What is the Happy Path for a Private Money lending Transaction?

[Matthew Holtry]

BP Community,

I recently did my first private money deal (as a lender). The borrower is someone I know personally, and we intend to do additional deals together in the future. We stumbled through this first one together (relying heavily on a real estate attorney), but I wanted to reach out to the community to see if we could find a way to streamline the process and hopefully reduce transaction costs.

For this transaction, the borrower was purchasing a duplex in Pennsylvania that needed significant rehab, and he intends to do future deals in this neighborhood. For the sake of the discussion, let's say I was lending $25k and the borrower was paying $1k in origination fees (points).

Here is how the transaction went step-by-step:

1. We agreed to initial terms via email.
2. The borrower paid for a real estate attorney to draft up a note with our terms and prepare an open-ended mortgage to establish me in first lien position on the property.
3. Unfortunately, Step 2 took a long time, and the buyer had to go to settlement on the property (via an all cash transaction) before we could get the mortgage in place.
4. About 1 week after closing, the real estate attorney coordinated with the title company to get the mortgage in place. This led to a lot of additional questions from the title company (including confusion about how the funds would be distributed from me to the borrower) which created at least another 1 week delay.
5. After we got those issues resolved, the borrower had to go through settlement again (and pay a bunch of title fees, including Title Insurance) for the second time.
6. Within a few days after settlement, the mortgage was recorded, I received a check from the title company in the mail (for the points I charged), and I sent funding to the borrower.

It took about 5 weeks from the day the borrower contacted the real estate attorney to the day I sent funds to the borrower.

For those who have done this kind of transaction in the past, what does the "happy path" look like?

Here are a few specific questions:

1. Assuming we were able to process the note and mortgage at the first settlement, how and when are funds typically distributed? I had assumed the borrower would pay the $1k in origination fees (points) to the title company and I would provide the title company with a cashier's check for $25k, and then at settlement, the title company distributes the funds all at once. The real estate attorney told us the title company would collect the $1k for points but would not be involved in the $25k distribution. So how does this typically work to ensure the buyer has the funds he needs for the transaction with ensuring the lender's lien is properly recorded all at the same time?
2. For private money lenders, what title endorsements do you typically require in Pennsylvania? The attorney suggested a Closing Protection Letter and endorsements 100, 300, and 900.
3. Now that we have a note and mortgage format we like, do we still need to have the real estate attorney prepare these documents each time or can we use the existing format as a template for future transactions?

Thank you all for your insights and advice!

Matt

[John M. Erdek]

I am writing as a) an attorney who represents both private lenders and borrowers (both traditional and self-directed IRA borrowers/lenders) and "regular" lenders (e.g., banks), b) a partner in a RE investment private lending company and, c) a RE investor for many years.

I have given numerous presentations on private lending to local (Phila-area) RE investment groups over the past 10 years and I am always amazed at how loose private lenders will be with tens of thousands--or more often, over $100,000-- of their hard-earned money.   The posts here are evidence of that.

Without trying to sound harsh, a private lending transaction is not rocket science, but it is complicated and should be handled by someone who knows that they are doing.   The first post here sounds like a farce--that process should have NEVER happened the way it did.  The title company sounds clueless--in several instances. 

A title company should NEVER prepare loan documents--EVER.  The borrower should NEVER prepare loan documents (did Wells Fargo let anyone provide the loan documents for their home mortgage.....?).  The lender is in control and lender makes the rules.   A private lender---just like "real" lenders--should have its counsel prepare the loan documents, and at the borrower's expense.  Just like a bank does. 

There are SO many nuances to private lending that are never touched on by those "winging it".  They may include: Loan structure- single advance, or multiple advances?  When?  How? Lender's title insurance.  Borrower as entity or individual?  Spousal waivers to protect collateral.  Property insurance in favor of lender.  Assignment of leases and rents.  Loan extensions.   Interest or principal/interest payments.   Property/construction inspections.  Invoices for construction materials at property/incorporated into project.  Assignment of construction contracts.  Personal guarantee(s). Confession of judgment for money.  Confession of judgment for possession.  Confession of judgment waivers.  Type of mortgage--open ended or not? Mortgage priority.  Loan agreement (a "note and mortgage" is NOT sufficient--who says the borrower HAS to use the money you advance for the purposes you *think* you are lending it?  Hint:  that's not covered by the note nor mortgage).  Closing protection letters. Endorsements.......   The list goes on.   And on. 

Not every private loan incorporates all of the above, but 70% of it applies to every transaction.   Why would anyone try to wing it?  As I say when I teach RE investment courses:  If everything goes to plan, and everyone does what they are supposed to, you don't need ANY paper. But, when things go sideways, what's the first thing EVERYONE does?  They go to the paper to try and figure out their rights to get the other side to do what they are supposed to do.  Just like RE investment partnerships:  everyone loves each other on day 1, but what happens on day 195 when the project is overbudget/not sold, the payments stop, the contractor has run off, the borrower is in the middle of a divorce--or dies, etc, etc, etc.

Personally, as a private lender using my own and my partner's funds, MY loan documents look an awful lot like those a bank makes you sign when you want money from it.  WHY wouldn't every lender want the same protections a bank requires?  For the relatively small cost of having an attorney review things like the title report, title insurance exceptions, property insurance and borrower documents, as well as preparing the RIGHT documents so everyone knows what is expected of them, it seems like a no-brainer.   That said, the RE investor universe is well-populated by folks who will hesitate to spend $1500 on doing it the right way, but will fork over $100,000 with crossed fingers and a prayer.  

As an attorney, I HATE--HATE-HATE getting a call from a private lender asking "xxxxx happened! What can I do now?" and seeing loan documents that leave them hanging waaaaaay out in the wind.    Old saying in law:  "Pay me now, or pay me later--later is always more expensive".  Totally applies here.      PS--for those trying to save a buck:   reusing loan documents is a tremendously bad idea--details matter. 

Just food for thought---climbing off my high horse now....

John M. Erdek, Esq.

This message is not intended as legal advice and may not be relied on by anyone for any purpose whatsoever. The information in this message is intended solely for general informational purposes.