What Are Private Mortgages?
Typically, individuals purchase property by arranging a traditional mortgage with a financial institution or mortgage banks. But sometimes home buyers choose an alternative option: private mortgages. These agreements are less common and they have some benefits for buyers — but private mortgages can also be more complicated, so let’s take a look at the pros and cons.
What Is A Private Mortgage?
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 provide assistance while generating investment profits from the interest.
Some home buyers may consider this option — as opposed to a more traditional loan — because they have 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 lender has a lien on the pr
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.
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. However, the loan can be riskier and 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.
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.
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, 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.
How Does a Private Mortgage Work?
While it may differ slightly per lender and situation, here’s how the private mortgage process typically works.
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.
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.
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, amount of time left on your loan and 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.
Finalize The Paperwork
When you finalize your loan, be sure to arrange for a deed of trust, which is a method of securing 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.
Also, it’s important to obtain a mortgage promissory note, or a written promise to repay the loan’s principal. 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.
Alternatives To Private Mortgages
If you’re looking to take out a non-traditional 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:
- Low down payment: FHA loans allow borrowers to make a down payment of only 3.5% of the purchase price, compared to the 20% that is typically required for conventional loans.
- Flexible credit requirements: FHA loans enable borrowers with credit scores as low as 500 to qualify for a mortgage loan, though most lenders, including Rocket Mortgage®, require a minimum credit score of 580.
- Shorter waiting period after bankruptcy: FHA loans have some of the shortest waiting periods to apply for financing after a recent bankruptcy with only 2 years.
- 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.
- 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.
The Bottom Line
Private mortgages 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 speak to a real estate attorney before taking out a private loan.
If you’re looking to buy a home with a traditional loan instead of a private mortgage, get started today.