Private mortgages have been in existence for a while; however, since United States banks and traditional mortgage lenders have tightened up their lending criteria following the 2008 mortgage crisis, they have become an increasingly popular option for consumers. A private mortgage is popular with two types of person: 1 – Those who are having trouble qualifying for a traditional mortgage, and 2 – Those who desire a quicker turnaround time or potentially better financing on the property in question. These mortgages aren’t just for home buyers though, as investing in companies who specialize in private mortgages has also become more popular.
How Do Private Mortgages Work?
In today’s home buying environment, private mortgage options are commonly being touted as an alternative to going through a traditional bank or mortgage company by mortgage brokers. Besides providing home ownership opportunities to those who can’t qualify for traditional loans in the more strict regulatory environment, they also help consumers avoid many of the predatory lending tricks found in the marketplace. One of the easiest methods to locate potential private mortgage lenders in the United States is to leverage a mortgage broker who includes private mortgage companies in their available listings of lenders. Once this type of mortgage is obtained and closed, it works very similar to a traditional note. Lenders will need to read all of the “Small Print” when obtaining a private loan, since some lenders may have slightly different requirements than traditional mortgage companies with regards to pre-payment penalties and interest payments.
Private Mortgage Dangers
Although private mortgages provide the opportunity to individuals to own a home who may be currently shut out of the mortgage market, they are not without danger. Similar to other industries, the private mortgage industry does have its own shady cast of characters who prey on those who are extremely desperate to get into a note. Since private notes have increased in popularity, some of the “less-than-desirable” companies have started advertising their loans on late night infomercials, junk mail, and email spam. Although these opportunities “could” be legitimate, its critical for consumers to read the fine print on the actual interest rate to be paid, repayment terms, early payment penalties, and hidden balloon payments when dealing with a private mortgage company on your own. Although a mortgage broker can provide a layer of security, it is still important to have all details of the loan explained to you and demonstrated in the mortgage contract before agreeing to terms.
Do Private Mortgage Companies Require PMI?
Yes, most private mortgages will require PMI on new loans when the consumer cannot meet loan –to-value ratio requirements. The exact percentage of a down payment will vary on a private mortgage depending on the lending company; however, it will normally be between 10 and 20 percent of the total amount of the mortgage. It’s also important for individuals to understand the terms for eliminating payment of PMI once there is sufficient equity in the home or property being financed before closing on a private mortgage.
Advantages and Disadvantages of a Private Mortgage for Borrowers
The primary advantage of a private mortgage for consumers is that the note can be obtained from just about anyone with sufficient capital to underwrite the note. As a result, the terms of a private mortgage can be significantly more flexible than those underwritten by the Federal Government or VA. Private notes have become more popular amongst family members in addition to companies providing the loans since they allow the money to be kept within the family. Many private lenders also do not require collateral when providing the loans which provide consumers with bad credit a means to improve their scores while buying their own home.
One significant negative for making a private loan within a family is the risk of the relative not being able to pay back the loan. Besides being a negative impact on each person’s finances, it can also result in a soured relationship between the lender and family member who borrows the money. Depending on the nature of the private loan, the person obtaining the mortgage may not be able to deduct the interest from their federal income taxes.
Advantages and Disadvantages of a Private Mortgage for Lenders
If the private loan is documented and structured in accordance with the law (and correctly accomplished), lenders can see a number of benefits from a private mortgage. These include: a higher rate of return on the investment when compared to other alternatives and a regular stream of income from the mortgage payments. Since the loan is backed by the property being purchased, it is more secure than other investment options. Some lenders use the investment as a way to move money around quickly when making short-term private mortgage agreements. Some home sellers who have difficulty in unloading a property will also make a private loan an option to help the home buyer take over existing mortgage payments and use the private loan to pay the difference between this and the sales price of the property.
The primary risk of a lender with a private mortgage is the always present potential of the borrower to default on their payments or damage the property. A significant consideration on the part of private lenders is the inherent risk entailed with offering a mortgage to a person or family who can’t qualify for a publicly backed note. This includes the possibility that the person may be unable or unwilling to make payments on the loan once obtained. There also may not be as many options to obtain the money lent if the person dies or decides to abandon the home if they don’t provide specific terms on what will happen to the debt in the event either of these events occur. Some states will also mandate a cap on the total amount of interest that can be charged on a private loan.
How to Avoid Problems with a Private Mortgage
The easiest way to avoid issues with a private mortgage is to make sure one researches the local and state laws that govern this type of loan before entering into a private loan for a home or property. This requirement doesn’t just apply to those seeking loans; however, as lenders need to make sure they understand the rules associated with entering into a private home loan. Both parties will need to make sure they agree on how the loan is going to be secured. This primarily consists of any collateral that will be provided to secure the loan or the details on what will happen if the person who is taking out the loan must enter foreclosure or is late on payments. Copies of all documentation that related to the loan should be maintained by both parties as well.
Considering Private Mortgages as an Investment
There are some third-party private investment companies who will offer private mortgages or seller-financed mortgages as an opportunity to make an investment. These types of investments are then bought and sold through a financial exchange. In some of these cases, the investor can then sell their “stake” at a later date for a discounted price and provide the seller with a single lump-sum payment vice the normal monthly payments. In order variants of this type of investment, a “balloon clause” can be included that requires the person who obtains the loan to either pay it off by a certain point or convert it to a conventional mortgage. Depending on the setup of the investment, it can take a number of years to turn a profit based on overhead or may not provide as much income as putting one’s money into the stock or bond market.
What Role Does PMI Have with Private Mortgages?
Unless you are seeking out a private mortgage through a family member (and sometimes even in these cases), the lender is going to want to make sure that there is enough equity in the home that they will not take a significant loss in the event of foreclosure. This comes from most homes being sold in foreclosure realizing a reduced price compared to what is outstanding on the home loan (in most cases). As a result, the lender will want to make sure that they have a buffer in place to mitigate their potential losses on the property. This is where the 20% figure comes into play with regards to the requirement to carry private mortgage insurance.
Most private lending entities will still allow consumers to pursue loans when they can’t afford to pay a 20% down payment if PMI is an option to obtain. This allows the mortgagor to take out the loan with sufficient PMI coverage to cover the difference in the loan-to-value (LTV) ratio. In reality, PMI is issued by a company specializing in this type of coverage to lending organizations to the benefit of the lender in the event of property foreclosure. PMI will then pay the bank or company that owns the mortgage the difference in the price realized at the foreclosure sale versus the amount of money financed for the loan.
Mortgages that are “public” or backed by governmental agencies such as FHA or VA loans are not eligible for PMI. Instead, these loans leverage an equivalent insurance to PMI that is managed in a slightly different manner. For example, VA and FHA loans will continue to require the insurance equivalent or fee be paid well past the point of the LTV dropping below the 80% threshold.
When Do Consumers Require PMI?
There are a number of instances that require a mortgagor to have PMI on a home loan. The most prevalent reason is if the LTV on the home or property is more than 80%. In other cases, the lending agency may require PMI be paid if the person obtaining the loan has a sub-par or poor credit history, the individual seeking the loan has a previous foreclosure on their record, have undocumented or unsteady income, or are otherwise considered to be high risk. If PMI is required, it will be outlined in the mortgage documents and should be reviewed at length prior to finalizing the loan.
How Do You Avoid Paying Private Mortgage Insurance?
The most straightforward manner to avoid paying private mortgage insurance is to have enough capital to put down on a new mortgage to ensure the loan-to-value threshold meets the requirements for avoiding PMI. In year’s past, another popular option was to seek out a piggyback mortgage, or an 80-10-10 option. This would leverage a combination of a second mortgage or home equity loan along with a down payment to make sure the loan-to-value ratio was beneath the percentage that required PMI be paid.
Another more common option for existing loans that have been paid on for a given time fame is to seek out a refinance of the loan if the property has seen significant appreciation or sufficient equity has been built in the home. Another option is to simply as the lender if you have enough equity in the home to eliminate PMI if you are close to the 80% LTV ratio. Most private lenders will wait until LTV’s reach 78% to automatically remove the insurance from your monthly bill. If seeking out the removal due to appreciation of the property, the lender will likely require you to seek out a professional appraisal on the home and provide to the bank as proof.