How Does Using Private Money Work?

Question

I recently got off the phone with a lender and he explained to me that if I was to use private money to help fund the down payment on my next deal, the funds would have to be in my account for 60 days. I was always under the impression that I would find/present the deal to a private investor and then get access to the funds to buy the property (in conjunction w/ my own money).

I suppose my disconnect is.... it doesn't make sense for a private investor to give you thousands of dollars to sit in your account waiting for the right deal to pop up.... just to satisfy that 60 day rule.

Any insight to this would be helpful, thanks!

Nghi Le · Answer

What kind of lender were you talking to?  More bank-like, or a hard money lender?  Either way, it sounds like they don't like to see secondary financing in your bank account, so having it seasoned for over 2 months means the lender probably asks for 2 months of bank statements as part of their underwriting and will think it's coming from you and a third party since they won't see the deposit.

Private money is mainly relationship-based and can be structured however you want.  There are almost no rules.  There are certainly guidelines, like there should be a lien (Deed of Trust) and money should be wired into an escrow account at closing.

@Michael B. I see more private money used for acquisition (i.e. gap funding and down payment) than for refinances.  Normally long-term lenders offer cheaper pricing for refinances.  You can also use bank financing for flips, either through FHA/203k (for owner occupants), HomeStyle Renovation loans, or portfolio/commercial lenders.

Also, no lender would jump on a 20k deal... even the ones that do it.  What's the rehab cost you usually have for these types of properties?

@Jamaal Johnson I see PML and HML used together all the time, especially at the higher price points for gap funding.  Everybody wants 1st lien position, but typically the HML gets it (or whoever puts in the most money).  There are some nuances in using PML in conjunction with HML because a lot of HMLs don't allow for subordinate liens.  Again, seasoning it for 2-3 months (outside of the window of requested bank statements) is one way, and another would be to partner with the PML and take title instead of a lien position.  But that's also a riskier position for the PML to be in.

@Michael Doherty Just wanted to make sure you are aware that you can't use hard money if you plan on living in the property.  By the way, I know of a lender that will do a fixed HELOC up to 125% of a primary residence.  That could solve your 5% equity problem.  Whether or not you should actually do a 125% CLTV loan on your primary is another question...

Jamaal Johnson · Answer

@Michael B. That is incorrect. A lot of smaller credit unions offer commercial renovation loans on SFR 1-4 units and MFR with far more favorable terms than the typical HML. You just have to call around to a lot of lenders and have that discussion to see what they will be able to do for you.

@Michael Doherty Typically people use either HML/Bank financing or PML. Almost 100% of the time the whoever you use to fund your deals will want 1st Lien position and this is why you cant really get away with using both at the same time. My suggestion is educating a potential private money source on becoming a partner with you, utilize him to finance the downpayment/ renovation and then split profit after the sale.

Michael Doherty · Answer

@Jamaal Johnson The 5% equity was in regards to my current Multi. I brought that up as an example of having to use a hard money lender on my second property because I do not have enough equity to Cash out REFI or use HELCO (hope that makes sense).

So in other words... if you were currently house hacking a Multi you bought last year with FHA loan but wanted to buy another Multi this year..... What method/strategy would you personally use to purchase your second house? Would you save up the 20-25% for down payment on Hard Money Loan and do cash out REFI or would you pursue another strategy?

Michael B. · Answer

I personally don't know any private investor that would send funds directly to your account. If he did, there would be no security for the PML that you won't run with his money. After all it wouldn't be tied to a property. The PML always transfers the funds to the title company who disburses the funds after closing.

Also, you can't use bank financing on fix and flip deals. You either use hard money outright or you have to find a PML that pays for the whole acquisition and rehab. I'd suggest you purchase a buy and hold property first, push it to performance and let a PML refinance it. This way can show a track record and it will be easier to attract private money to fund your deals upfront in the future.

During the refi process you will also learn the mechanics of financing that is tied to an asset. The refi process is like a regular closing when you purchase a house.

Jamaal Johnson · Answer

@Michael Doherty gotcha. In my opinion the quickest way to wealth building is through partnerships. Think about it this way. If you had two or three reliable partners you can go in on deals with rather than saving up that 20% down for a 4 unit property you guys can save up 20% down for a 16-24 unit using eachothers experience,strengths and capital. So what if you was to have to share the profit, if you buy right that will take you to the next level. So in my opinion partner up with someone or use a family member/friend for private money for a Downpayment.

Michael Doherty · Answer

@Nghi Le Appreciate the insights. The lender I was talking to was a conventional lender and he required 25% down for an investment property. I have some money saved up but not enough for 25% down. I reached out to some friends and family to help with the down-payment and they said they would gladly lend me 5-10k to help.

After mentioning this to my lender he said the funds would have to be in my account for 60 days which took me off guard. I don't want to tie up someone's funds for 60 days while looking for a deal. In a perfect world I would find a deal, then get private money for (part) of the down-payment and move forward with conventional financing. My idea was to pay off my private money investors with the cash flow generated from the property over the course of a few years. On second thought however, it may make more sense to just save up the 25% myself and BRRR a house to repeat and scale.

Ian Walsh · Answer

We are all different :) Private lending should not be complicated.  If someone makes it complicated, they are likely not a good lender or don't know what they are doing.  True hard money is asset based and not institutionally underwritten.

Jamaal Johnson · Answer

@Michael Doherty it all depends on the ARV my friend. If you only have 5% equity in the property there is no lender or HML who will lend on it unless the improvements will increase value substantially. Even then they typically will only give 70-80% LTV. Example: 120K duplex with 30K reno needed.. ARV of 200k - They would provide up to 140k potentially. It would help out a lot if we had numbers for your property.

Michael Doherty · Answer

@Michael B. @Jamaal Johnson Thank you both for the responses. I guess I should explain my situation in a little more detail for it to make sense.

Currently house hacking a duplex with FHA loan. Because I have very little equity in the house, my guess is 5%, I cannot Refi or take out HELOC.

For this reason I am only left with a few options- the BRRR strategy makes most sense to scale as quickly as possible. I thought I could have private money along side my own personal money to help with the down payment and pay the investor off when I REFI out of the note.

After doing more research it may just make more sense for me to save up for the entire down payment and use a hard money lender. Thoughts?

Michael B. · Answer

Interesting. Thanks @Jamaal Johnson

How Does Using Private Money Work?

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