The Federal Reserve’s decision to raise its benchmark interest rate to the highest level in 15 years is no longer breaking news. And effective February 2023, the Federal Open Market Committee voted to raise the overnight lending rate by a quarter of a percentage point, bringing it to a target range of 4.5% to 4.75%.
Besides the rise, officials expect rates to remain higher, with no reductions until 2024. However, the key question on the minds of private money lenders and borrowers is how the Fed’s ongoing rate hikes could affect private money lending in 2023 and beyond.
When And Why The Feds Increase Interest Rates
The Federal Reserve hiked interest rates by three-quarters of a percentage point to combat increasing inflation on June 15. Now, it’s expected that rates could reach a 17-year high of 5-5.25 percent from its current level of 4.5-4.75 percent, according to the Fed’s December median prediction.
While hiking interest rates is one method the Federal Reserve uses to combat inflation and sustain the economy, it has several direct and indirect effects on the average borrower. For example, borrowing money is now more expensive for the average consumer, putting a halt to the acquisition of investments.
Effects of Fed Interest Rate Hike on Private Money Lending
Unlike traditional loans, private money loans are primarily influenced by supply and demand rather than rising federal interest rates. And, because private moneylenders are private organizations with complete control over their approval criteria and interest rates, they significantly influence what borrowers pay in interest rates.
Additionally, because private money loans are intended to meet short-term financial demands (fix and flip), lenders focus on loan structure, developing the best exit strategy, and flexibly releasing collateral.
For example, at Merchants Mortgage & Trust Corporation, we start by grasping the borrower’s financial goals and the feasibility of their project, allowing us to design a payment plan that benefits both the borrower and the lender.
On top of that, our private money lenders take a more tailored strategy rather than a one-size-fits-all approach. As a result, borrowers who choose private money loans are more likely to be unaffected by changes in federal budgetary policy.
Factors That Impact Private Money Lending Interest Rates
While private money loan interest rates will continue to be determined by supply and demand, four factors will play a role in determining rates to varying degrees: supply of money, property location, leverage, and underwriting criteria.
Supply of Money
In the private money lending industry, supply and demand play a huge role in the interest rate borrowers receive. In a nutshell, the more money available to lend, the lower the interest rate borrowers will receive. So, for example, rates are often lower in places with more money to lend, such as Texas.
Another key determinant of private money lending rates is location. When deciding the rate a borrower receives, lenders consider mortgage versus deed-of-trust states. Rates are typically lower in deed-of-trust jurisdictions, where lenders can foreclose through trustee sales. Because the foreclosure process is less costly and time-consuming in these markets than in other states that require court foreclosures, private money lenders can offer slightly lower rates.
The lower the “loan to value” (the amount borrowed compared to a property’s current or prospective value), the lower the rates private money lenders can give. Typical LTV percentages range from 30% to 80%. Lower ratios attract lower interest rates because the borrower is less likely to default.
Generally, the more severe the underwriting process, the lower the rates. As location influences lender overhead, underwriting regulations affect how strict a lender’s underwriting requirements will be.
For example, private money lenders, especially those connected to an institution, are required to get credit checks, reserve verification, and appraisals, all of which might delay the financing process.
Compare this to lenders who are truly “asset-based” (meaning they underwrite the asset, not the borrower), and you can see why some lenders demand higher rates and others can act more swiftly.
Looking to Fund Your Next Project
Are you looking to get into fix-and-flip or seeking to finance your next small-sized commercial property? Merchants Mortgage & Trust Corporation can help you secure a low-interest private money loan for your next fix and flip or construction projects. To learn more, contact us now.