Getting approved for a mortgage the traditional way can be difficult. If your credit score isn’t great or you haven’t saved up enough of a down payment what can you do if the perfect opportunity presents itself? Most people think they only way to buy a home is through a bank or a mortgage lender, while this is the norm it’s not the only option, you can get a private mortgage.
What Is a Private Mortgage?
A private mortgage is not a very well-known way of financing a home but, in today’s market, a lot of people want to buy a home and are looking for alternative ways to get funding. With a private mortgage, money is lent to you by someone other than a bank or mortgage lender. This can mean the money comes from family, friends, acquaintances, businesses, or investors. Any mortgage loan not from a licensed mortgage broker is considered a private mortgage.
There are a lot of upsides to going to private mortgage lenders. If you have friends and family who are willing to lend you the money you need to buy a home, you can work out a repayment plan that works best for both parties.
If you don’t have people close to you who are willing or able to lend you that kind of money, another option is to go to a business or investment firm for a private mortgage. These mortgages are a lot easier to qualify for than a standard 30-year mortgage and are great for purchasing property that you intend to flip or fix up. Why? Because any improvements you make to the home will quickly increase its value, meaning you could then sell or refinance the debt.
That said, there are some downsides. Loans from private money lenders for real estate or similar aren’t paid back over the course of 30 years like a typical mortgage. Instead, you’re given a much shorter time to pay back the loan and a higher interest rate to encourage you to get it paid off as soon as you can. This is primarily because you don’t need to have perfect credit for a private mortgage and money lenders see this as more of a risk.
When taking all the pros and cons into account, there are still some ways to make a private mortgage work for both the money lenders and the borrowers. Here are five tips to consider.
1. Get everything in writing.
This is really important no matter what, even if you’re borrowing from a family member (or similar non-traditional mortgage lenders). You’ll likely need a lawyer to make sure everything is documented properly. Make sure you have a promissory note that specifically states the name of the borrower, lender, and the exact amount owed. You’ll also need to register the deed to the property to secure the loan. Why? In case the borrower defaults on the loan for any reason, the lender can prove that they still legally own the house and that it is not a part of the borrower’s financial assets.
2. Work out Some of the “What If” Scenarios Ahead of Time
This is especially important if you’re borrowing from family and friends as businesses or investors are much less likely to be forgiving or lenient if something unforeseen happens. With people that you know and love in your personal life, making sure both parties understand what’s expected and what will happen if those expectations are not met is one way to make sure that a private mortgage doesn’t destroy your relationship.
Work out the consequences for what happens if the borrower is late with or misses a payment. What if they lose their job? How will payment be restructured? What will the financial penalties be?
3. The Lender Has to Charge Interest, Even If It’s Family
While it might seem that private mortgage from a friend or family member is a great way to buy a house interest-free, there are tax laws in place that make it better for the lender to charge interest. To figure out the best way to approach this and understand the IRS requirements, it’s best to consult a CPA about interest rates.
4. Try to Get a Private Mortgage to Count in Your Credit Report
If you get a loan from a business or investor, it’s likely that the loan will show up in your credit profile. That said, if you have an agreement with a family member, it’s unlikely to affect your credit score, good or bad. If you’re trying to rebuild your credit, proving that you have a private mortgage that your payments are current on could really help.
The best way to try to do this is to contact the credit reporting bureaus. If you provide a copy of the promissory note and other paperwork, they may be willing to add your private mortgage to your credit profile but you may have to pay a fee.
5. Really, Really Think It through
If you’re borrowing from an investment firm who believes that you’re going to be able to flip a property, sell it, and pay back the loan in say, a year’s time, ask yourself if that’s really plausible. It very well could be in the right market with the right person doing the work. But what are you going to do if it doesn’t work out as planned? Are you going to be able to cover the payments if you don’t make a sale within six months?
While the consequences of borrowing from family are much different, they’re equally as important. Do you and your loved one have a relationship that’s strong enough to withstand a loan of this much money? A lot of people will just jump to the conclusion that “so-and-so has been my friend for thirty years” or “It’s fine, my mom won’t mind if I’m late with the payment once or twice.” But is that really true? If everything goes right, you should be fine. But what if something goes wrong? It’s essential for both parties to understand what they’re really getting into.