, Virgin Money has a program in place to create such loans with proper paperwork and administration.
Private Mortgages
Private mortgages should be treated just the way that a commercial lender would handle real estate financing. This means there should be an appraisal of the property, the borrower should provide financial information, there should be a formal written loan agreement prepared by an attorney and the loan should be properly recorded.
The reason both buyer and lender want such formalities is very simple: Relationships can change. Verbal agreements can be unclear. When everything is in writing and saved in a business-like manner then the obligations of each party are clear.
Private mortgages do not necessarily have to have the same terms as conventional financing. For instance, there can be loans where interest accumulates and the debt is paid off from time-to-time with lump sum payments. The interest rate can be lower and the qualification terms can be more liberal. With an individual as a lender, it’s actually possible for the debt to be forgiven in a will.
One concern with private mortgages is there length. Rarely can you get a 30-year private loan. Shorter terms are much more common.
I have obtained a number of loans from private sources. These typically are pension funds from law offices and medical practices which hold millions of dollars. The trustee for the fund can sometimes extend mortgage loans, depending on the terms of the pension.
Such extensions of credit are not minor matters. The trustee has fiduciary obligations to the pension and its beneficiaries and must act in a responsible manner. In my situation, there was always a formal settlement with recorded documentation. I am pleased to say that all loans were fully repaid, with interest.
Hard Money Lenders
Less attractive are asset-based loans from hard money lenders. These are typically short-term loans with high interest levels, big fees up front and small loan-to-value ratios — say a loan for as much as 65% of the property’s value.
As with all real estate loans, if the borrower does not pay the property can be lost to foreclosure. Of course, the tougher the terms the more likely default.
For specifics regarding a private mortgage, both lender and borrower should speak with an attorney.
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