There are different types of mortgage lenders and even more so types of mortgage loan products. There are commercial lenders, construction lenders, residential lenders and more. There are notably two types of mortgage lenders which don’t always compete with one another, and yet provide a valuable service – private and conventional. Are you familiar with these two terms?
Conventional loans are those made by mortgage lenders and most often refer to mortgage loans underwritten to guidelines issued by Fannie Mae or Freddie Mac. Both of these mortgage giants corner nearly two-thirds of all residential home loans made today. Private loans are those issued by a mortgage lender that is not underwritten to third party guidelines. Why is that so important?
Conventional lenders operate under a different business model compared to a private lender. When a mortgage company issues a loan using third party guidelines, the company does so in order to be able to sell that loan in the secondary market. Lenders make money by issuing a mortgage loan as well as selling that same loan to a willing buyer. When a conventional loan is approved, the lender taps into its line of credit to fund the loan then as long as the loan was approved using proper guidelines the loan can be sold, the credit line replenished and in a position to make even more home loans.
A private lender doesn’t sell the loan in the secondary market and doesn’t underwrite a loan using any external guidelines. When a borrower selects a private lender it’s because the property being financed falls outside of current industry guidelines due to any variety of factors, thus making it ineligible for conventional lending. For example, the subject property could be in such a state of disrepair that a traditional bank or mortgage company won’t finance the project. A private lender can, however, provide the necessary funding to acquire and rehabilitate a property. Once done, the property can then be refinanced with a conventional loan.
A private loan is issued for only as long as it takes to acquire and rehabilitate or remodel the property. During this period, the property is marketed and the borrower searches for a buyer. Because the property will be remodeled to the point it no longer falls outside of conventional lending guidelines, borrowers can subsequently refinance the property with a conventional, long term loan. At the end of the construction period, the private loan is replaced with a conventional mortgage, replenishing the private lenders line of credit in order to finance more projects. Alternatively, the borrower can flip the property to pay off the private loan.
Private lenders are also more focused on the before and after value of the property, as well as being provided with a solid exit strategy from the borrowers. If the project makes sense and the private lender can easily see how and when the property will be sold and how their private loan will be paid back, the lender can approve the loan application.