What is a private equity loan?
A private equity loan is a unique kind of financing that can usually be distinguished by the singular nature of the relationship between the lender and the borrower. Here, the borrower does not deal with a professional lender or a bank. Instead, he/she is financed by an individual or by a business enterprise that possesses substantial sums of money, is looking to obtain higher returns on the said money, and can afford to part with it for extended periods of time.
What drives such individuals and enterprises to finance private equity loans?
Private equity lenders are less risk-averse then traditional lenders. Therefore, they are readily available to invest their money or grant loans to finance various projects (buying a home, for instance) that have been deemed too risky for various reasons by banks and other lending institutions.
What about people with low credit scores?
This type of financing is primarily based on the value of the property that is mortgaged, and not on the credit worthiness of the buyer. This means that in case the prospective borrower suffers from a low credit-rating or has excessive existing debts as a result of which he/she may be ineligible to access other sources of funding, private equity loans are a great option to meet funding requirements. Consequently, private equity loans are fast becoming one of the most lucrative and sought-after options for new and experienced home buyers alike, and they perfectly fill the void created by banks that are hesitant to finance such borrowers.
What are the parameters that make a borrower eligible for a private equity loan?
Although the credit score tends to take a backseat when it comes to determining the eligibility of a borrower, these four primary investment parameters are normally considered by the lenders during evaluation:
1. LTV ratio –
The ratio of financing depends on the type of property or house that the borrower intends to buy. For instance, raw land or undeveloped properties would be eligible for up to 50% of financing, while commercial properties that are capable of generating a steady stream of income (such as office buildings and commercial complexes) are eligible for up to 65% of financing. Multi-family apartment complexes, on the other hand, are eligible for a maximum of 70% of financing.
2. Property disposal –
This parameter takes into consideration the ease with which a property can be sold or disposed of in the case of default. Single family homes, for instance, are ranked higher and are better preferred as they are easier to sell when compared with multi-family or multi-tenant properties.
3. Cash flow potential of the collateral –
Lenders tend to prefer properties that have adequate potential to generate cash flow. This is because the likelihood of generating future cash flows acts as a safety net as this income has the potential to cover the monthly payments of the borrower.
4. Exit strategy –
One of the most important considerations when financing private equity loans is the exit strategy that the borrower employs. The exit strategy is evaluated by the lender to determine whether it is viable and whether the borrower is qualified enough to be able to
utilize the strategy to its full effect. For example, private equity is commonly utilized by browsers employing a purchase, fix and flip strategy.
Are private equity loans comparatively more beneficial to the borrower?
Private equity loans come with a number of advantages to the borrower. For instance, the transaction fees and charges
involved in obtaining a private equity loan can be lower when compared with more conventional loans. Private equity loans also offer greater flexibility to the borrower as their term length is short and not fixed, and can even be easily negotiated between the parties involved so as to cater to the best interests of both the borrower as well as the lender. Furthermore, although the rates of interest for
these types of loans always tend to be comparatively on the higher side than what institutional lenders (such as banks) offer, private equity loans score higher when it comes to getting things done swiftly. The borrower’s financial position and credit history is not necessarily taken into primary consideration for approving the loan, therefore the process of application is made somewhat easier
as he/she is not required to keep the same up-to-date personal financial information when compared to traditional loans. Also, unlike other conventional lenders, the individuals and firms that finance private equity loans do not typically ask for any personal guarantees, which consequently results in a reduction in the processing time. Underwriting flexibility, combined with extremely quick and effortless processing procedures, ensures that prospective borrowers can zero in on the deal in less than 30 days.
How are lenders interests safeguarded?
As for how the lenders are protected, the investments of these individuals and firms are secured by a promissory note or by mortgage of any property (including the house for which the loan is being taken). This effectively means that in the case of any default in the re-payment of the loan, the lender is legally empowered to foreclose the loan and take possession of the property or the house.
What kind of borrowers benefit from private equity loans?
Private equity loans are the perfect source of funding for home buyers looking to acquire, rehabilitate, or cash out equity of
income producing property, and who otherwise do not qualify for more conventional sources of funding.
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