Can someone explain the process of private money lending?

Question

Hey everyone!Newbie here probably asking a very basic question, but nonetheless, I need some clarification. I am trying to figure out how the process of paying back a private money lender works. Now, I'm sure there are many different ways and or methods to structuring a payment plan with your lender, so I am open to any suggestion. I don't know much about how payment plans look for private money, but this is generally how I think of it, maybe someone can let me know if I'm close or way off.So lets say I've got a rental property that brings in $1000 a month in income. After ALL expenses, I am left with a $250 cash flow. And let's say I've borrowed 10k from a private lender and we've agreed on a 10% return for them letting me use their money (so that would equal me having to pay them back 11k, right?) So would I then just subtract a portion of the cash flow to pay to that lender every month until the 11k was paid off? This is where I get confused. Any help is appriciated!

Robert Ferrell · Answer

@Mike McCarthy Great tip on having the lenders claim the interest as income. It makes sense, but is something I probably would have over looked.

Andrew Postell · Answer

@Robert Ferrell If you were to refinance into a conventional loan it would count against your conventional loan limit of 10 mortgages.  Banks could have what's called an "overlay", which means the bank could limit how many loans they want you to have but if you work with a bank with no overlays then they will allow you to have 10 conventional mortgages (if you are buying your primary hoe you are allowed to go over that amount).

Robert Ferrell · Answer

@Andrew Postell Definitely a lot of information, but after rereading several times I think this basic finance tutorial is finally starting to click! The manner in which you lay out your information is clear, concise, and extremely helpful. I do have a follow up question though. So when you refi with a bank out of your initial lending situation, will this refi go against the (I believe the number is 4...or is it 10?) mortgages a person can claim under their name? Or would these fall under some other category?

Jay Hinrichs · Answer

@Mike McCarthy  0 interest loans the IRS will charge imputed interest.. I have done a lot of it.

of course you can also have the gift angle as well..

so when setting these up its important to clarify debt and equity.

Christine Kankowski · Answer

The 10% rate is a yearly rate.  SO if you still have a balance at the end of year one, you have to pay interest on that amount for year 2.

So year, you woudl owe $11000 if it is fully paid off at the end of year one. but more if it drags on for more years.   Time is value.

Andrew Postell · Answer

@Robert Ferrell all good questions again.  You are on the right track with your thinking.  100% would only be available through private financing.  When lenders did 100% financing in the past the foreclosure rates were through the roof.  Even a hard money lender would want something from you on the deal even if it were small.

Now for the refinancing part - refinancing out of hard money or private money is something that occurs every day.  It's probably the most common type of transaction that occurs within investment properties.  You need to know some specific numbers:

• To refinance you out of a loan on an investment property will limit your loan amount to 75% of the "After Repair Value".  So if you buy a home with private money or Hard Money and the home is worth $100,000, then we can refinance $75,000 of their loan (taking cash out is different though - more on that later)
• Hard Money lenders know this rule.  So most of the time they will only lend you 70% of After Repair Value on the home.  That way, when you do refinance with a conventional loan, you can roll some closing costs in and not bring any extra money to closing.
• So what happens if a private loan/hard money loan lends you over the 75% threshold?  Then you would need to be prepared to have cash to bring to closing when you refinance.  So if the home is worth $100,000 and the total costs/loan is $80,000 that's still a really good deal!  But just be prepared to bring $5,000 to closing when you refinance.
• What happens when the loan is lower than 70%?  Can I get cash out...sort of.  You can get less than $2k within the first 6 months of owning it.  After 6 months then you could get more cash out with a loan. (if you buy with all cash that rule changes but for sake of time I'll limit it to just the loan for now)

Lots of information but hopefully this helps!

Robert Ferrell · Answer

@Andrew Postell Since you encourage using one type of loan for the first deal, instead of trying to do a mixture of both, do you think it would be better to use private money or possibly even hard money to fund the entire purchase price and acquire the property, then after a few months refinance with a bank? And if you would suggest something like that, would you mind explaining how that may generally work. Such as, is it common for a bank to refinance the total amount that I would need to pay off my first financing source? And do hard money lenders even fund 100% of a deal?

Andrew Postell · Answer

@Robert Ferrell lots of good comments on this post. Great topic.  I'll try to answer this your second questions as best I can here.

Most investors want to spread out their loan as long as possible so their cash flow is better.  The renter is paying the mortgage (in a sense) and the interest is tax deductible.  That's most investors mentality.  There's certainly a case to do things differently but for sake of time let's use this strategy.  When structuring your private loan it better to have it over a longer period of time than a shorter so you can cash flow.  Most private investors don't want their loans to go out to 30 years though.  So this part is very negotiable.  I've seen 5 year loans and I've seen 20 year loans from private individuals before.  It's just kind of up to everyone's tolerances.

I would encourage you to do all of one type of loan on your first deal.  Keep it simple in the beginning.  You can certainly use private investor money to purchase a home with a conventional loan but their money would need to be in your account for about 90 days.  Long enough to show at least 2 months of bank statements.

To properly structure the private money loan might require a lawyer...but might not.  If you were to properly document the transaction you would need a note, to file the note at the county courthouse, and to place a lien on the property.  A title company can do the last 2 of those items so really the note would be the only item that you would need drafted.  There might be some examples of a note here on BP or maybe on the web.  Try there first before paying an attorney to do it.

Hope this helps but continue to ask questions if you need.  Thanks!

Robert Ferrell · Answer

@Andrew Postell Thanks for the reply! So when it comes to term, is there an industry standard or does it just come down to what can be negotiated? Also, is using a mix of private and conventional a good strategy, or will this eat too much into cash flow? Because my plan is to try and round up some private money, typically from friends/family for a down payment on my first property, then have a bank finance the rest. So in this case I would have a traditional mortgage payment plus a payment to any private money investors involved. And while were discussing the matter, what would you say is the best way to go about working with private money lenders, in my case at this point being close friends and family, from a legal standpoint? Should a lawyer be involved? Should I just have a simple contract written up describing the terms?P.s. Excuse the duplicate reply. I mistagged you in the first reply and could not fix it in the edit section.

Can someone explain the process of private money lending?

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