To understand what a private mortgage is, you need to know what a mortgage is. A mortgage is a loan taken by a person with a promise or seal to repay a large debt. It involves official documentation and government regulation.
This means that the borrower must keep to the agreement reached to repay the loan. If there is a breach in the agreement, the lender can take over their home and sell it so they can get back their money.
What is a private mortgage?
Private mortgages are mortgages financed through a private source of funds. It is a home loan that is given by a friend, family member, colleague, investment firm, or a business and can be beneficial to both lender and the borrower.
The loan is therefore paid back overtime either at a fixed time or through monthly principal and interest (P&I) payments.
All terms involved in a private mortgage are negotiated. From the length of the loan, type of loan, interest rate, and down payment amount.
Without negotiations and agreements by both parties, certain laws would be a limit on the type of loan or maximum interest rate allowed depending on the use of the property.
A private mortgage bypasses a lot of the hurdles that can be associated with getting a loan from traditional mortgage lenders. It also provides a return in form of passive income to the private lender.
However, you also need to consider the risks involved as well as its benefits to both parties. Private mortgages are created for any of these three reasons:
- As an investment.
- As a favor to a family member, friend, or loved one.
- As a combination of both
Private mortgages are beneficial to both the lender and the borrower and some of the benefits include;
1. Less paperwork:
This benefit is, particularly for the borrower. A private mortgage doesn’t offer a lot of borrowers qualifications or paperwork, unlike the banks which have strict underwriting criteria.
Private lenders establish their requirements which in most cases is usually quicker and easier than it would be with a traditional lender.
2. No Private Mortgage Insurance (PMI):
This is one of the major benefits of private mortgages. PMI is a form of private insurance that protects the lenders in cases where the borrower defaults. If your down payment on the purchase of a home is less than 20 percent then you will be advised to consider PMI.
PMI protects your liability as a lender in cases where you default, which allows them to issue mortgages to persons with lower down payments.
3. Higher Interest Rates
This benefit is mainly for the lender. This is a source of profit to the lender because private mortgages charge higher interest than traditional lenders may change at any given time.
This is as a result of the risk involved in lending to an individual and as compensation for lower down payment or poor credit score or simply as part of their business model.
Risks involved in private mortgage
Understanding the risk involved in any business transaction is as important as understanding the benefits involved in such a business transaction. They include:
- Any default by the borrower affects the lender negatively: Even if the lender decides to sell the property of the borrower, it could come with a discount which is still a loss to the lender.
- The terms of a private loan are not always favorable: The borrower may have to pay higher interest rates or possibly, a balloon loan payment.
It is important to properly weigh the risks to rewards involved before entering into a private agreement. Seeking professional guidance is not also out of place.
Private mortgages can be beneficial to both parties (lender and borrower) if executed properly. However, without proper guidance, things could go sour for both relationship and finance.