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Private Lending (14) – Purpose of Borrowing
Continuing from the last post, I think private lending is a way to really understand local consumers quickly. I mentioned before that I couldn’t really understand why people would borrow like this before I started doing it, but after doing it, I deeply felt what Jen said about it being genuine. Before doing it, I couldn’t figure out this issue and felt like it didn’t make sense, like many people’s initial reaction. They’re buying houses here; how come they still need to borrow money at double-digit interest rates? The truth is, they really do, especially locals. Only about 5% of the private loans we manage are for non-local people. Most of these owners borrow because they are self-employed, retired, or need funds for furniture, renovations, etc., after buying a new house, and cannot borrow more money from existing properties through banks (I really have to rant a bit here—banks here are really strict; regardless of how much equity you have in your property or how good your cash flow is, as long as the numbers don’t fit their rule book, they won’t lend. But who doesn’t have times when their funds are tight?). In such cases, they will turn to private lenders for loans. We’ve probably processed hundreds of deals, and summarizing them, most of the reasons for borrowing private loans can be classified into three categories:
- Property investors – These borrowers usually have high networth and can be lenders too. Because local banks often don’t care about your net worth, as long as there’s no income or very little income on your tax returns (who doesn’t optimize their taxes when they’re self-employed?), and the target property’s debt-to-income ratio and cash flow aren’t enough (property investors usually have multiple properties), even if you’re willing to pay a 40% down payment, banks still won’t lend. These types of borrowers are usually solid.
- Self-employed and business owners – Similarly to the above, they often legally minimize taxes and have little income on paper, and can usually provide multiple assets as collateral.
- Homeowners with low debt-to-income ratios. They generally have low credit and income but, because they’ve owned their homes for a long time, have low mortgage ratios and relatively high equity. Generally, banks are the first lenders,
and private loans are the second lenders. This category of homeowners with low debt-to-income ratios can generally be divided into four types:
– They renovate their homes for more comfort. This usually demonstrates the homeowner’s good intentions and habits of maintaining the property, and also makes the property more attractive when selling, which is a plus.
– They intend to immediately sell the property and need a renovation loan to achieve a higher selling price. This indicates a potentially fast payout/discharge, also a plus.
– They need bridge financing for a year to repair a poor credit score, preparing to reapply for a bank loan after a year.
– Divorce, urgently needing funds to buy out the other party’s shares in the property—as long as the safety margin is sufficient, fundamentally, this situation also belongs to bridge financing.
The last two types above need to be especially cautious; there are many pitfalls. Till next time.