Private Lenders Provide Option for Borrowers
The Wall Street Journal - July 31, 2008
As lending standards have become tougher, a rising number of people and businesses are turning to an unlikely source for money: private lenders.
In recent years, the practice of borrowing money from private parties was rare, except among those who were unable to qualify for traditional loans. Banks were flush with cash and eager to lend, meaning even people with a tarnished credit history often could find quick sources of cash.
Now, even those with good credit are bypassing banks to borrow money -- despite interest rates that can reach 20% or more, and down payments of 35% or more.
These private funds -- which aren't from banks or credit unions -- are being used for everything from second homes to apartment construction. Many borrowers have excellent credit, but they are trying to avoid the added time, scrutiny and uncertainty of a conventional bank loan. Such transactions are "not as publicly available as one might expect," says Ron Phipps, a real-estate broker in Warwick, R.I., "but there is definitely money available."
Arrangements for such loans are equally low-key. While hedge funds and high-net-worth investors are providing cash, it isn't unusual for a private lawyer to get five friends to each throw in $100,000 for a home loan. Wealthy investors, hedge funds and private-equity firms are lending money in pursuit of consistently higher returns. The bear market for stocks may make alternative investments such as this type of lending more attractive.
Typically, borrowers hear about private loans from lawyers, mortgage brokers and real-estate agents. Borrowing and lending opportunities are even sometimes posted on Web sites or in newspapers.
For investors, well-structured deals could reap significant returns, because private lenders typically charge much higher closing costs and interest rates than traditional lenders. They also require a much higher loan-to-equity ratio. So if the borrower falls behind, the lender potentially could resell the property at a profit.
"For the investors, there's an opportunity," says Scott Haislet, owner of LEC Mortgage in Lafayette, Calif. "But you better know who is in charge and who's making the decisions about the property."
Borrowers "need to make sure they understand the way the loan works," says Allen Fishbein, director of housing for the Consumer Federation of America. Mr. Fishbein recommends that borrowers "seek out independent professional advice before committing themselves."
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