Consider private money lending and/or note investing for a passive income source? You're in good company. It's a lucrative alternative investment if done right, offering strong interest returns without the headaches of managing properties.

But it's not without its risks. I've seen a lot of deals being presented lately where would-be individual private money lenders are potentially placing themselves and their capital at risk.

Here are key pitfalls to avoid:

🛑 Over-reliance on relationships

Knowing someone personally doesn't mean you know their financial stability. Fine, you've known each other since you were 6 yrs old, but can you tell me what their credit score is, their debt-to-income ratio, or net worth is (and not what you THINK they have as assets). Without clear terms in promissory notes with punitive measures to set standards for performance, and security against the subject property, there's little incentive for timely repayment.

🛑 Insufficient property equity

Lending without enough equity in the secured property as-is can leave you unable to recoup your investment in case of default. Don't just focus on the after-repair value (ARV) - that's pure speculation until the project is actually completed and sold.

🛑 Unrealistic ROI

Beware of deals promising excessively high returns without proper collateral or penalties. Savvy investors seek cheaper capital elsewhere if the project's potential is truly strong so why would they really want to promise you 12% interest and 10 points on the back end when the project is completed? If the deal and the investor is so great then they should absolutely be capable of getting cheaper debt elsewhere. Question why they came to you in the first place with such a big promise of returns.

🛑 Blind trust in others' opinions

While guidance is valuable, ultimate responsibility lies with you. Don't defer decision-making to others without thorough understanding and legal review. And stop reading proformas or prospectuses and taking it at face value. It's your responsibility to vet out the numbers yourself, stress test it, and ensure the numbers are accurate, realistic, and inclusive of all costs associated with the project.

🛑 Lack of due diligence: Seek multiple opinions and legal reviews to fully understand the investment, your legal protections, and how to safeguard your capital. Build a network of experienced professionals to provide insights and perspectives relative to property valuations, project scope and budgeting, title and escrow, private lender laws and regulations, loan servicing, document collection and review. Private money lending is a team sport!

In short, approach private money lending and note investing with caution, thorough research, and a network of trusted advisors.

Your money, your responsibility.

Beth Johnson

[email protected]

Podcast Guest on Show #210

4 Votes