What can one expect to pay/earn with a private lender?

Question

A couple of days ago I read about a newbie on here that was about to make $200 cash flow (I've made the same mistake) on a huge risky investment.
The pros weighed in and one stated "you can make more money managing someone else's place a month than you can your own - don't do this!", Im paraphrasing

But he was right!

I am in a position where I have a nice chunk of change to buy, but in my markets, NYC, Scottsdale, Upper NY State REI is impossible. 
So then I find myself looking for REI where I could do a few small 75K-100K all cash deals in cities like Memphis and ATL but it's a bit out of my comfort zone. I feel like I am at the mercy of the market, manager and inspector. The people on here are wonderful, and great advisors, but things can go wrong....So....It got me thinking and since there is a wealth of info on this board I thought I'd ask.

If the person defaults on the loan, is it mine?
Pros? Cons? Maybe this is the way I should go?

Any ideas and advice would be greatly appreciated

Account Closed · Answer

David Janash

I have also looked into Private Lending and this is what I understand. You can earn a good rate of interest in excess of 12%. The typical way seems to be going through a broker. The borrower pays points (typically 3-6 points)  but the brokers keep a good chunk of this. You get a deed of trust. You should only take a first deed of trust. The broker is supposed to verify the title etc. Then if all goes well, borrower pays back on time and you get interest and principal returned. Rinse and Repeat.

However, if the borrower does not pay back, the property is not automatically yours. You have to foreclose, just like a Bank. This takes time and money that eats into your return (and causes stress). Theoretically if you have lent only 65 to 70% of the value, you still come out whole. The issue is how do you really assess the value of the asset? Unless you understand the market very well and construction costs etc on a rehab process, how do you assess the risk? In other words you are attempting to do what banks have whole departments of underwriters for.  I dont think I am that good.

Another option though is to invest in a fund that does Private Lending. I have recently invested in such a private placement fund. You have to do your diligence on the fund but once thats done, the investment is fully passive. In return the fund manager takes a management fee (typically 2%) but thats less than what most brokers take to bring you deals.

Bill Gulley · Answer

Unifor Commercial Code Setion 9, secured collateral, as I reacll. That's absolutely correct, it depends on the type of siezure of collateral you have, and in any  case it can be contested, and the lender can be sued for excess equity.

I realize that this may go against what predatory types do. Investigate it and you'll find that there is a difference between a collateral interest and obtaing fee simple, as it can always be contested. Lokk to collateral, redemption rights, what interesys are convey for collateral and law of equity allowing a lender to be indemnified beyond thier interests. :)

J Scott · Answer

This doesn't answer my original question...

Let's say you lend $100K, end up foreclosing on the property, and then it doesn't sell at auction because nobody is willing to bid $100K on the property (assuming that's the current value of the loan plus fees, etc).

So, your bid at auction is $100K (what you're owed) and you now have an REO on your hands.

Are you saying that property is not yours with fee simple ownership?  And that you're not allowed to move into it?  Or give it away?  Or rent it?  Or whatever you want to do with it?

If not, what are you allowed (and not allowed) to do with that property once it doesn't sell at auction and you get it back as an REO?

Pat L. · Answer

J  Scott FYI
Last year I foreclosed on a Large duplex I financed up here in NY.
Owners just didn't understand DILO ??? & it took 12 months.
(I have taken it back 3x DILO over 10 years so the bldg owes me nothing.)
I assumed ownership after the 'auction' failed to entice any buyers, but the foreclosure amount was sufficiently Inflated with expenses etc above MV. Plus I wanted it back as I had a new buyer. The subsequent assumption of ownership took < 30 days.

The New owner took possession & then had to evict the old owner but was able to immediately collect the rent from the lower unit.
Eviction was swift & the new owner rehabbed the upper unit & had it rented b4 the rehab was completed.

Karen Margrave · Answer

We have used hard money lenders many times over the years, as well as conventional lenders.  We have built spec commercial buildings (office buildings, small office parks, office/retail condos, residential subdivision, etc.) all using Hard Money Loans. We have paid 2-5 points, with interest usually at 12%, max 14%. We get our loans are through a mortgage broker, that has lenders that are private individuals, retirement accounts, etc.

Because our deals are new construction, spec, etc., it's important for the mortgage broker to understand the market, and the construction process. We have a system we set up for release of funds and inspections to safeguard the lender, etc.

Bill Gulley · Answer

Say you give two properties as collateral, one at 95% ltv and one that is just made as additional collateral free and clear, a 300K property for a 50K loan. Let's get to the end, the small hosue is sold and you're 10K down and you foreclose on the 300k property, doesn't sell. Yes the example is extreme, but you are not going to end up with a 300K property for a 10K debt. It maybe sold, say for 200K, you're not keeping that 190K as a benefit from a collateral position. Been there!

This issue goes back to the 30s. If memory serves, it's the Land Transfer Act and under the Uniform Commercial Code, as a lender, you're always in a position of being indemnified for your loss by the sale of collateral, by public auction or, if not sold, by the future sale.

It's an old saying, once a lender, always a lender. Collateral does not carry the full bundle of rights in title as a buyer in fee simple. The concept of collateral is to ensure a lender that there is no loss, it's not a pledge to credit a lender with excess profits, that is predatory.

There are some other issues as well, a lender is required to advertise and make a good faith attempt to sell the property and gain the highest price as amounts in excess of amounts due go to the borrower.

I'm well aware that the practice of some private lenders is contrary to these issues of equity and they sell and keep the proceeds or rent them. I'm also aware that 99% of borrowers walk away, not sure just guessing there, and probably in most cases there is not a great deal of equity, but if there is and you lend/foreclose to gain properties you'll have several issues if someone cries foul, you can be sued and you'll lose as the concept of collateral is not as a profit center but to ensure that a lender doesn't lose amounts lent.

That's true in all states, but can be more of an issue as to the disposition of collateral under state laws, imposing types of sales, reduction of price or holding auctions.

What lenders do too is run up fees during the holding period, servicers contracted to manage collateral, jacking the price to reduce equity. Lenders have gotten caught and fined, I believe 2 large lenders were caught with affiliated servicers stripping equity and were fined. It's another form of equity stripping, the shoe is on the other foot too.

Time is an issue too, if you hold a property for a reasonable time to sell it and it doesn't sell, the equity claim can deminish, but if you make no attempt to sell it then you're not making the attempt to be indemnified and remit excess equities, that can be a claim and violation.

You'll see that a lender's title policy is limited to amounts owing, unlike an owner's policy as a collateral interest. When the property is sold it will then carry full ownership rights to the new buyer with title coverage.

Actually, over collateralized loans, besides the subject property, is an issue to lenders where more collateral is offered to obtain a loan, I have had several issues like this. It's a problem in that if there is a default and you end up with such overally collateralized properties, you have a contingent liability to sell it and get your money and then remit excess amounts, so, sometimes it doesn't even pay to go there with excess collateral.

I was involved, not as a lender, with a suit down at the lake with a lady buying on an installment deal where the lender foreclosed arising from taxes not paid within 30 days. The lender bid the price at the steps, the property didn't sell, he later sold it at a profit, he was sued for the equities and he paid the equity plus court costs and attorney fees. Once a lender, always a lender.

Many attorneys are unaware, but ask a finance attorney. :)

J Scott · Answer

Bill -

Can you expand on this?  If the property doesn't sell at auction, presumably the lender gets a foreclosure deed.  What rights does that give the lender?  Can the lender not just give the property away at that point?  Or keep it as a rental for himself?  Or sell it to a friend or family member at any price he wants?  Or just move in?

I've never really thought about it, but always assumed that an REO (or whatever the equivalent it with a private lender taking a house back) was now the property of the lender and they could do whatever they wanted with the property.

Bill Gulley · Answer

To continue the myth of getting the property, as a lender, as Jeff mentioned you are to be made whole. If the property does not sell at foreclosure you don't get fee simple interest you still have a collateral interest, you can't just move in. When the property sells you're stilllooking for indemnification,being made whole, any amounts received in access can be required to go back to the borrower or they can sue you for it. Once a lender always a lender.  A deed in lieu of foreclosure puts you in the property  as the owner in fee simple, do what you like at that point. :)

Jeff S. · Answer

As a lender, presumably holding a note secured by a first trust deed (or mortgage), you don’t automatically get the property if a borrower defaults.  This is a myth.  You’re the bank, so you have the same options you read about in the news: agree to a short sale, deed-in-lieu, renegotiate the terms, foreclose, and a few others.

The most common is to foreclose.  Here, you add up everything you are legally owed, including late and legal fees and put the house up for public auction.  You set the reserve price as the amount you are owed (or less, if you really want the house to sell and are willing to take a loss).

If the house makes more than it’s reserve, the buyer gets the house, you get paid off, and any other lien holders receive the rest according to their seniority.  That is, at best, you are only made whole under foreclosure.  There is no excess enrichment.

If the house doesn’t meet your reserve, you get the house and everyone junior to your lien receives nothing.  In this case, since the house didn’t make it’s reserve on the open market, it’s probably not worth what you are owed and you will have lost money. So, be careful not to loan so much that you can’t get all your money back, plus expenses, at a public sale.  This is why some lenders set their lending limits at as low an LTV as they can.

I’m a bit biased, but in my view, as long as you have some cash and can make sensible first position loans that are local to you, lending is the way to go. It’s easy to learn, relatively safe, doesn’t require much time per loan, and the annualized percent returns can be well into the teens.  One drawback is that it’s short term, so you have to keep a pipeline full.  On the other hand, many markets are still thriving with flips so business can be excellent.

Jeff

J Scott · Answer

This sounds more like hard money lending than private lending to me...

Private lending is when you lend to someone you know or are familiar with and have a comfort level with.  Hard money lending is when you lend to strangers and/or on deals where the relationships doesn't matter -- the deal is good enough to warrant the investment.

In my experience, private lending is generally in the 10-12% range (with maybe a point paid to offset some costs).  Hard money tends to be more expensive -- in excess of 12% and 3-8 points.