Private lender red flags and how to spot a quality lender
Are you a small business or a developer looking for a private loan for your next project? Here are some great tips for spotting those private lending red flags before your pen gets anywhere near a dotted line.
Borrowing from one of the big banks, or other traditional lenders can be a bit tricky for some business owners, especially those with lumpy cash flow or those looking for construction or property development finance.
That’s why borrowing from private lenders is a great alternative. Faster processing times and a win-win approach to lending are just the Private Mortgages Australia (PMA) way.
However, as with most industries, not all private lenders are made equal. There are some private lenders who use unscrupulous methods which can make people a little wary of the private lending market. When it comes to finding the right private lender, it helps to understand some of the private lending red flags first.
What’s private lending? (or private lender vs banks)
Private loans are made up of funds provided by private individuals, usually high net worth investors who are looking for higher yields than a bank can offer. One investor may provide the entire amount of funds required by the borrower, but most often, investors’ funds are pooled together and lent out to various borrowers. This is done through a mortgage fund which is operated by the mortgage manager or private lending company (like Private Mortgages Australia).
A few of the main ways private loans differ from bank loans include:
- Loans are generally for much shorter loan terms (usually between 3 – 36 months)
- Settlements are a lot quicker – funds can be issued within a few days, not 6-8 weeks like most banks.
- Serviceability is not a requirement – a private lender doesn’t look at whether the borrower can make regular monthly payments but rather how they plan to pay back the loan at the end of the term.
- There’s more flexibility – banks can be very strict with who they’ll lend to, but a private lender is willing to find a solution that works for both the borrower and lender.
When to consider private lenders?
One reason borrowers turn to private lending is that they don’t meet the requirements insisted upon by the traditional lenders, such as banks and other financial institutions.
Maybe you don’t have all the paperwork the banks need. As business owners, it can sometimes be difficult to satisfy a bank’s documentation requirements. Private lending is far more flexible and accommodating in this respect.
You may have some sort of credit impairment, such as a tax debt, or your business doesn’t have two years worth of financials yet.
Perhaps their timelines won’t work for you. Or their terms don’t, and never will, align with your immediate and long-term business needs. Especially in the building and development game when fast turnarounds and quick settlements give you a distinct business advantage.
There are many reasons why you find yourself in a private lender vs banks situation. And whatever that reason may be, we’re happy to sit down and chat with you about your private lending options.
But before approaching a private lender, we take a look at how you can spot a good one, and also explore what are some of the red flags you should be looking out for?
How to spot a good private lender
A good lender will be upfront about everything and be happy to answer all your questions. And a good private lender will have all the answers and proof to back up everything they say.
In fact, an easy way to spot a good private lender is when they encourage you to ask lots of questions. They prefer their clients to understand exactly what’s happening and why. Again, trust your instincts. If something seems wrong or ‘dodgy’, it probably is.
What questions should you ask your private lender?
Some great questions to ask include:
- What’s your average settlement time period?
- What’s your settlement record?
- Where does the funding come from?
- Who makes the lending decision?
- What’s the default process?
- Do you have any case studies I can see?
- Do you have any testimonials I can read?
Private lending red flags
There are a few private lending red flags that should have you running for the hills.
Too good to be true
Mostly applies to rates but if anything feels too good to be true, trust your instincts. Chances are you’ve got this far in business by trusting your gut so, don’t ignore it now. Some lenders will offer ridiculously low ‘from rates’ just to get you in, however when they come back with the official offer the interest rate will be much, much higher (sometimes after you’ve already paid an upfront fee – more on that below).
Another too-good-to-be-true scenario is when you are offered 100 percent of the value of the property you are borrowing against Most private lenders will have a conservative loan-to-value ratio (LVR) of 70-80% of the property value. LVRs will usually be even lower if you are using vacant land or a development site as security or the location of the property is in a rural area.
Large upfront fee
As mentioned above, some lenders will get you in with a promise of a low-interest rate or high LVR and then charge a large upfront fee, only for the official offer to come out with a higher interest rate and a lower loan amount. This practice remains one of the biggest problems within the private lending industry. Read the contract very carefully because, you’ll likely find it’s been written into the contract that, even if the loan doesn’t proceed, any upfront fees don’t have to be refunded.
24-hour loans
One of the major benefits of a private mortgage is speed. A private mortgage can be settled within a fraction of the time in which a traditional lender would require. This is because a private lender tends to focus on the security – the property to be used as collateral for the loan – rather than on ‘red tape’ processes and the applicant’s credit history, which a traditional lender might be more focused on.
Now, we’re pretty fast here at PMA, but usually, settlement will take around 5 business days. Some lenders will say they can settle within 24 hours, however, it’s highly unlikely this will actually happen. While in some cases this may be possible, there is a phenomenal amount of work that needs to go into any lending decision and it would be very unlikely that every loan could be settled within this time frame. If they can settle in 24 hours they’ll most likely be cutting corners and do you really want a loan from someone who isn’t doing things properly?
Expensive ‘forced sale’ valuation
A ‘forced sale’ valuation will usually come in well under the current market value of a property because that’s what a forced sale valuation is. Typically, it’s a valuation offered without the adequate time needed to have a proper valuation carried out.
Then, when things don’t measure up against the LVR (see explanation above), the borrower still has to pay the upfront fees and charges.
This is why it’s important to allow them time to have a proper, independent valuation carried out.
Cancellation fees
Watch out for cancellation fees applied if a borrower decides not to continue. There’s even the possibility that, during this time, the lender has managed to place a caveat on your property, effectively holding you to ransom until the fees are paid.
Now you know what to look for in a great private lender, we welcome you to contact us and ask us anything about private lending. We’re happy to answer all your questions.
