What Do Private Lenders Gain?

[Gordon Olson]

I just started reading the BRRRR book by David Greene. MIND BLOWN! Up to this point I had only considered the traditional way of borrowing money through a mortgage company.

I am a newbie and am looking to not only purchase a property but to buy my 1st home as well. Thing is, and I'm sure I'm not alone due to my credit situation (meaning since I've previously paid cash for everything for almost 30 years and don't have a BAD credit score, just NO credit score) it isn't likely that I'm going to be getting any kind of loan via mortgage lender anytime soon.

I get the idea of paying cash so a private lender seems to be the best option for me. But what kind of criteria are we talking about here? And in exchange for their lending me the money what do private lenders get in return? @David Greene- you can just tell me to keep reading if this is covered later in the book and that will be end of it. Otherwise, any feedback on this? I am working with a realtor but it looks like I need to get the funding 1st before I can really tell him what to look for. Thanks for any help anyone can give. 

[Wren Martin]

@Gordon Olson- On a construction or rehab project, the Contractor will submit a payment application at specific milestones of completion.  The payment given to the contractor is a Draw against the entire construction/rehab budget.  

Some experienced Rehabbers or Flippers like to pay for the project costs out of their pocket and only uses a private lender for the purchase price. This saves them interest costs on the project.  But uses up their capital which could be used for down payments on their next Deal.  

If you have a Lender who will also loan the cost of construction the Rehabber can submit a Draw application to the Lender as reimbursement for each of the Draw's paid to the Contractor.  This saves the Rehabbers capital for future Deals and can also improve their cash on cash return.  But it increases the project costs which can turn an otherwise profitable project into a loser if it takes too long to flip.

The milestones for Draw payments to the Contractor are part of the contract negotiations so it can establish them at any point that works for both parties.  Typically, the Rehab/Flipper wants to make sure they have received all materials and labor required for each phase of the project before paying the Contractor.  On a simple Fix & Flip this might look like:

• Draw 1 - 20% paid at Demo/Haul Off
• Draw 2 - 20% paid at Frame/Rough In (plumbing, electrical, mechanical)
• Draw 3 - 20% paid at Drywall - tape, texture, and paint (to include ceilings)
• Draw 4 - 20% paid at Cabinet/Countertop install, Fixture install (lights, sinks, faucets)
• Draw 5 - 20% paid at Flooring and Close Out/Punch acceptance

You might only do (3) Draw’s to reduce the paperwork on a short timeline project.  Each project can be a little different depending on timing and capital availabilty.  
The reimbursment application doesn’t need to follow the Draw payment schedule but the Lender will want to see the work has been completed satisfactorily before they issue the reimbursment funds.
You may want to hold retention on each Draw.  This is an additional incentive to make sure your Contractor finishes the project and/or you have enough funds available to finish it yourself if needed.  Retention might be 10% of each Draw held back and paid as a final payment at a certain date after the punch walk acceptance payment.  This acts as a warranty to ensure all parts of the project are working as designed.  
You may develop such a great relationship with your Contractor after a few projects that you determine this retention isn’t necessary.  However, if you are using funds from a Lender, they will always require the condition of retention.

All the Best!