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.
Loans from mom, dad, and great-granddad also fall into 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 businessperson will make use of what is available to them, in a way that minimizes their cost of lending money. Private money loans can be tempting to take but could have some drawbacks. This article covers the pros and cons of private lending that you need to know when considering this type of loan.
Advantages of Private Money Loans
Easy to Access
No formalities are required nor hefty paperwork to get private money into your bank account. In terms of collateral, you typically will not be required to put up your home, business, on the line to secure a private money loan.
Flexible Interest Rates
The interest rate is not tied to Libor or other indexes which means there is leniency from family, friends, or investors when compared to financial institutions. The average interest rate on private loans is typically lower than the going interest rate with institutions.
No Credit Check Required
No background or credit check is required since you will be borrowing money from someone you know or another private party. You can choose whether or not you want to make these lenders privy to your financial details. 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. Since you are lending directly from these people, they will likely be amenable to changing terms if required.
Disadvantages of Private Money Loans
Could Affect Personal or Business Relationships
You may ask someone for a loan and their answer will be no. Would this question and answer 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.
Lack of Official Terms or Contract
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 wins.
The Bottom Line
When it comes to private money loans, 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.