The Reasons Why High Interest Rates Impact Private Lending

Interest rates remaining high have a significant impact on private lenders and hard money lenders and the interest rates that private lenders charge.

In This Article

Since March 2022, the Federal Reserve, the Fed as it is commonly known, has been increasing interest rates to combat inflation. This has had a significant impact on the cost of borrowing for ordinary Americans, making it more expensive to borrow money or obtain credit. 

Private mortgage lending, also known as hard money lending, operates differently from traditional lending. In this article, we explore what Private Lenders need to know about what affects their private mortgage lending and the key factors that determine private mortgage rates. We also discuss the challenges facing private lenders.

What does the Federal Reserve Have to do with Interest Rates?

Firstly, we need to briefly talk about interest rates. The Federal Reserve plays a crucial role in shaping the interest rates that affect various types of lending. By adjusting the federal funds rate (the rate at which banks lend to each other) the Federal Reserve can influence borrowing costs. 

The Federal Reserve has a balancing act, in that it must stop the economy overheating with too much inflation by increasing interest rates, and cuts to interest rates when the economy weakens and has high unemployment. In other words, to keep prices stable and maximize employment.

The Federal Reserve had been holding the federal funds rate around zero and had decreased the interest rate in response to Covid-19. On March 16, 2020 there was a -100 basis point decrease to a Federal Funds Rate of 0% to 0.25%. 

Increases or decreases in interest rates are described as basis points. A basis point for mortgages is a unit of measurement used to represent a percentage point, where one basis point is equivalent to 0.01%. It is commonly used to express changes in interest rates for mortgages and other financial products like credit cards and auto loans.

Why Has the Federal Reserve Been Increasing Interest Rates Since 2022?

As the economy started to pick up after Covid-19 and inflation started to become a problem, the Federal Reserve realized it had to act and it did so quickly.

The table below shows how fast the Federal Reserve moved in order to tame inflation:

On March 17, 2022, the Federal Reserve increased interest rates from 0.25% to 0.50%. This means there was a +25 basis point increase in the federal fund rate. Since March 2022, interest rates have continued to rise and by May 3, 2023, they were at 5.00% to 5.25%.

On average, private mortgage rates in 2022 hovered around the 6% to 7% mark which represents a premium over conventional rates. However, with the Federal Reserve’s rate hikes in 2023, there has been a noticeable increase in these rates. The exact increase, however, can vary significantly among different private lenders, primarily due to their business model, location and appetite for risk.

Learn about the Federal Reserve and their monetary policy.

The Distinction Between Conventional and Hard Money Lenders

Conventional lenders, such as banks and mortgage companies, follow guidelines set by government-sponsored enterprises like Fannie Mae and Freddie Mac. These lenders are influenced by changes in the federal funds rate and typically offer long-term fixed-rate mortgages. These loans could be up to 30 years.

On the other hand, private lenders and hard money lenders are private entities that operate outside of these traditional lending standards. They have more flexibility in setting their interest rates and approval criteria. Hard money loans are often short-term (weeks/months or even several years) and cater to specific financial needs, such as fix-and-flip projects or construction financing. As a result, the impact of high interest rates on private mortgage lending can differ from that on conventional lending.

Factors Influencing Private Mortgage Rates

Several factors contribute to private mortgage rates. While the supply and demand dynamics of the lending market play a significant role, other factors should be considered:

1. Cost of Capital

Private lenders’ cost of capital is a crucial in deciding the interest rates they charge. The cost of capital refers to the expenses associated with obtaining funds to lend. When the Federal Reserve raises interest rates, it can increase the cost of capital for private lenders who rely on external sources of funding. This, in turn, may lead to higher interest rates for borrowers.

2. Risk Assessment

Private lenders evaluate the risk associated with each loan and adjust their interest rates accordingly. Factors such as the borrower’s creditworthiness, loan-to-value ratio, and property location can influence the perceived risk. Lenders may charge higher interest rates for riskier loans to compensate for potential losses. The “loan to value” ratio can also significantly affect the rates that private money lenders can offer. A lower ratio usually attracts lower interest rates, as the risk of default is minimized.

3. Loan Structure and Terms

Private mortgage rates are also influenced by the loan structure and terms. Hard money lenders typically focus on short-term financing, which allows them to tailor loans to meet the specific needs of borrowers. The flexibility in loan structure and terms may result in higher interest rates compared to long-term conventional mortgages.

4. Market Conditions

Supply and demand dynamics within the private lending market can significantly impact interest rates. When there is a surplus of available funds, lenders may lower rates to attract borrowers. Conversely, when demand outpaces supply, lenders may raise rates to manage their lending capacity.

5. Investor Demand

Some private lenders sell their loans to institutional investors or individual investors. Investor demand for private mortgage-backed securities can influence interest rates. When demand is high, lenders may offer lower rates to attract investors. Conversely, if investor demand wanes, lenders may need to increase rates to entice buyers.

Do Private Mortgage Rates increase along with Conventional Mortgage Rates?

Private mortgage rates are often higher than conventional mortgage rates, which can be attributed to the shorter-term nature of hard money loans, the higher perceived risk associated with certain borrowers or properties, and the unique loan structures offered by private lenders. 

However, rising interest rates is not all good news for private lenders, as rising interest rates can lead to a decrease in the demand for private mortgage loans. As borrowing becomes more expensive, potential borrowers may reconsider their investment decisions or opt for traditional mortgage loans instead. This reduced demand can affect the volume of private mortgage lending and potentially lead to a slowdown in the real estate market.

Furthermore, higher interest rates can impact the value of existing private mortgage loans. As interest rates increase, the present value of future cash flows decreases. This means that the value of existing loans decreases, potentially leading to lower returns for private lenders. It is crucial for private lenders to assess the impact of higher interest rates on their loan portfolios and make necessary adjustments to mitigate any potential losses.

Challenges of Private Mortgage Lending in a High Interest Rate Landscape

As interest rates remain high, private mortgage lending faces several challenges and opportunities, as private lenders must adapt their strategies to remain competitive.

One potential opportunity is to diversify lending products and services. Private lenders can explore alternative financing options, such as offering bridge loans or construction loans. By expanding their offerings, private lenders can cater to a wider range of borrowers and mitigate the impact of rising interest rates on their business.

Moreover, private lenders can focus on building strong relationships with borrowers and investors. Providing exceptional customer service, transparent communication, and flexible loan terms can differentiate private lenders from traditional lenders. In a rising interest rate environment, borrowers may value the personalized approach and flexibility offered by private lenders.

Check what would happen if your Interest Rate increased by up to 5%

Use our calculator and enter your loan amount, number of years and the initial interest rate. Then see what happens to your payment amount if the interest rates increases by a further 1-5%.

Rising interest rates and interest rates remaining high have a significant impact on private mortgage lending, but it is more nuanced than that. By staying informed about the Federal Reserve’s decisions and economic indicators such as the real estate market, private lenders can make informed decisions about their lending practices.

The absolute bottom line is that at the end of the day you want to make a profit. Whether you are a private mortgage or hard money lender or a borrower, you need to do your research and run your numbers and make sure you understand what you are doing before you start. 

Summary For Potential Private Mortgage or Hard Money Borrowers

In an increasing and high interest rate market, borrowers of private or hard money need to be aware of the potential that increased borrowing costs can erode profits. You need to think is it really the time to be buying that fix and flip property, if prices are starting to go down or potentially could before the project is finished?

The Key Points for Borrowers:

• Potential for higher interest rates to come.
• Increased borrowing costs.
• Difficulty in repaying loans.
• Reassess ability to manage debt.
• Review repayment strategies.
• Consider alternative sources of financing.
• Changes to underwriting standards may result in tighter lending.

Summary For Private Lenders or Hard Money Lenders

Private lenders and hard money lenders need to understand the economic environment they are lending in as interest rates rise and stay high and need to be proactive and adapt. Is that borrower requesting funds for a fix and flip deal going to be able to make monthly payments and finally payoff the loan?

Key Points for Lenders:

• Beware of Increased borrower defaults.
• Know your market and whether local Real Estate is looking overvalued.
• Reduced demand for loans.
• Impact of rising interest rates on your lending margins.
• Need to adjust underwriting criteria, e.g. Loan-to-Value.
• Need to increase cash reserves.
• Research what other lenders are charging for similar loans.
• Consider alternative investment strategies to mitigate risks and maintain profitability.

Current and Historic Mortgage Rates

It is important to obtain up-to-date mortgage rates. They are of course subject to change, so we have not created a table of them on our site. What we can provide you is the links to get this information.

Weekly Primary Mortgage Market Survey®

Visit the Freddie Mac website to view the weekly Primary Mortgage Market Survey®

Historic Mortgage Rates from Freddie Mac

In the Freddie Mac archives, you can download historic mortgage interest rates since 1971. With over 50 years’ worth of data you can see how interest rates have increased and decreased over the years. The interesting point to see is that the high interest rates of 2022 and 2023 in comparison to the 1970’s and 1980’s are not actually that high!

https://www.freddiemac.com/pmms/pmms_archives

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