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Everything You Need to Know about Private Money Lending

Wondering should I get a personal loan or get money from private lenders? Here's everything you need to know about private money lenders.

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When it comes to finding the right loan for your small business, understanding the different kinds of loans and what they bring to the table is key. Loans from private individuals and groups and those that are issued by banks are generally what small business owners are looking for.

Both private loans and bank loans have attractive benefits. However, these loans also have their share of downsides to keep in mind. Researching both types of loans is instrumental in picking the one most suitable for your particular small business needs.

Private Lenders

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Private loans are capital that private investors or lenders/companies lend out for investments. These lenders typically follow unorthodox qualifying rules and issue loans with more expensive terms because of the above-average risk they’re prepared to take on.

These loans are often awarded to entrepreneurs and small business owners who don’t qualify for standard bank loans. There are many reasons why small business owners might seek out private lending instead of a traditional bank loan. The PMLG provides a list of reasons why these loans are sought after, including:

  • A need to make extensive repairs on a property to renovate it or “fix-and-flip.”
  • The desire to find better loan-to-value rates than what banks normally grant.
  • Require money for projects that are difficult for banks to fund, such as land or construction projects located in areas with higher-than-average default rates.

Bank Loans

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Bank loans are capital issued and lent to businesses and individuals by banks or third parties to finance medium- to long-term business projects or assignments. With these loans, the bank sets a fixed period over which the loan must be repaid, along with the interest rate and amount of the repayments. All banks have access to federal funds, which has been at a relatively low rate of 2.5% since December 19th, 2018.

While private lenders consider credit scores as a factor for issuing loans, banks use credit scores as the primary factor for making the decision to approve a loan or not.

Banks also require loan borrowers to have good credit with documented sources of income. More often than not nowadays, banks use automated underwriting software to make the final decision to approve or reject a loan application.

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Private Lenders: Pros and Cons

The following are the benefits and hazards of choosing private loans to finance small business projects, as stated by the PMLG:

Pros:

  • Loans can be originated faster than bank loans.
  • They can be approved with fewer pieces of documentation than bank loans.
  • Private lenders are more willing to accept different forms of collateral than what banks usually accept.

Cons:

  • Private lenders have higher costs for loans being issued, which is reflected in their loan rates.
  • It’s more difficult for newer business owners to obtain large business loans, often with unfavorable terms, like higher interest rates or smaller amounts than under normal circumstances.

Bank Loans: Pros and Cons

Pros:

  • Banks have a lower cost of funds than private lenders because their depositors keep most of their money in checking and savings accounts.
  • Due to the low cost of funds, banks don’t have to charge as much as private lenders to earn the spread needed to keep their businesses in operation.
  • The interest paid on your bank loan is a tax-deductible expense, so long as it’s used for business-related reasons.

Cons:

  • Banks usually won’t lend to small business startups or businesses that aren’t very profitable or have low cash flow as they are deemed too high-risk.
  • They don’t have much of an incentive to negotiate terms with the borrower, as banks have multiple ways to earn revenue, such as from collecting fees and investing the funds from their depositors in stocks and bonds.
  • Banks are generally unable to lend to new or small, early-stage businesses due to restrictive regulations.

Conclusion

So, in the end, which type of loan is the best option for a small business owner? Ultimately, it depends on your credit score, borrower criteria, and funding timeline.

If your small business is in a tight bind for funding, you have a low credit score and you only need the funding temporarily, taking a private loan might be your best bet.

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John Meeks
John is a freelance writer specializing in finance and entrepreneurship. He also consults clients about financial management and small business solutions.

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