With current interest rates hitting historic lows, one would assume it should be easier than ever to obtain a mortgage loan, especially since the mortgage payments are more affordable due to lower interest rates.
However, pretty much 100% of loan products offered by institutional lenders today are strictly “prime” loans and they are available only to the best qualified borrowers with perfect, or nearly perfect credit, income, and employment. In addition, the property, which serves as collateral, must be in top shape as well to qualify.
One of the most significant bi-products of the most recent financial crisis, and the ensuing “great recession,” was effective disappearance of “alternative,” also called “non-prime,” mortgage loan products.
In the past, when borrowers buying or refinancing property did not have a high enough credit score but had solid jobs and incomes, they could qualify for alternative mortgage loans which compensated for the extra risk with higher interest rates.
Lenders which were making these types of loans demanded between one to three percentage points higher interest rates than those on the “prime” loans. The higher rates were deemed sufficient to compensate for the extra lending risk.
In today’s market that would make the interest rates on “non-prime” mortgages around 5% – 7%. However, a plethora of strict financial regulations and the effective disappearance of the private secondary mortgage market virtually eliminated these mortgages.
At the same time, due to the tough economic times, many real estate buyers and owners who have solid down payments or good equity in their properties, cannot qualify for prime mortgages due to lower FICO credit scores or because they are not meeting some other loan qualifying requirement.
In some cases, it is the property, not the borrower, which does not qualify for the financing. This is common in case of purchase or refinance of foreclosure properties or the so-called “fixer-uppers,” which are properties requiring significant repairs.
Private Placement loans, some time called “Bridge Financing” or “Hard Money,” can provide a viable financing alternative for borrowers or properties, which do not qualify for the prime loans.
What is a Private Placement loan? In short, it is a mortgage loan funded through a non-institutional lender such as non-public pension fund, IRA retirement account, hedge fund, investment group, mortgage broker, and/or private lender, which is primarily asset-based.
These loans require higher down payments (purchase), or substantial equity positions (refinancing). In some cases multiple properties can be cross-collateralized as a security for the loan.
Typically, the Private Placement loans are short-term (two to five years) and it they are used as temporary (bridge) financing, not a permanent loan. Here are two real-life examples how this type of financing was used effectively.
Bob (name has been changed) was a real estate investor who wanted to purchase a short-sale condominium property at a substantial discount. Bob was a solid borrower with excellent credit, job, income, and a large down payment. However, the project in which the condo was located had a pending litigation between the Homeowners Association and the developer.
None of the prime lenders would not lend on it, even though the condo unit was not directly involved in the lawsuit. Bob got a really good price on the condo, which was about 30% below the market value.
He put a considerable down payment and our firm obtained for him a Private Placement loan, which funded in about three weeks. Bob thinks will sell, refinance, or pay off the property within three years. In the meantime, this condo is an excellent investment rental for which he paid about 70 cents on a dollar.
The second example illustrates how Private Placement was used to assist property owners with saving their equity through refinancing. Mark and Joan (names have been changed) were successful business owners and operators for over 30 years. They owned a commercial building and several income properties, most of which had significant equities.
After Mark was diagnosed with serious illness and could no longer work, their business deteriorated and eventually had to be closed down. Their primary source of income was gone and so were their savings and good credit rating.
Soon they defaulted on their mortgages and the bank called the loans due and payable. The lender started the foreclosure and Mark and Joan were unable to refinance their properties due to poor credit rating and reduced income. In addition, there was some deferred maintenance on their properties, which made them very difficult to sell in as is condition.
When Joan contacted us, their situation was urgent. They had no funds to cure the defaults and they were about to lose their properties with substantial equities. Our firm was able to arrange a Private Placement Loan with a non-institutional lender, which was funded in about four weeks.
The new mortgage paid off all existing loans and gave Mark and Joan much needed cash reserves, including additional funds to fix up the properties. About one year later, Joan was able to sell their commercial and income properties and cash out their equities. The private placement loan was paid off in full and the borrowers saved hundreds of thousands of dollars in equity.
Here are basic characteristics of Private Placement financing:
- Loan must be secured by real estate (all types of properties are considered, cross-collateral can be accepted)
- Loan-to-Value (LTV): 50% – 75% of the appraised value (lower in case of vacant land)
- Loan amounts range between $100,000 to $5,000,000+
- Typical loan term: 2 – 5 years (longer terms are available)
- Typical interest rates: 8.9% – 12.9%
- Quick funding, usually in 3 – 5 weeks
Obviously, Private Placement loans are not appropriate for every lending situation and seldom are used as permanent or long-term financing. They require solid equity and the interest rates are higher than those of prime loans. However, these kinds of loans can be especially useful when prime lenders are unwilling or unable to lend due to borrower or property requirements and/or when there is a need for a quick funding.
In most cases Private Placement loans are used as “bridge” financing, allowing borrowers to either quickly acquire an attractive property or to refinance their property in order to preserve equity or get a cash-out. The typical exist strategies are refinancing or sale of the property.