UNDERSTANDING PRIVATE LENDING
How Financing Works Behind the Scenes
When a buyer purchases real estate, the transaction often involves more than the buyer and seller. There is frequently a third participant: the lender. A lender provides financing under a contractual arrangement that establishes how money is borrowed, how repayment is calculated, and when payments become due.
Although banks are the most familiar source of real estate financing, certain transactions can also be financed by private individuals or organizations.
KEY QUESTIONS
Questions Every Lender Should Ask
How Does a Lender Earn Interest?
Interest is the cost of borrowing money. In an amortizing loan, scheduled payments typically include both interest and principal. As principal is repaid, the outstanding loan balance decreases. Other loan structures may require interest-only payments, a balloon payment at maturity, or a different repayment arrangement. The lender's actual receipt of payments depends on the borrower's ability and willingness to meet those obligations.
Is Lending the Same as Owning Property?
No. A property owner typically holds title and bears the responsibilities associated with ownership. A lender generally holds a contractual claim for repayment and may hold a security interest in property. The lender does not automatically become the owner simply because a mortgage secures a loan.
Is Private Lending Risk-Free?
No. Borrowers can default. Property values can decrease. Collateral may be insufficient, and enforcement can involve legal expenses and delays. Some promissory notes and lending arrangements may also be regulated as securities. Private lending requires careful consideration of the underlying transaction, documentation, and applicable laws.
THE BASICS
What Is Private Real Estate Lending?
Private real estate lending involves financing arrangements outside conventional bank lending channels. Depending on the transaction, a loan may include:
• A written promissory note setting out repayment obligations.
• A stated interest rate and repayment schedule.
• A mortgage or other security instrument.
• Terms defining maturity, default, and remedies.
• Documentation addressing the property and parties involved.
Not every private loan uses the same terms or documents.