Mortgages & Creative Financing

4 Risks and Drawbacks to Using Private Money

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Although using private money is a smart way to invest in real estate without using your own cash, it's not a perfect solution. Let's explore some of the risks of using private money, so you'll get the full picture and decide if this is an avenue you want to pursue.

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4 Risks and Drawbacks to Using Private Money

1. Legality

The legality of raising money is not easy to understand, and it differs largely depending on your location. Because of this, we advise using a lawyer, and as we all know, lawyers are not cheap. However, hiring a lawyer to set up your business correctly at the start is much better than not doing a deal at all or sitting in a federal jail cell for doing it incorrectly.

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Related: Before You Invest Using Other People’s Money, Know the REAL Costs

2. Networking Required

Networking is neither easy nor quick. As I have noted, networking is a lifestyle, and if you don’t like that lifestyle, you may find the process of raising private money cumbersome and difficult.

3. Higher Interest Rates

Although the rates you and your private lender agree on may not be as high as those you'd pay with a hard money lender, chances are the rates will be significantly higher than you'd see with a conventional bank. Typical private money interest rates I see are between 6% and 12%, depending on term length and other circumstances. If these rates fit your business model, great!

4. Personalities Are Involved

When borrowing from a bank, you are typically dealing with a system that has no emotion involved. However, borrowing from real people always involves the potential for drama, emotion, and problems. What if your lender suddenly needs his money back? What if they get into legal trouble? These scenarios are further evidence that you need strong written legal paperwork with any lending arrangement.



Related: 4 Ways to Find Private Money Lenders to Fund Your Real Estate Deals

Private money is not for everyone, but if it’s an avenue you want to pursue, it can be a terrific way to raise enough capital to really scale your business to new heights. Be sure you understand the risks involved and take the necessary steps up front (ahem, lawyer) so you don’t get into trouble at the end.

Finally, just remember that raising private money is about having great deals, building relationships, and ultimately delivering on the promises you’ve made. If you can do those three things, you’ll have a successful future as a private money–funded real estate investor.

[This article is an excerpt from Brandon Turner’s The Book on Investing with No (and Low) Money Down.]

Do you use private money in your business? Have you run into any of these common drawbacks?

Let me know your experiences with a comment!

Brandon Turner is an active real estate investor, entrepreneur, writer, and co-host of the BiggerPockets Podcast. He is a nationally recognized leader in the real estate education space and has tau...
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    Louise A. Investor from Rochester, NY
    Replied about 3 years ago
    Brandon – Great article. Thanks for sharing. I loved your comments on private money as I’m working through these pros and cons myself currently. I especially liked your comments about networking being a lifestyle. I just reread ‘Never Eat Alone’, and that’s a perfect way to encapsulate Ferrazzi’s thesis.
    Megan Greathouse Rental Property Investor from Saint Louis, MO
    Replied about 3 years ago
    Great article, Brandon! I am interested in private lending as a way to fund deals in the future. I think most of these points could also apply to the risks and drawbacks of working with a partner, which makes sense considering a private lender is sort of a silent partner. Thanks for the thoughts!