Using private money

[Ian Kisbert]

I am planning to use private money (close friends and family) to help fund the rehab portion and some of the purchase of a BRRRR. To transfer funds, is it as easy as signing an agreement with them, then they wire funds to my bank account? Or is it best to set up an account with escrow or have them transfer into the bank account set up for the property?

[Alex Breshears]

Hi Ian! I hate to be the Debbie Downer here but there are a lot of considerations you may be skipping over in this line of thought. I just wanted to chime in with some additional information so your close friends and family understand what they are truly lending on, and how everyone can enter the lending relationship with realistic expectations of what can happen, and what will be happening in the future.

If you are borrowing from friends/family and having just a promissory note before closing not secured. Additionally, you should consider how long your friends/family are willing to have their money out to you. If you use DSCR loans as permanent financing, (or really any!), you may be required to let the lender know there is now another debt out there before closing, which could affect your approval. Most lenders use a standardize application, and there is generally a question on there about any other outstanding debt that you are responsible for that doesn't show up on your credit report. In order to prevent mortgage fraud, you would need to disclose this new loan before closing.

Also - lenders may ask there large deposits come from if they are sourcing where the capital came from. If they see a large deposit, they will want an explanation, and then you will be forced to explain you took out another loan before closing, so again, just be upfront if this is the route you want to use. 

While borrowing from friends and family is typically the starting point for most people when finding private money loans, it's also the quickest way to sink relationships, if not done correctly or as a true business transaction. I find a lot of people just assume that since they inherently trust their friend/family member, a lot of the "what ifs" and worst-case scenarios are not hammered out in fine detail which can lead to confusion and personal interpretation after the deal is closed, which it should have been addressed pre-emptively before the money was lent out. The other party may think they are lending on a property, but unless they have a recorded lien they are not lending on property, they are giving you an unsecured loan, like a credit card. I would make them fully aware of this. If you decide you want to record the lien after closing, the 1st lien holder needs to know and also you may not be allowed to take out junior liens, so asking about that before closing on your 1st lien would be a good idea. 

So my recommendations are 1) get an attorney involved so you know what your able to do legally and s/he can draft up the proper legal documentation to support the path forward, 2) consult with your lender to understand if they will want to know the source of funds and would allow another loan to be the source of funds,  and 3) consider the cost of capital in relationship terms rather than monetary since that matters more than getting the money. You don't want to burn any bridges by miscommunications or not properly addressing resolution paths, buy-outs, exits, etc. in a legal manner on paper and signed by parties. If you and your family wants to become more educated in how to transact this loan safely, you could check out BP's newest book - Lend to Live: Earn Hassle-Free Passive Income in Real Estate with Private Money Lending. I happen to be one of the co-authors and an experienced private lender.