When it comes to Commercial real estate investing, one of the most important decisions to make would be to choose the right kind of financing. While there are many opportunities to explore while choosing the right form of financing, it is important to understand the pros and cons of the two most basic financing forms: banks and private lenders.
This blog is an overview of private lenders and banks and comparing the two to understand what’s best.
There is no correct or singular answer to which form of financing is better: private lenders or banks? It varies from case to case, and it depends on various factors like the borrower’s creditworthiness, the lending history, the down payment, and so on.
In this blog, we will understand the basic differences between private lending and Bank lending along with their overall comparison.
What is a private lender?
Private lenders are lenders who are in the business of lending private business purpose loans with funding that’s raised from private investors or even by banks in some cases. Private lenders generally expect a decent return from their Investments, and US interest rates on private money loans are generally significantly higher than traditional bank loans.
Besides, other expenses like legal costs and loan origination fees are borne by the lenders and will be ultimately passed on to the borrower.
In times of need, commercial real estate investors generally turn to private lenders for immediate financing. Private lenders are known for their flexibility in terms of choices and options, along with their light-speed processing.
While private lenders may not always be the best option, it is often one of the best options, especially when borrowers do not meet the stringent qualifying standards set up by traditional banks.
What is a bank lender?
Bank lenders are banks who are in the business of taking funds from depositors and lending money to borrowers while having a profit margin between the two and making a profit from the interest collected as opposed to the interest paid.
Bank lenders generally impose low-interest rates in comparison to private lenders. However, it isn’t easy to qualify for a traditional mortgage as the bank lending standards are very high.
Private Lenders Versus Bank Lenders
While talking about the comparison of private lenders with bank lenders, one of the first things to discuss is flexibility. Bank lenders are generally much harder to deal with than private lenders.
Banks are subject to state and federal regulations and regulations from quasi-governmental agencies like Freddie Mac and Fannie Mae and the department of housing and urban development. These regulations will often dictate what kind of businesses a bank can lend to and determine an ideal borrower profile – making the lending standards even higher.
On the other hand, private lenders are still subject to state and federal laws but are significantly less regulated and thus are more flexible concerning the types of loans they can make and who to lend.
The second thing to talk about would be the factor of customizability. It is generally easier to approach a private lender and get your loan approved than a traditional Bank.
Further, you can work out the terms that fit your financial position because private lenders are willing to customize each loan based on the needs of the borrower and can make changes in the qualifying standard such as credit scores, debt to income levels, loan to value ratio if the borrower can negotiate a good deal.
Banks generally tend to look at financial histories and check the borrower’s credit with easily traceable and documented income sources, making it very difficult for self-employed borrowers to qualify for bank loans.
However, the case is different when borrowers are working with private lenders who are still interested in the borrower’s creditworthiness – but they do not necessarily stick to the old school way of verifying a borrower’s credibility by looking into income statements. They generally do not have a problem with an unstable cash inflow.
As long as a borrower can convince a private lender or hard money lender about his repaying capacity and some support statements like a projected income statement for the period of the loan, private lenders do not back off from funding loans.
In most cases, it is common to see that private lenders are more creative and investigative in their loan processing standards and procedures and may be willing to overlook some background flaws upon reasonable explanation provided by the borrower.
How to select the Right Lender for Commercial Real Estate Investment
Selecting the right lender for your commercial real estate investment is probably one of the most important decisions you would make. The difference in pricing between a bank lender and a private lender is generally not the only factor that needs to be looked. If it were that simple – all borrowers would choose Bank lenders because banks provide financing at the lowest rates.
However, it isn’t that simple and straightforward. Various factors like the term of the loan, a challenging property, a long-term investment plan vs. short-term, one-time financing, a time period to seal the deal, etc., are some of the numerous factors that come into play. Thus, depending on your needs and financial history, the answer to what’s the best form of financing varies largely.
As a general rule – If you have a solid financial history, a sound credit score, a straightforward property you wish to buy, and there’s no immediate rush to close the deal – banks might be a good option.
On the other hand – If you have a disrupted financial history, an average credit score, a challenging Property, an urgency in buying the property, and are willing to put down large down payments for an overall better and bigger picture, private lenders might be a good option.