When consumers seek out financing for a home, most end up with a mortgage lender. That might be a retail bank or a mortgage banker or a mortgage broker. These are the primary sources for home loans. But sometimes a consumer doesn’t quite fit any of these boxes. It might because of a low credit score or temporary unemployment. Perhaps the calculated debt ratios are higher than acceptable. Sometimes these people seek out financing from private lenders. Individuals or a group of individuals who will issue the funds needed to buy and finance a home. In turn, the buyers pay the individual each month just like any other type of financing. Investors who participate in private financing can expect much greater returns compared to other types of investments. Why might someone consider an ‘owner finance’ transaction?

One of the main reasons is the rate of return. Private loans can carry interest rates higher than what is regularly available from other mortgage sources. How much higher? That’s completely up to you. You don’t need to compete with a traditional mortgage lender. Another reason is the loan is secured by a real, appraisable asset. When someone buys a stock or mutual fund, the value of the asset can and does change. If the stock market suddenly turns for the worse, the value of the asset could fall below the original purchase price. An extended period of low valuation could potentially mean the individual corporation could even file for bankruptcy, immediately wiping out the value of the stock being held.

Investing in real estate means the asset is secured with real estate. If the individual buyer falls behind on the mortgage payments, the investor can begin to recover the asset via foreclosure. In addition to recovering the asset with a foreclosure, it also means not only is the property being returned but the original down payment is also kept. Private lenders can ask for a down payment of 20 or 30 percent or even more. But why you might ask would you consider a private loan for someone who couldn’t otherwise qualify for a traditional mortgage?

It does take some due diligence on your part. You’ll perform the traditional process a lender would perform by making sure the buyers can comfortably make the payments each month. A down payment will be needed and a credit report run. Finally, you’ll want to find out why someone is seeking private financing in the first place.

Let’s look at a typical scenario. A couple have had good credit for years. One person however is laid off from work. Originally needing both incomes to qualify, now they have to pay the monthly bills with just one income. A payment is missed. Then two. One missed payment won’t hurt credit scores all that much but several recent ones will. Scores will begin to fall below the minimum score requirements for a traditional mortgage. Also remember that scores are quick to fall but slow to rise. It could take another couple of years before credit scores get to acceptable levels. You, as a private investor, look beyond the debt ratios and scores and find out why the credit had been damaged in the first place. You also find out the unemployed spouse has recently found another full time job. But it will take a while for the scores to begin to recover.

This is an ideal scenario for a private loan. The situation was easily explainable and rectified. As a private lender, you can ask for a larger down payment, higher interest rates and monthly income from the private note. In a couple of years, the couple’s credit scores rise to acceptable levels and they refinance out of the private loan with a conventional mortgage while at the same time you get your entire investment back into your bank account.