Most buyers use traditional mortgages to purchase property from lenders such as banks, credit unions and other financial institutions. In some cases and under specific conditions, buyers opt for an alternative option: private mortgages.
These agreements are less common but may offer benefits for buyers with poor credit, those who require quick funding or those planning to purchase an unconventional property not financed by traditional lenders. Private mortgages can be complicated, so let’s look at the pros and cons.
Key Takeaways:
- Private mortgages are helpful for people with poor credit who need quick funding or want to purchase unconventional properties that traditional lenders cannot finance.
- They offer flexibility, faster approval and more straightforward eligibility, but they may also have drawbacks, such as higher interest rates, shorter repayment terms and fewer protections.
- To obtain a private mortgage, you should find a lender, hire a real estate attorney, negotiate terms and finalize necessary paperwork, including a deed of trust and promissory note.
How Do Private Mortgages Work?
A private mortgage is a financial arrangement between a borrower and a private individual lender in which the lender provides financing to the borrower to purchase a home. Lenders often offer private mortgages to family or friends, allowing them to assist while generating investment profits from the interest.
Some home buyers may consider this option – as opposed to a more traditional loan – because they have a poor credit history and don’t qualify for a mortgage with a traditional lender. The loan itself works like a regular mortgage – the borrower must pay back the loan, plus interest, within a certain agreed-upon time.
The loan terms are much, much shorter than a traditional mortgage, and could require payback within 6 months to 3 – 5 years, depending on the loan agreement with your lender. If you have a longer loan term of 15 – 20 years, similar to a traditional mortgage, plan on paying high interest rates along with it.
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What Is A Private Mortgage Lender?
A private mortgage lender is typically a person or company that creates their own rules, guidelines and loan qualification requirements, which could be different for each borrower. This can make the loan riskier for both parties involved.
A private loan can also be a non-arm’s length transaction, meaning the buyer may have a personal relationship with the mortgage lender. An example of a non-arm’s length transaction in real estate is buying from a family member, like your parents.
Traditional vs. Private Mortgage Lending
A private mortgage could be an option for borrowers who have a hard time qualifying for a loan based on their financial situation, credit history or type of home they wish to purchase. Using private financing is an untraditional route to owning a home, but it doesn’t come without risks. If it isn’t paid back, it can be damaging to finances and personal relationships. It’s a good idea to fully consider the loan and consult a financial professional before deciding whether a private mortgage loan is the right option for you.
Even if you have reservations about financing with a direct lender, like a bank, it still might be worth a visit, because private mortgages come with more risks than traditional loans.
Taking out a private mortgage from a company could possibly include faster approval and funding, while private lenders may be more willing to negotiate loan terms and offer more flexible repayment options. However, private mortgages can come with higher interest rates and fees compared to conventional loans, and a borrower might also face stricter terms and conditions.
Similarly, taking out a private mortgage with a family member or friend can bring more flexible repayment terms, lower interest rates (or no interest at all) and an easier application process. By using a personal connection as a direct lender offering private financing, it can cut down on traditional closing costs, too.
On the flip side, borrowing from a friend or family member can strain personal relationships and lead to conflicts if there are disagreements or delays in repayment. Additionally, unlike a traditional mortgage, this type of loan likely won’t provide an opportunity to build or improve one’s credit history, since private mortgages typically aren’t reported to credit bureaus.
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Pros And Cons of Private Mortgages
Like a traditional mortgage, there are pros and cons to private mortgages. Some of the challenges and drawbacks include potentially higher interest rates and shorter loan terms. The average private mortgage term is hard to quantify since these loans may vary depending on the lender, unlike traditional 15- or 30-year mortgages.
Of course, there are also benefits, like easier qualifications and potentially no closing costs, depending on the lender.
Pros
- Shorter loan process
- Possibly no closing costs
- Easier to qualify for
- Potential for negotiation over interest rate
Cons
- Shorter repayment terms
- Potentially higher interest rates
- Less security and fewer protections
- May be awkward borrowing money from a friend or family member
- Doesn’t help you build good credit
- May not allow for 30-year terms
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How To Get A Private Mortgage
While it may differ slightly per lender and situation, here’s how the private mortgage process typically works.
1. Find A Private Lender
The process of finding a reliable private lender involves comparing different lenders based on their reputation, interest rates, loan terms and reviews. Seeking recommendations from trusted professionals, such as real estate agents or mortgage brokers, can also be helpful.
If you’re entering into an agreement with a family member or private individual, it is critical to establish clear terms and expectations to avoid conflicts. Factors such as interest rates, repayment schedules, collateral and legal documentation should be carefully discussed and addressed.
2. Hire A Real Estate Attorney
Because private mortgage arrangements are less common than traditional mortgages, it’s especially important to work with a real estate attorney or another real estate professional when entering into this arrangement.
A real estate attorney can help ensure the process goes smoothly while providing legal advice, managing your paperwork and guiding you through the complicated process. A real estate attorney can also help you understand the legal jargon, look for any red flags and ensure the proper paperwork and processes are being done correctly.
3. Negotiate Mortgage Terms
There are several criteria to consider when you establish your private mortgage. Such factors include:
- Amortization schedule: A mortgage amortization shows the amount of your monthly payments, the term of your loan and what portion of that payment goes toward paying down the loan balance each month compared with the amount that goes toward interest. This is critical for a private mortgage, to ensure you understand your home equity, the amount of time left on your loan and the amount that’s going to the principal over the loan’s duration.
- Loan length: The length of your loan determines the duration of your financial commitment and the total interest paid over time. Choosing the right loan length is essential to ensure affordable monthly payments and to align with your long-term financial goals.
- Interest rate: Private mortgages can come with higher interest rates compared to conventional mortgages due to the increased risk level.
4. Finalize The Paperwork
You’ll need to finalize paperwork on your loan. Here’s what you will need:
- Deed of trust: This secures a real estate transaction that includes a lender, borrower and an independent third-party trustee. Given the less-conventional nature of private mortgages, it’s critical to obtain this document.
- Mortgage promissory note: A promissory note serves as a legally binding document that outlines the terms of the loan, including repayment terms, interest rate and any additional provisions. This note is a written promise to repay the loan’s principal.
Alternatives To Private Mortgages
If you’re looking to take out a nontraditional loan, there are other options to consider, including:
- Federal Housing Administration (FHA) loan: An FHA loan can be a viable option for some home buyers – particularly those with lower credit scores or limited down payment funds. These loans offer certain benefits, including:
- U.S. Department of Agriculture (USDA) loan: Offered by the United States Department of Agriculture, this mortgage program is designed to help home buyers in designated rural areas purchase a home and lets them begin the process with little to no down payment. USDA loans typically offer other benefits that include low interest rates and flexible credit requirements, in some (but not all) ways similar to an FHA loan.
- Down payment assistance programs: These programs provide financial support to home buyers by helping them cover a portion – or in some cases the full amount – of their down payment. These programs aim to make homeownership more accessible, especially for first-time buyers or those with limited savings.
Private Mortgage FAQ
The Bottom Line
A private mortgage can be a good option for someone who may not qualify for a traditional mortgage or wishes to use a less-conventional method of obtaining a loan. However, there are several financial and personal risks for both lender and borrower, so be sure to speak to a real estate attorney before taking out a private loan.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
