Private Lending Rate

[Bryan Kelly]

I know that a large majority will state that deals need to be formalized and gone through loan services, however, please humor me. 

With a friend to friend loan, I know...taboo and risky, what would a fair rate be for 3 year, 5 year and 10 year loan? 

Other advice is still welcome! 

[Alex Breshears]

Quote from @Allison Collins:

Quote from @Alex Breshears:

Quote from @Allison Collins:

Quote from @Alex Breshears:

If you are borrowing from friends/family and plan to pool their money together in an LLC that is not secured, you will need to research state and federal law related to this type of activity as that could be considered a security in your state and/or potentially subjected to SEC regulations associated with a pooled mortgage/debt fund or private equity fund (syndication). 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, you could be locking yourself into loans with stiff prepayment penalties that usually have a 5-year prepayment step-down penalty. If your capital investors want their funds back before year five, consider how you might be able to pay them off earlier than your refinance would allow.

`I would say for typical rates, that is really going to be all over the board. It depends on the state, the LTV, the hold time, etc. For example if you have someone who is coming in at 80% LTV that may be a higher rate than someone else coming in at a 50% LTV. I would NOT recommend doing a 100% LTV with friend money. As soon as the market corrects, there's a problem with the property, they are going to be holding a note for a property that has more debt on it than the value can support. If you want to remain friends with this person, please don't rely on the friendship alone to carry you through. Do the legal documents with an attorney, make sure everyone is crystal clear on expectations and timeline, and only do it for non-owner occupied property.

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.

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 DSCR lenders to understand your prepayment penalties and bake that into your exit strategy with your private lenders, 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. Bottom line, if you plan to pool funds so that you don't have 2nd, 3rd, 4th liens, then you will need to tread lightly and ensure all parties involved are on the exact same page so that no one gets hurt/annoyed/disappointed/angry after funds are already tendered.

 I was thinking about doing this with a flipper friend of mine, but the loan would be in the 2nd lien position.  What should I be asking him to see if this is a loan I would want to lend?

There are a lot of variables on this one, so great question. I can share with you what I would consider for my risk tolerance, but realize your risk levels might be different than mine. For a second lien, they must have a current 1st mortgage that NOT a hard money lender. The combined loan to value between the 1st and 2nd will not be more than 75% of the ARV. Depending on what they plan on using the funds for and how much it is, there may be construction draws associated with that. It gets a little intense when you start talking about guidelines for a second, so if you have the ability it might be better to try a 1st lien that is a rather simple deal while you are learning the process.

I'm looking to do a loan as a second lien holder. The borrower already has a loan out on the property but needs more money to finish the rehab.  He didn't price out the materials needed before closing on the home and has run out of money. Would you do a loan like this?

 Hi Allison! Like so many answers in real estate, my answer is going to be "it depends".  There are several variables you didn't mention that would shape my answer.

1. What type of loan is the first lien? I will not lend in the 2nd lien position behind a hard money lender. 

2. Does the first lien holder allow junior liens on the property? Some lenders do not allow 2nd liens to be placed on the property. If the lender in this situation is one of those, and they find out, it could throw the 1st lien into default for not abiding by the terms in the promissory note/lien instrument.

3. What is the combined loan to value? How much does the borrower need to finish the project? How close to completion is the home? We are in a part of the economic cycle where the markets are changing. Some markets are seeing asset devaluation, so a long lengthy rehab may result in a lower sales amount than previously underwritten for when you issued the loan. I would also get a clear idea of what was already done by the borrower to sort of vet out the money he has already spent on the project and how. I also would not do a 2nd lien over 75% loan to value for both loans, and that is my highest point. At least at a 70% cap they should be able to qualify for a rate and term refinance and get out of the loans currently on the property should they reach the end of the loan term.

4. How feasible is the exit strategy and are there others that could also be pursued? It sounds like this loan is for a fix and flip, but what happens if the borrower can't sell it? Will it still pencil out as a long term rental? Could the borrower qualify for some type of financing?

If those hurdles are cleared, then I would move forward with the loan.