What Is A Private Equity Loan?

When you call up a mortgage broker, sometimes they may recommend something called a “private equity loan.” This loan can go by a few names, such as “trust deed loans” or “hard money loans.”

What exactly is a private equity loan?

A private equity loan is a type of loan typically offered by mortgage brokers, which involves private investors. Whenever you are receiving financing on a mortgage, somebody is lending that money – whether it is a bank, a mortgage lender, or in some circumstances, a government program. In the case of private equity lending, it is a private investor. Oftentimes, this can be an individual who has a lot of funds that they are looking to invest, instead of having it sitting around.

In California, private equity loans are often temporary loans, and they must have a business purpose. This business purpose reason can vary, but here are a few examples:

-If the property is an investment property, not owner occupied, any funds going towards renovating the home or remodeling may qualify as business purposes.

-If you are self-employed and utilizing funds to help grow your business, start a business, or help sustain the business you have, this may qualify as a business purpose.

The terms can range, but usually we don’t see many private equity loans that are longer than 5 years. This type of loan has its pros and cons, and one of the biggest pros is that the qualifying criteria to be approved with this loan program is a lot more flexible than a traditional FHA or conventional loan. When it comes to seasoning requirements, such as bankruptcy, pre-foreclosure, or any other credit derogatories – private equity loans do not have the same seasoning requirements, and usually there is no specific period of time that you have to wait. So, if you just got out of a Covid-19 forbearance, and your lender told you that you have to wait 12 months to pull equity out of the home; with a private equity loan, you may still be able to access that equity now. They are also a lot faster of a process, so if you need cash-out quickly, can be a great alternative to more traditional loan programs.

One distinctive quality of private equity loans is they usually have a balloon payment at the end of the term, for the principle that you borrow. During the time you are in the loan, you typically make interest only payments – and then before the end of the term, you would usually either refinance it into a different loan program (to pay off the private equity loan in full), sell the property, or pay it off in full yourself if you are able. During the loan process, your loan officer should help you come up with an “exit strategy” for the private equity loan – so that there is a game plan in place, specific to your situation, to pay off the loan. Ultimately, the private investors lending on your home want one thing and that is a return on their investment, during the life of the loan, from the monthly payments you make. Foreclosure is never the goal, and your broker will work to give you all the resources you need; with information and full disclosure of all terms of the loan. Make sure to keep track of all your monthly payments, and the loan term’s end, so that you are able to exit the loan before the term comes due.

Why are private equity loans temporary loans?

This is because ultimately, the investors are not looking to hold the mortgage for longer than that time. They are looking to make a return on their investment, with the interest-only payments that are made, and then once the loan is paid off – re-invest it into another loan. Having capital tied up for long periods of time can be difficult, which is why it is left up to big banks and lenders to offer 15-30 year mortgages. Since there are more funds available to them, it is easier to have it tied up for longer periods of time. Plus, when big banks and lenders need cash quickly – they can always sell the loan on the secondary market, to another bank or lender; which is something not commonly done for private equity loans.

Why might a private equity loan be good for you?

If you want to pull cash out of the equity in your home quickly, and are self employed or own an investment property, you may qualify for a private equity loan – even if you have bad credit, or recent derogatories/financial events. In many circumstances, monthly payments can also be built into the loan, which is a big perk. Say that you are transitioning between renters as you remodel the home, you may be worried about cash flow while there is no renter in place. In that situation, we could utilize some of the cash out funds to build in the monthly payments. Then, while you are working on remodeling the property, you don’t have to worry about having a monthly payment for the months that are prepaid. It can be a very flexible loan program, that can be tailored to meet your needs!

If you’d like to hear more about private equity loans, reach out to us directly!