Private money loans – or simply private money – is a term used to describe a loan that is given to an individual or company by a private organization or even a wealthy individual. The organization or the individual is known as a private money lender.
Yes, loans from mom, dad, and great-granddad fall in this category. As do loans from “angel investors”, venture capitalists, or financial institutions that have specific loan programs for people just like you.
A smart businessman will make use of what is available to him, in a way that minimizes his cost of lending money. These loans can be tempting to take since they are from family, friends and people we know. Therefore, let us look at some pros and cons of private lending.
There is easy access to private loans. No formalities are required nor hefty paperwork to get that money in your bank. In terms of collateral, you will not be required to put up your home, business, on the line to secure a loan.
The interest rate is not tied to Libor or other indexes which means there is leniency from family or friends compared to financial institutions. Besides, the average interest rate on private loans is very close if not lower than the going interest rate, which is less than you’ll get through most sources.
No background or credit check required since you will be borrowing money from someone you know for a long time. You can make these lenders privy to your financial details. A friend or family member probably won’t run a credit check on you. This is a key benefit if you have credit problems.
Since everything is negotiable, you will have much more flexibility around the length, payment date and loan amount then you would if you were dealing with the finance manager at the local bank.
All parties can work out terms that are convenient for all so that it becomes a win-win situation. That since you are close to these people, they will likely be amenable to changing terms if required.
You must consider that you may ask someone for a loan, and their answer will be no. Factor that into account and ask yourself, would it change your relationship with this person? How you would feel about them after?
Also, consider what could happen if you do end up taking that private loan. What will happen if you miss a payment, or can’t pay it off at all? It may alter your relationship with your “lender” forever.
Since there is no filling out a mountain of paperwork, this can work against you if either person feels the other is not living up to their side of the “agreement.” The lack of a written agreement could turn litigious if either side becomes dissatisfied with the loan.
If you don’t have terms on paper, you will end up in a blame-game situation where no one comes out the winner. You will determine that using a friend or family member as a private investor is not right for you.
The Bottom Line
Private money loans are given to individuals or companies by a private organization or individual instead of a bank or other financial institution. The lenders must be diligent and discerning when offering private money to borrowers.
The borrowers on the other hand should be equally wary of taking such “easy loans”. The repercussions could be huge and be detrimental to close relationships. To summarize, you should be thoughtful and use private loans accordingly.