How to use a Private Mortgage
A private mortgage makes sense for those having trouble obtaining a conventional loan through traditional banks. The use of private loans gained popularity as the government began to impose stricter mortgage regulations on mortgage banks. Private lenders can offer more flexibility for the borrower and a much quicker loan process.
Private mortgages are meant to be short-term solutions for borrowers who might want to improve their credit history, are self-employed with an unverifiable, steady income, or investors looking to rehab a rental property before financing it with a long-term loan. These private loans are a great alternative to the conventional loan process and, once obtained, provide similar terms.
Some private lenders might require the borrower to pay for private mortgage insurance when the borrower lacks the capital to pay the required 10% - 20% of the loan value.
What is Private Mortgage Insurance?
Private mortgage insurance (PMI) allows new borrowers to enter the housing market more easily by lenders accepting a lower down payment. The lender will arrange PMI through a private insurance company. Most conventional loans require PMI when the borrower’s down payment is less than 20 percent. Obtaining PMI reduces the risk for lenders, protecting them against loss in the case the borrower defaults.
The borrower’s PMI premium is usually included in the monthly mortgage payment; however, it does not build equity in the property. Typically, PMI premiums can range from $30 - $70 per month for every $100,000 borrowed. It is possible for the borrower to make a one-time PMI premium payment at closing.
Paying for PMI can help a borrower qualify for a loan that might otherwise be denied. Alleviating the risk for the lender makes providing the loan more attractive; although, including PMI will increase the cost of the loan.
Some lenders might offer a conventional loan with a smaller down payment that does not require PMI. However, these loans come with a higher interest rate that might be more costly than paying the PMI premium.
If a borrower has a high credit score and their loan to value ratio is relatively low, it is possible to obtain a loan with a low PMI premium, making the mortgage payment more affordable.
The advantage for lenders is that they can offer a broader range of loan options when including PMI. They also have access to a wide range of insurance products to suit the borrower’s needs.
Benefits of Using a Private Mortgage
Private mortgage lenders usually require less documentation for the approval process and offer more flexibility when it comes to a borrower’s credit history. Private loans are relatively quick and easy to obtain.
While traditional mortgages focus on the borrower’s financial position, private lenders place more emphasis on the value of the property and the client’s capability to pay back the loan.
Private lenders often have more loan options and can tailor the loan based on the type of property, which might save the borrower money. These lending companies are typically smaller than the traditional banks; so, they can provide more personalized attention.
Risks of Using a Private Mortgage
One of the greatest risks with a private loan is the short payback period. Private lenders want a quick return on their money, as many deliver regular returns to their group of investors.
An unforeseen economic downturn or severe weather event could impact the completion of an investment project. Borrowers who fail to repay their loan on time could lose everything since the loan is backed completely by the asset.
Failure to fully research the private mortgage company means the deal could potentially fall apart if the funding becomes obsolete. As such, it is important to know who the financial investors are and where the money comes from that backs the loan.