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of Private Loans
If done properly, private
loans can have many benefits, including:
Interest/Cost
Savings.
Private loans can carry whatever interest and other
loan charges the parties determine. Loans that individuals
obtain from financial institutions typically carry points,
fees and other charges, that must be paid at closing.
In addition, these institutions typically set the interest
rates they charge by taking some benchmark rate, such
as LIBOR or the average rate of U.S. Treasury Securities
over a given period, and adding a margin, typically
in the range of 3%. The benchmark rate approximates
the institution’s cost of funds and the margin
compensates for the institutions marketing and other
costs, plus profit. The result can be high charges.
Private loans offer the ability to avoid these high
interest costs and fees, because private individuals
do not have to charge these amounts. In addition, the
secondary market for loans from financial institutions
may mandate additional loan items, such as private mortgage
insurance. Private lenders have the flexibility to eliminate
these mandates that add costs.
Rate of Return/Safety
of Investment.
Private loans can offer attractive returns for a lender’s
use of his/her money. If a private lender offers a loan
at the same rate as a financial institution, he/she
will receive much more than if the loan proceeds were
deposited in a bank account, CD or most any other fixed
income investment. Moreover, the loan investment will
provide a steady stream of regular payments to the lender.
Because private loans can be secured by property that
can be sold, if necessary, to repay the loan obligation,
they can be quite safe for the lender.
Tax Savings.
Private loans may also offer tax advantages. For the
lender, it may provide a way for him/her to provide
money to a borrower/relative without paying gift tax.
For a borrower that uses the loan to purchase a residence,
the interest payments the borrower makes can be deducted
as an itemized home interest expense.
Bankability.
Private loans can be extended in circumstances where
financial institutions would not make the loans. In
addition, they may be extended in participation with
financial institutions, as loans whose repayment is
subordinate to the financial institution’s right
to repayment. In this way, private loans may make the
difference between the borrower being able to obtain
the financing he/she needs. For example, a lender may
be willing to extend a loan only equal to 80% of the
value of the collateral for the loan. If that loan amount
is insufficient for the borrower’s purposes, then
the loan financing may not fill the borrower’s
needs. A private loan may bridge the gap, as long as
it is subordinate to the loan of the financial institution.
In other words, the private loan can provide the shortfall
between the amount of loans (capital) the borrower needs
and the amount of loan the financial institution is
willing to provide. After the private loan establishes
a payment history, and the underlying security or collateral
for the loan improves in value, the private loan may
be “seasoned” to a point where it can be
refinanced.
Flexibility.
Many loans originated by financial institutions and
brokers are sold into the secondary market or are held
and serviced by the financial institution pursuant to
regulatory requirements. As a result, these have to
conform to rigid underwriting and servicing guidelines.
If a borrower hits a bump in the road, and needs modifications
to the loan terms, the loans can not accommodate those
needs. The result may be a foreclosure and financial
meltdown, where one was not necessary. Parties to a
private loan may modify their loans as necessary to
accommodate changed circumstances, and they are not
bound by rigid underwriting guidelines dictated by the
secondary market.
Establish Credit.
If private loans are structured, closed and serviced
correctly, they may be used as a basis for establishing
credit. Through our servicing, we make sure that payment
history is reported to the three major credit history
repositories: Equifax, TransUnion and Experian. Through
such reporting, the credit scores tabulated by the credit
repositories may be established or improved, therefore,
making it easier to obtain credit that the borrower
may need for other purposes, such as growing his or
her business.
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