It is not strictly necessary to obtain a mortgage through a mortgage broker, bank or credit union. With a private money, or hard money loan, the money is not borrowed from a bank, but rather another person or a business.
A private mortgage is a legal agreement between two individuals, or an individual and a business. While there are several potential risks to a private money loan, most can be avoided through clear planning and documentation.
Private money loans are often used by borrowers who have been turned down by financial institutions. Many borrowers over the last few years have found themselves unable to obtain a mortgage due to strict lending requirements imposed by major lenders. While hard money loans have typically been used by home investors to secure real estate, more homeowners are now turning to private lenders.
Private mortgages almost always have much higher interest rates than conventional mortgages. The rates are sometimes more than double the average 30-year mortgage rate, (generally between 10 and 20%). This is because private lenders do not require excellent credit.
Private money loans also require a higher down payment, as private lenders lend at significantly lower loan-to-value (LTV) ratios, (usually just 65% compared to 80-90% with an institutional lender). This means borrowers must put down at least 25-35% to purchase a home with a private loan.
Private loans are usually not paid back over 15 or 30 years like a traditional mortgage. Most private money lenders expect the loan to be repaid in six to twelve months, occasionally going as long as two years. For this reason alone, most homebuyers should look elsewhere for a home loan. However this does not pose a problem for most home flippers, who often turn to hard money loans while flipping property.
Borrowers will also be unlikely to receive tax benefits, such as mortgage interest deductions, that are received with a traditional loan.