Private Money vs. Bank Financing: A Builder’s Guide to Maximizing Returns
In today’s fast-paced real estate market, builders and developers face a critical decision when financing their projects: Should they choose the traditional route of bank financing, or opt for the flexibility and speed of private money? While bank financing is often seen as the go-to for cost-effective loans, private money’s advantages—from higher leverage to faster funding—can significantly enhance profitability and growth potential. Let’s break down the key differences, using a simplified example to illustrate the impacts.
The Setup: A Real-World Comparison
Imagine a builder embarking on a project with a total cost of $100 and an anticipated sales price of $130. Here’s how the scenarios play out:
Bank Financing
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Loan-to-Value (LTV): 70%
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Loan Amount: $70
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Equity Invested: $30
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Interest Rate: 8%
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Project Timeline: 1.75 years
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Interest Cost: $70 × 8% × 1.75 = $9.80
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Net Profit: $130 (Sales Price) - $100 (Cost) - $9.80 (Interest) = $20.20
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Return on Equity (ROE): $20.20 ÷ $30 × 100 = 67.33%
Private Money
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Loan-to-Value (LTV): 85%
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Loan Amount: $170 (Builder scales up the project size to $200)
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Equity Invested: $30 (No additional equity required)
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Interest Rate: 11%
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Project Timeline: 1 year
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Interest Cost: $170 × 11% × 1 = $18.70
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Net Profit: $260 (Sales Price) - $200 (Cost) - $18.70 (Interest) = $41.30
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Return on Equity (ROE): $41.30 ÷ $30 × 100 = 137.67%
Key Takeaways for Builders
1. Faster Profits with Private Money
Private money enables faster project cycles, reducing the time to complete and sell a development. In this example, the builder finishes the project in just one year with private money versus 1.75 years with bank financing. This accelerated timeline allows builders to realize profits sooner and reinvest them into new opportunities—a critical advantage in competitive markets.
2. Higher Return on Equity (ROE)
By leveraging a higher LTV (85% vs. 70%), private money dramatically increases the builder’s ROE. In the example, the builder’s ROE jumps to 137.67% with private money compared to 67.33% with bank financing. The ability to achieve more with less equity means builders can scale their operations and take on multiple projects simultaneously.
3. Scalability and Leverage
Private money’s higher leverage frees up the builder’s equity, enabling them to pursue larger projects or multiple developments concurrently. In the example, the builder scales up to a $200 project without increasing their $30 equity contribution, doubling the potential sales revenue.
4. Time Value of Money
Earning profits faster and reinvesting sooner magnifies the long-term financial benefits. Private money’s quick funding and shorter timelines help builders optimize the time value of money, compounding their returns over time.
5. Flexibility and Speed
Private lenders provide faster funding (often within 7-30 days) and more flexible terms, including combined land and construction loans. This reduces delays and allows builders to capitalize on time-sensitive opportunities, whereas bank financing’s strict underwriting and slow processes can hinder progress.
Strategic Implications for Builders
While bank financing offers lower interest rates, the hidden costs of slower timelines, higher equity requirements, and reduced flexibility can outweigh the savings. Private money, on the other hand, provides builders with the tools to maximize their growth and profitability by:
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Reducing total project timelines.
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Enabling faster reinvestment of profits.
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Increasing operational scalability through higher leverage.
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Offering strategic support in sales, marketing, and financing promotions.
In restrictive banking environments, private money isn’t just an alternative—it’s often the smarter choice for builders looking to scale quickly and optimize returns.
Conclusion
Choosing between bank financing and private money isn’t just about interest rates—it’s about understanding the true costs and benefits of each option. Builders who prioritize speed, flexibility, and return on equity will find that private money offers a competitive edge in today’s market. With faster project cycles and higher leverage, private money allows builders to grow their businesses while delivering greater returns on their investments.
For builders ready to scale and maximize profitability, private money could be the key to unlocking your next opportunity.