Private mortgage: What to know before you borrow

If you struggle to qualify for a traditional mortgage, a private mortgage can offer an alternative with flexible terms and faster approvals. But it can also come with higher costs and greater borrower risk.

Here’s how private mortgages work, who makes a good candidate, the types of private mortgage loans to consider, the fees and costs to expect, and the steps to get one.

Key takeaways:

• A private mortgage loan can provide flexible and speedy financing that’s based on the property’s value, not strict income or credit numbers, which makes it ideal for the self-employed, real estate investors, buyers of unconventional properties, and others.
• Private loans come with higher interest rates and origination fees, shorter terms, and fewer legal safeguards, so it’s important to establish a clear exit strategy – like refinancing or selling.

• Before committing, check out safer and lower-cost traditional options like a Federal Housing Administration (FHA) loan or credit improvement program, and always finalize private agreements via an attorney or title company.

What is a private mortgage?

A private mortgage is a home loan offered by a private individual, group, or private company that sets their own loan terms and requirements for borrowers. These lenders often use their own funds or investments to finance the loan.

Private loans are nontraditional alternatives to conventional or government-backed mortgages provided by banks, credit unions, or online lenders.

How private mortgages work

With a private mortgage loan, you borrow money directly from a private lender like an individual investor or private firm instead of a traditional bank. The lender depends on asset-based underwriting, so they will scrutinize your application mostly based on the value of the property you are trying to finance instead of your credit score or earnings. The property will serve as collateral, and you must agree to repay what you borrow over time with interest charged based on your negotiated contract.

Expect the transaction to be completed via a formal third-party closing, usually with a real estate attorney or title company involved. The agreement will be legally recorded to safeguard both parties. But if you fall behind on repayments, you could be charged fees or risk foreclosure.

Who should consider a private mortgage?

Good candidates for a private mortgage are borrowers who may have a hard time qualifying for a traditional mortgage. These include the following:

• Borrowers with lower credit scores. Though government-backed loans offer some flexibility, most mortgages have minimum down payment and credit score requirements. If you’re unable to meet these requirements, private mortgages offer an alternative. 
• Self-employed borrowers. If you work for yourself or have been in business for less than 2 years, it can be hard to qualify for a mortgage from a bank or credit union. Lenders perceive self-employed borrowers as riskier, so they may have higher credit requirements and request additional documentation. Private mortgages allow you to avoid this kind of red tape. They’re also ideal for those with complex tax returns, including business owners whose tax write-offs hide their true cash flow.
• Borrowers buying from a family member. If you’re buying a home from a family member, the owner may finance the property instead of going through a bank. 
• Fix-and-flip investors. Real estate investors depend on private financing because these loans provide fast capital based on a property’s future renovated value, not its current condition.
• Buyers of unconventional properties. Private loans are a good solution for purchasing distinctive homes, rural land, or fixer-uppers that traditional lenders turn down due to strict property standards.
• Buyers who prefer a speedy transaction. Private lenders can fund a deal in days instead of weeks because they bypass the lengthy regulatory paperwork and strict underwriting requirements of conventional lenders.

Types of private mortgage loans

Here’s a breakdown of different private mortgage loan options you can pursue.  

Owner financing

With owner financing, the seller serves as the bank and directly funds the purchase for the buyer without requiring a standard mortgage loan. The buyer will make consistent monthly principal and interest payments directly to the seller per an agreed-upon promissory note and legal contract.

Hard money loans

Hard money loans are funded by private companies or investors as high-interest, short-term loans, ideal for financing house flips or investment properties. This provides quicker access to capital for speedy repairs and acquisitions because underwriting depends mostly on the property’s value and possible resale profit, not the borrower’s credit.

Bridge loans

This short-term financing option aims to “bridge” a brief gap between 2 financing events or real estate transactions. A bridge loan is commonly used to leverage a buyer’s equity in their existing home to cover a down payment on a different property prior to selling their current home.

Portfolio loans

A portfolio mortgage loan is originated by a lender that keeps it on its own balance sheet instead of selling it to secondary market investors like Freddie Mac or Fannie Mae. The lender can set unique underwriting criteria and provide flexible requirements to nontraditional borrowers because they assume all the risk involved.

Bank statement loans

A bank statement loan enables business owners, self-employed workers, and freelancers to validate their eligible earnings by furnishing 12 to 24 months of business or personal bank deposits. The underwriter totals average deposits, rather than depending on W-2 records or tax returns, to evaluate the borrower’s actual cash flow and means to repay the loan.

Private mortgage rates, fees, and loan terms

Look closely at the fine print on a private mortgage loan to fully understand the rates, fees, and terms involved.

Interest rates and fees

Count on paying higher costs with a private mortgage loan than a conventional mortgage loan from a bank. That’s because private lenders assume greater financial risk while also providing quicker and more flexible funding. You can likely expect interest rates to span between 7% and 12% or more, and lender fees (sometimes called “points”) equivalent to 2% – 5% of your total loan amount. This pricing isn’t set in stone, however; it can vary based on your credit and financials, the market value and condition of the property, and other factors.

Repayment structures and exit strategies

A private mortgage loan is commonly structured as a 1- to 3-year balloon note, with monthly payments often being interest-only to keep your ongoing costs lower across the loan term. These interest-only payments don’t decrease your principal balance. That means the total remaining loan amount is due in full as a single payment when the 1- to 3-year term ends. That’s why it’s crucial to have a clear exit strategy from the start with a private loan. You may opt to refinance into a long-term conventional mortgage if your credit, property, and income are eligible. Or, you may want to sell the property to repay your full balance.

Private mortgages vs. traditional mortgages

While both private and traditional mortgage loans help borrowers finance a home purchase, each comes with different regulations, borrower requirements, and loan structures. The table below shows the primary differences between the two.

Pros and cons of private mortgages for buyers

Private mortgages can be a good alternative for borrowers who don’t meet traditional lending requirements. But there are risks to consider, too. While the easier approval and flexible loan terms are appealing, you may have fewer legal safeguards.

Pros

• Lower credit requirements: Private lenders may be willing to work with you if you have a lower credit score or a limited credit history.
• No PMI: Private lenders don’t usually require private mortgage insurance, even if you make a smaller down payment. This can save you hundreds of dollars on your monthly mortgage payment. 
• Faster approval process: Since private lenders don’t have the same regulatory requirements as banks, they can approve and fund a loan much more quickly. 
• Flexible loan terms: Private lenders may offer more flexible loan terms, especially if you’re working with an individual or smaller company. A private mortgage can be more suitable for unconventional properties or income, as well.

Cons

• Fewer borrower protections: Private mortgages don’t offer the same legal safeguards you’ll receive from a licensed financial institution. That means if the lender suddenly changes the terms of your agreement, you may have limited recourse. 
• Possible balloon loan: Some private mortgages are structured as short-term loans with a large final payment, also known as a balloon payment. This can be risky if you’re unable to refinance or pay off the balance.
• Higher rates and origination fees: Though they don’t charge PMI, some private lenders charge higher origination fees, and the interest rates on these loans can be costlier than expected.
• Stiff penalties and fees: Private mortgage contracts may include late fees, prepayment penalties, or default clauses that you won’t find with a traditional lender.
• Larger down payments: Private lenders usually want a larger down payment than traditional lenders. 

How to get a private mortgage

Securing a private mortgage requires a slightly different approach than working with a traditional lender. The process tends to be more informal, but also comes with more risk if you aren’t careful. Here are the common steps involved.  

Define your financing needs and exit strategy

Identify whether the transaction is a purchase, refinance, or cash-out refinance. Estimate your down payment or equity position. And determine how your loan will be repaid at maturity.

Compare legitimate private mortgage lenders

You can find private lenders through real estate networks, investment groups, mortgage brokers, or online platforms. If you’re considering multiple lenders, be sure to check the loan terms, interest rates, and fees. It’s also a good idea to ask questions to gauge how transparent the lender is and how well they communicate. Be wary of red flags like guaranteed approval, unexplained upfront fees, missing paperwork, pressure tactics, and suspicious wiring instructions.

Review and negotiate the agreement

Once you’ve found a lender, you’ll need to negotiate your loan terms. Private mortgage agreements can vary depending on the lender, so it’s vital to understand the fine print. In particular, note the annual percentage rate, repayment schedule, amortization, and fees. Also, carefully review the default terms, late payment provisions, and foreclosure rates with an appropriate professional.

Prepare documents and close through a third party

Here are the documents you’ll need to provide or review:

• Promissory note: A promissory note is a written document that states your agreement to repay the loan. It outlines the loan amount, interest rate, repayment schedule, and maturity date.
• Deed of trust: The deed of trust secures the loan by tying it to the property and gives the lender permission to foreclose if you stop making payments.
• Bank statements: Bank statements demonstrate proof of funds and your ability to cover monthly payments.
• Tax returns and pay stubs: These verify your income and help lenders assess how much of a lending risk you pose.

Keep in mind that the closing should occur through an escrow or title company rather than through direct peer-to-peer cash transfers.

Alternatives to private mortgage loans

Private mortgage loans can be helpful in certain situations. Still, they’re generally used as a last resort due to the lack of borrower protections. If you’re not sold on private loans, consider these safer alternative options and action steps first:

• Consider FHA loans. FHA loans are designed for borrowers with lower credit scores or smaller down payments. They come with more flexible qualification requirements than conventional loans.
• Improve your credit. Take time to boost your credit score, which can increase your chances of qualifying for a traditional mortgage with better terms and lower interest rates.
• Save for a larger down payment. Putting more down reduces the amount you need to borrow and makes you more appealing to lenders. It may also help you avoid having to pay private mortgage insurance on a conventional loan.
• Seek down payment assistance. Many state and local programs offer grants or low-interest loans to help eligible buyers cover their down payment or closing costs, easing the burden of homeownership.

If you’re an investor, other routes include real estate investment trusts, which let you invest in residential property without owning or managing it directly, or long-term rental properties, which can offer steady cash flow.

FAQ

Still have questions about private mortgage loans? Let’s fill in some of the loose ends.  

How much is private mortgage insurance on a $300,000 loan?

Private mortgage insurance (PMI) and a private mortgage are different concepts. PMI is generally required when you put down less than 20% on a conventional mortgage loan. For a $300,000 loan, expect to pay between $125 and $375 monthly ($1,500 to $4,500 annually), depending on your credit score and down payment size, based on an average PMI rate that typically ranges from 0.5% – 1.5% of the total loan amount yearly.

How much money do I need to be a private lender?

If you want to be a private mortgage lender, you need personal funds or investor capital and must be prepared to manage underwriting, servicing, legal requirements, and default risk. The exact amount required will vary based on many different factors.

What happens if I miss payments or default on a private mortgage?

The consequences of missing payments or defaulting on your private mortgage loan will depend on the agreement and applicable laws but can include late fees and foreclosure.

Do private mortgage lenders check credit?

Private mortgage lenders may check your credit, although they typically place greater emphasis on the property’s value, available equity, and your exit strategy as a borrower.

Do private mortgage lenders require appraisals?

A private mortgage lender may require an appraisal of the property you are trying to finance, or another property valuation, to assess the collateral and their lending risk.

Are private mortgage lenders regulated?

Private lenders may have fewer constraints than traditional institutions but can still be subject to federal, state, and local requirements.

The bottom line: A private mortgage is one of many options

Don’t fit traditional lending criteria as a borrower? A private mortgage may provide flexible and faster financing. But be aware of risks involved with these loans, including higher costs, shorter terms, risks of default or foreclosure, and reduced protections. Carefully explore your mortgage options before deciding on the best mortgage for you.

If you’re interested in exploring your loan options, you can reach out to Rocket Mortgage and get preapproved.