How to become a private money lender

[David C.]

Hi All,

Would love to learn how to lend money privately, underwriting deals vs junk, ins and outs. Where to begin and best to learn? Your feedback is much appreciated.

Regards,

David

[Jeff S.]

We do exactly what you are asking about, @David C., and I've published our process here a few times over the years. It really hasn’t changed much and has proven safe and reliable for us. We do not run a fund or accept investors, and we hold all notes until they mature. Every dime we lend comes from either our hard-earned after-tax or retirement (SD401k) money.

When we’re at a real estate club, which is where we find almost all our borrowers and are asked what we do, our elevator pitch is, “We loan our own money to local, experienced, house flippers toward their properties in Los Angeles and North Orange County.”

At a top level, and hopefully actionable, here is our process in 10 easy steps …

1) You’ll need to spend some time with a good lending attorney. This is not the same as a real estate lawyer. Call some hard money lenders in your area and ask them if they sell their notes or need investors. Buying their loans is one way to get into the business. Also, ask which lending attorney they use. Lending attorneys are a rare breed, and you’ll likely only hear the same few names. Pick one and spend an hour or two with him or her to get educated.

Lending attorneys sell loan documents to HMLs or provide them on a deal-by-deal basis. You could wait on this until you do a few deals and instead use those from a broker at first.

2) Ask some of your potential borrowers for a broker recommendation or ask around at some local REI clubs. Take him or her to lunch and get to know one another. Never do business with anyone you don't know, like, and trust. Negotiate a flat dollar amount per loan. Don't pay a percent of the loan amount. Your borrowers will pay this anyway so you're really negotiating on their behalf. Some real estate knowledge is great, but your broker must be super knowledgeable about private lending and have experience as well as access to legally vetted bulletproof loan docs, perhaps from your lawyer.

3) Go to some real estate clubs and let people know you have money to lend. Everyone will want to know your terms. Set one interest rate and point percentage. Don't get into making deals up or negotiating on the fly. They'll also want to know the percent of purchase price you'll lend (LTV/LTC), max loan amount if you have one, note duration, location restrictions, what happens if they need an extension, and a host of other questions you'll hear over and over. Here's where you'll have to determine what you're comfortable with. For example, we will never make a 2nd position loan and you shouldn’t either. Don’t be shy about asking the same questions to the other lenders in the room.

4) Only loan to those with experience and who do this full time. No newbies, hobbyists, or anyone learning on your dime. MOST IMPORTANT OF ALL before you lend to anyone, spend some time driving around with them looking at their properties. Go to lunch or dinner a few times. The idea is to get to know, like, and trust them and vice versa. If you don’t, then don’t loan. Your safety is not in the property but in the experience and integrity of your borrower.

5) Don't loan far from home because you'll want to drive and see every property you loan on. For deals greater than about $250k, if their purchase price plus rehab total less than 75% of the ARV, an experienced rehabber will earn 10 to 15% of the ARV. In our opinion, this is a fair profit for your borrower and the minimum for a loan. (Yes, it's a modification of the dreaded 70% rule-of-thumb that some here hate. Sorry, but it really does work.)

6) Separate from here is to learn how to evaluate the property using comparables, to verify it's a good deal for your borrower. You are not making 96.5% of ARV loans like FHA but it's important you confirm the ARV and Rehab Estimate. Using the formula above, your loans will end up being less than 60 to 65% of ARV so you don't have to hit the ARV exactly, but you should generally agree with their estimate and do an evaluation on your own. Your state law notwithstanding, there's generally no need for appraisals once you are comfortable with your comping skills. Your broker should also be able to help.

Ditto rehab costs, which you can generally estimate with a walk-thru after you’ve done this for a while. This is unless the rehabber is going crazy with finishes, as some seem to be doing lately in our only slightly cooling but still overheated market. Here, you absolutely want to see contractor bids.

These are just some of the reasons you always want to visit every property. Obviously then, you should only lend locally.

7) Soon after you’ve developed a relationship, your borrower will call you with a property they have under contract that fits the criteria you defined for them. Tell them honestly if you don’t have the money to lend at this time or if it doesn’t meet your criteria. Never agree to fund a deal if you don’t have the cash in the bank. Never rely on one deal closing on time to fund another. Ever. The cash must be in the bank.

Meet your borrower as soon as possible at the property but no later than 24 hours from the phone call. Bring comps with you and ask them to bring theirs as well as their contractor bid if they have one. You should already know the answer.

Confirm the amount you’ll loan and shake your borrower’s hand at the site.

8) Call your broker and put him in touch with your borrower. The first document he/she will provide should be a handwritten one-page description of what they need the money for. You are not making consumer-purpose loans. The “Use of Funds” in this case must be for a business purpose. These are typically flips, in the case of our loans. (Not to be confused with non-owner occupied which is all but irrelevant for almost all private loans -- another topic.).

Various parties, including your broker and lending attorney will provide the Note, Deed of Trust or Mortgage, sales contract, preliminary title insurance report (prelim), lender instructions to escrow or title, fire/hazard insurance policy, lenders title policy requirements, a host of state and federal disclosures, and much more I can’t remember off-hand. Read and understand everything – at least at first. Your broker (who is very experienced at this, yes?) should be able to explain everything. If not, call your lawyer but don’t obsess.

9) I don’t know how it works in your state. In CA, your broker will work with your borrower, escrow, and title. Perhaps you use closing attorneys? There’s really little for you to do except review the loan documents and wire money to title. Here, the loan will be in your name or that of your entity (state dependent).

10) You chose professionals so let them do what they do well and rehab the property without your help. Visit maybe once and take them to lunch or dinner. Attend the open house. Definitely look at more deals with them.

11) When the property sells, you will receive an email from escrow asking for a payoff amount (called a “Demand”). Tabulate the amount owed and document it in a demand letter. Be clear and show all work, you’re borrower will authorize this and should understand your numbers. So should title, because they will be wiring the money into your account.

12) When the money hits your account check the amount. You can now commit it again. Not sooner.

Ok, 12 steps, and I’m sure I skipped some. Others here might be horrified, but this process has worked for us 100% of the time. Always put yourself in your borrower’s shoes. They appreciate extreme speed, fairness, and someone who is easy to deal with. They also work their asses off and earn a lot of my respect. Keep it mutual. Good luck.

Gee, maybe this is the outline for my new book. 😆