Private lending has become an increasingly popular alternative to traditional banking for borrowers seeking funding for various purposes. However, navigating the world of private lending can be challenging without a clear understanding of the terminology and concepts involved. In this blog post, we will delve into key private lending terms and concepts to help you make informed decisions when considering private loans.
Private Lender
A private lender is an individual or organization that provides loans to borrowers. These lenders are not traditional banks or financial institutions and operate outside the regulatory framework of traditional lending.
Interest Rate
The interest rate is the cost of borrowing money, typically expressed as an annual percentage. Private lenders often set their interest rates, which can vary depending on factors like the borrower’s creditworthiness and the type of loan.
Loan Term
The loan term refers to the period during which the borrower is required to repay the loan. Private loans may have shorter terms than traditional loans, and they can range from a few days to a eighteen months.
Collateral
Collateral is an asset that the borrower pledges to secure the loan. If the borrower fails to repay the loan, the lender can take ownership of the collateral to recover their investment.
LTV Ratio (Loan-to-Value)
The LTV ratio is used to assess the risk of a loan. It compares the loan amount to the appraised value of the collateral. For example, if you borrow $80,000 to purchase a property appraised at $100,000, the LTV ratio is 80%. A lower LTV ratio indicates less risk for the lender.
ARV (After Repair Value)
It is a term commonly used in real estate, particularly in the context of property investment and flipping. ARV refers to the estimated or appraised value of a property after it has undergone renovations, repairs, or improvements. In other words, it represents the projected market value of the property once it has been brought up to a certain standard or condition.
AIV (As Is Value)
It is a term used in the real estate industry to refer to the current market value of a property in its existing condition, without any improvements, repairs, or renovations. It represents the price a property is likely to fetch in the real estate market in its present state, taking into account factors such as its age, condition, location, and any structural or cosmetic issues.
Rehab Budget
It is short for “Rehabilitation Budget,” refers to a detailed financial plan that outlines the estimated costs associated with renovating, repairing, or rehabilitating a property. This budget is a crucial component of real estate investment and property improvement projects, especially in the context of house flipping, property development, or rental property management.
Origination Fee
Origination are fees paid to the lender upfront, usually as a percentage of the loan amount. They are common in private lending and can impact the overall cost of borrowing.
Underwriting
Underwriting is the process of thoroughly researching and evaluating a potential borrower’s financial situation, creditworthiness, and the proposed project or use of funds. Private lenders conduct due diligence to assess risk.
Exit Strategy
An exit strategy is a plan borrowers have in place to repay the loan, often involving the sale of a property or another source of funds. Private lenders may require borrowers to have a well-defined exit strategy.
Understanding private lending terms and concepts is crucial for anyone considering this alternative source of financing. While private lending can offer flexibility and quick access to funds, it also comes with unique risks and considerations. Borrowers should carefully review loan agreements, seek legal advice when necessary, and conduct thorough due diligence to make informed decisions that align with their financial goals and risk tolerance.