Private Money Lending Question

[John Jacobs]

Hello Bigger Pockets,

I am a Private Money Lender.  I only lend to real estate investors.  I only lend to business entities (i.e. LLCs and Incorporated).  I do not lend to individuals.  I also only lend on non-owner occupied properties.  I do all of this so as to avoid/not-having-to-comply-with the the provisions within the Dodd-Frank Act which require lenders to vet borrowers as to their ability to repay the loan.  That is, the Provisions, to my knowledge, require a formal vetting of the borrower taking into account that borrower's Debt to Income Ratio, along with other metrics.

The following situation has arisen which is this:  I have lent to a flipper on several flips in the past.  When lending to him in the past I have adhered to the rules I have stated above (see Paragraph 1).  He owns a primary residence which he currently lives in.  He just bought another home which at some point in the near future will be his primary residence.  Ultimately he will sell his current primary residence and then move into this new home.  The new home needs renovation and he was was wondering if I would make a loan to pay for the renovation of his new home.  He owns the new home in his name as an individual.  There is the possibility that he could move into his new home while my loan with him is still in effect.  

I am inclined not to make this loan (see Paragraph 1 above). Having said that, I am wondering though, would me making a loan to him (see Paragraph 2 above) circumvent the Dodd-Frank provisions because he didn't buy the home with my money (rather my money is only being used for renovation post-purchase)? Lastly when making this loan there would be a Mortgage and Promissory Note in place. The Mortgagor would be listed as an individual (as the individual holds the Deed to the home) and not be a LLC or Incorporated. So would this give you pause vis a vis the Dodd-Frank Act?

Thank You

JJ
 

[Jeff S.]

Quote from @John Jacobs:

@Jeff S.

Interested in your response to my last post.

Let me clarify something--This would have been the first time I would have lent to a borrower who was living in the home (i.e. Primary or Personal Residence).  I have never done this in the past.  Although worded poorly this was the reason I posted as this would have constituted the first time and I thought there could be a problem doing so.

That much was clear.  I wasn’t picking on the way you said it.

Would it shock you that there are attorneys out there now who specialize in going after private lenders, claiming their intended business-purpose loans are really for a consumer purpose and subject to all legal penalties, damages, and consequences?

The (un)importance of owner occupancy is a common misunderstanding among private lenders. It’s something I see on this board frequently and also hear from others. You can set an ironclad policy to never lend to an owner-occupant and still easily get into trouble. Whether it’s their primary residence or my gas station example above, I can think of a thousand examples. They all boil down to the use of the money, which is all that matters and all you should care about. Get owner occupancy out of your head. (The only exception is multi-families. Per Dodd-Frank, owner-occupied loans against three or more units are defined to be for a business purpose).

Regardless of occupancy, if a borrower intends to use the proceeds from a real estate loan for a personal, family, of household use, then it’s a consumer-purpose loan. Have you ever had a house flipper decide in the end to live in a house they renovated with your money? We have. If they filed a claim (which they did not in that case) how would you protect yourself?

Here is some free advice (worth what you pay for it):

• Upon application, obtain a handwritten statement from the borrower describing the intended use of the money. If it says, “I am a professional house flipper and intend to use the loan to purchase, rehab, and quickly resell 123 Main Street for a profit,” then this is a business-purpose loan. Not to be cynical, but if it involves a long story in several paragraphs (Hint: like you wrote above.), it’s probably a consumer-purpose loan. You knew that. Have your borrower sign this document upon application and then again at the closing table.
• Never use a 1003 Uniform Residential Loan Application. The name itself suggests you are making consumer-purpose residential loans, as does some of the verbiage in the form. There are many Business Loan Applications, which are virtually identical and carefully worded, that you can find online.
• Hopefully, your lawyer includes a Certificate of Non-Owner Occupancy in your loan package, and language to that effect is liberally mentioned in your note and mortgage/deed of trust.
• Consider obtaining a script offered now by some lending attorneys that you can use to interview your borrower about their intent during a recorded Zoom call. This is becoming popular.
• In my view, if you are not using a real lending attorney to keep up and stay educated, you are doing yourself a disservice. Lending attorneys are not the same as real estate attorneys.
• Learn the rules.  Your first question should always be, "What is the use of the money?"