Getting a private loan is easy
Getting a private loan from a private lender isn’t hard. There are plenty of private lenders in the market, and your mortgage broker won’t say no to getting you one. The hard part is living with one and getting out of one, which your mortgage broker doesn’t’ need to stress about.
For you as a borrower it is known as private lending, for the investor it is known as a private credit investment or private debt investment. It is the same coin, just with different sides.
So, lets start with the basics, and reverse engineer the process.
What would you want if you were a private credit investor?
If you were a private credit investor, or a private lender your self what would you want?
- Security for your capital
- A good borrower
- A clear exit strategy
- A borrower that can pay interest on time.
- Repayment of funds
This applies to all types of loans, whether they be a first mortgage private loan, heritage plate loan, construction loan, second mortgage loan or mezzanine finance. The principles are the same.
So now that we’ve covered what you’d want if you were a private lender yourself. Lets go through what you have to do as a borrower to cover yourself.
How do I repay a private loan?
Your exit strategy is the most important part you need to think of before taking a private loan.
The worst part about a loan, is that in the event you can’t refinance the debt or repay it, the lender can take possession of the asset and sell it. So to ensure you avoid that situation, you must be certain on your exit strategy.
The below are just a few scenarios for you to think about, from how you will use the funds and where the capital will come from to repay the loan.
Crystallization of an event
This can mean you selling an asset, in the case of a property development or you borrowing against an asset you will sell at a future point in time.
Business working capital
Have you borrowed funds against an asset to use in your business? If so, then will those funds produce a return, that allows the loan to be repaid? Is the payment date of those funds, lined up with the maturity date of your loan, and is the other party reliable for payment?
Government grant payouts or legal compensation
Some clients use their RnD government grant claims to repay business loans that they have taken. Other clients expect payouts from litigation matters. In either scenario, both are not guaranteed payments, and their respective payout dates may vary due to a number of factors. If this is your strategy to repay a loan, you are gambling with a number of unknown factors, so make sure you have a backup.
Refinance with a major lender
If you are going to refinance with a bank or a second tier lender, you must make sure your credit score is 100% intact, with no defaults. With low doc loans, you must make sure you have an accountant that can certify your income. Alternatively If going to a bank you will most likely need full financials for 2 years.
Another approach to repay business loans, is to borrow against assets in a business. This can involve equipment finance or using invoice financing to solve some shortfalls.
Refinancing with a private lender
Refinancing an existing private loan, with another private lender should only be used if you’re certain of an exit in the future. Some examples, including developers using a private loan to for site acquistion funding, then taking a private construction loan. However, some times borrowers out of desperation, will refinance loans for situations that are lost, and all they are doing is kicking the can down the road. So it is important, that you only use this option, if you’re certain of a positive outcome at the end.
How do I service a private loan?
Private loans can either be paid monthly, quarterly or interest and fees can be paid out of the loan amount in advance.
What is a paid in advance loan?
The main advantage of getting a loan from a private lender is that interest and fees can be paid in advance out of the loan amount, thus not needing you to service the loan for its duration.
If you opt to take a paid in advance loan, then this further reiterates the importance of you being able to use that extra cashflow to your advantage (that other wise would go towards monthly interest).
So, whilst the main advantage of getting a paid in advance loan, is that you don't need to service it. The main disadvantage of getting a paid in advance loan, is that the principal sum you will get on settlement of the loan will be significantly less than if you paid the loan interest monthly (as funds are used to pay interest and fees in advance).
So, if you are taking a paid in advance loan, make sure your net settled funds in your pocket is adequate for what you’re trying to achieve.
Paid monthly or quarterly
If you opt to pay a loan monthly or quarterly, then most likely it will be an interest only private loan, in which case you must determine how you will make periodic interest repayments.
The main cashflow advantage of an interest only private loan over a bank loan, is that your cashflow position should be better off than a principal and interest loan form a bank (despite the higher interest rate from a private lender).
What happens if I can’t pay interest on time on my private loan?
The most important thing when it comes to late payments, is communication with your private lender. Lets suppose you took a second mortgage loan, which typically has an interest rate of 20% with a default rate of 30%. If you knew in advance you were going to being late for one payment, or a few payments the first step is to notify your private lender. Explain the situation and the difficulty you are facing.
In a number of instances, private lenders will not charge the penalty rate and will work out a plan with you if they feel you are facing genuine hardship or have faced a genuine delay. Private lenders have to be careful as not be seen as predatory in the eyes of the courts. Other lenders may be very strict about their fees, and in some case may be predatory, which is why it is important you work with private lenders that also want to see you win (speak with us).
What happens if I can’t repay my private loan on time?
Let’s talk worst case scenario, in this example, your 12 months has expired on your first mortgage private loan for $1M, at 80% LVR, with a 12% interest rate, and a default rate of 18%. Subject to your terms a few things can happen and you can be liable for a number of penalties.
In reality you don’t have a problem! Yes, I know that sounds absurd, but the truth is your private lender has a bigger problem than you do. They loaned you 70% to 80% of a property’s value, with penalty interest and legal costs acuminating by the day. In reality that $1M property, may only get $950k on the open market and $150k isn’t much equity to cover interest costs, legals and agent fees for selling. On the other hand, you’ve received 80% of a property’s value with no headache.
So, who has the problem?
For a private lender to take possession, sell your property and to finally get paid it will take no less than 3 to 6 months. So it is in the lenders best interests to get you out of trouble ASAP and to work with you.
Yes, there are some predatory private lenders out there, who will use the situation to their advantage, which is why it is important to work with reputable parties like we do (mainly family offices).
In several instances, logical private lenders will cut thee penalty interest owed if it allows you to refinance, and them avoiding having to put your property up for sale.
If you are going to be late on repaying a loan, you need to communicate this with your private lender in advance and then work on a new exit strategy ASAP with them.
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