When you’re trying to get a loan to buy your dream home, is it better to borrow from a bank or a private lender? Here are some pros and cons of each to consider.
As a first time home buyer, you may ask what is better; a home loan from your bank or a home loan from a private lender?
The answer is simply the one loan that you can get approved for.
But we all know everyone wants a bank loan. In fact, most Kenyans think that their bank is the only place they can get a home loan.
Everyone wants a bank loan. Why?
It is usually because bank interest rates can be lower. Additionally, Kenyans have less trust in private lenders. Why?
It could be a scammer.
Why do bank loans offer lower rates?
Banks typically have a lower cost of funds than other lenders. Depositors keep a lot of money in their bank accounts. Thus, banks have easy access to the money to lend out. And, if banks don’t pay interest for those deposits or pay very little interest like they do today. hence, those funds are very cheap for the bank to use.
Moreover, all banks can access government funds. And, right now the funds rate is very cheap.
Why do private lenders offer higher rates?
Private lenders on the other hand either have to get funds from investors who are looking for decent returns or from other banks and financial institutions who lend these private lenders funds at higher rates then it costs them to acquire that money.
Either of which raises private lender’s cost of funds which in turns gets passed on in their loan rates.
Let’s look at an example:
A bank needs to earn a spread on their loans of say 6% to cover the bank’s direct expenses and overhead costs.
If they can acquire funds at 2.5% then they can lend them out at 8.5% and still earn their spread.
A private lender might need to earn a spread of 4% to cover its operating costs. But, its cost for the funds it lends out could be 7% or more to either repay the bank that lent them that money or to repay investors.
If the private lender’s cost of funds are 7% and its needs to earn a spread of 4% – it has to charge 11% at a minimum or go out of home.
Thus, it is easy to see why everyone wants a bank loan as opposed to a private lender loans.
Banks are also opportunistic.
While banks can lend out funds at lower rates, they hardly do. Here’s why:
Banks see that their main competition (the private lenders) have to charge 15% or more. Thus, banks know that all they have to do is be below that figure to win you over. Thus, banks can charge 10% or 13% and still beat the competition.
Banks have other ways to make money. Meaning, if you don’t want to pay their high rates, they really don’t care that much. They can still earn a ton of revenue from banking fees or from taking those cheap funds and investing them to earn their interest. Thus, they really don’t need to fund your home loan.
Moreover, banks add a lot of other costs to their loans including fees, reporting requirements, covenants, etc. that are not included in their rates but make the overall cost of their loans higher.
Private lenders, alternatively, don’t have all those restrictions or alternative ways to generate revenue (besides fees which only happen when they close a loan). In fact, they are usually in business only to make loans. Thus, private lenders tend to be easier to get approved by.
This is where it’s conflicting because cheap money but hard to get on one hand and easy to get loans but higher rates on the other.
However, which is better?
The answer still remains the loan that you can actually get, but it only remains true while you can’t get the other.
If you don’t qualify for a bank loan, make it your goal to grow your savings to the point that you qualify for bank funding (you might not actually need it when you can qualify for it). But, in the meantime, if all you can get approved for is a private lender loan, then by all means; knowing that it is only temporary as your home grows.
Two things to remember here:
- The difference between 13.3% and 12.9% on a short-term loan is really not that much given you are building your home.
- Private loans are much better than not building your home at all or losing your home.
So, when seeking a home loan, which is better a bank loan or a private lender loan? It really all depends on what you can get approved for, be able to repay, and profit from.