Hard Money Lending - My first time and I need help!

[Michael Clay]

I'm going to be hard lending money for the first time and I need some pointers. I've inspected the property with the lendee and I'm comfortable lending her 80% of the value. She's buying the property for 125k and I'm lending her 100K.  She hasn't given me an appraisal or inspection. She is going to be flipping the property and expects to repay me  within 6 months.  Here are my main questions:

-Should I be getting an inspection report and/or an appraisal from her?

-What type of contract should I use to write up the terms?

-What type of background info should I be getting from her (if any) ?

-What type of interest/points are standard for this type of deal?

I'm probably leaving out a handful of pertinent questions. Any additionally information would be great. Thanks in advance!

[Jeff S.]

All lenders have their own criteria, which I suppose works for them, @Michael Clay. I'm not sure we would know what to do with a borrower's credit report if it hit us in the head.

There is absolutely nothing in a credit report or background check that tells us a borrower knows how to flip a house, make money, and pay you back. These are business purpose loans, not consumer credit.

You didn't mention your relationship with this individual or their experience. The last thing you want to do is loan to someone you hardly know who has an 800 FICO score and has either never flipped a house or has minimal experience. Do you really want someone learning on your dime?

Several years ago, a few of us detailed our lending processes step-by-step here:

I would like to become a Hard Money Lender. Any resources?

My contribution to this thread is still about 90% accurate for us. You'll read that getting to know the borrower a little, as well as their experience, is paramount in our view. We won't loan to someone we've never met in advance or who doesn't do this full time. To know, like, and trust is an overused real estate cliché, but we've run a successful business around it.

Once you vet your borrower I strongly suggest you not try to re-invent the wheel. After you've spoken to a lending attorney in your state (NOT a real estate attorney who does closings), to get a glimpse of the law, I recommend you contact one of the larger hard money lenders in your area and have them originate the loan for you. It shouldn't be hard to find one if you attend a few local real estate clubs.

An experienced HML will have vetted paperwork and will know how to evaluate the deal, the borrower, and navigate within the law. Compliance can be a huge issue. We personally don't use appraisals because we can do our own comps. Your HML and you might want to though (and state law could require it). We also have one rate structure and never make anything up on the fly or use broad ranges. Rates are always local and no one here can give you the prevailing HML rates in Charlotte unless they are local. Plus, you never want a borrower to guess what you might charge. If they have a deal that fits, they'll call you.

Alternately, some HML's sell their loans and you could get into the business that way. Charlotte is a large city with plenty of business. It's just too easy to stay close to home when you loan money, Michael, so be careful and good luck.

Jeff S. Private Lender in Los Angeles

[Jason D.]

I'll preface my comment by stating that I'm not a lender, and have no experience lending. But, things that I would need to know when it comes to the property include, what is the scope of work? what is the estimated rehab costs (then add 10-20% buffer)? What is the current, as-is value? What is the ARV? What is the exit strategy? When it comes to the borrower, I would, obviously run a background and credit check, what's their experience? How much cash do they have in the bank after the purchase? Do they have a W2 job? What is their income? As for terms, it's pretty standard to charge 3 points and 12% interest for new investors, maybe a little less for the more experienced. There is probably more but that's what I could think of off the top of my head.

[Account Closed]

@Michael Clay

I'll give you my opinion on your questions:

1) Since you are lending you become the mortgagee and can require both an appraisal and inspection, but you need to make this explicit. I would require a formal inspection on the property. You can usually comp properties out yourself, but you need to know if there are any major structural problems. 

2) I would consult a local attorney to ensure you are considering all applicable laws (usury, registrations etc.)

3) This is up to you. My company does not lend to anyone under 720 credit or anyone with a criminal record to start. From there the questions I would ask are: is this her first flip? How mature is her project plan and does she have sub contractors lined up? Track record is a major focus in additional to personal credentials. 

4) Depends on the property and project plan. We value each deal independently and agree on a fee structure (usually 1-5 points and 10-15% interest as a broad range).

For context one of my company's business lines is first lien notes (hard money). 

PM'd you my info if you want to chat more. 

Disclosure: This is not to be considered any legal advice or solicitation. 

[Bob Floss II]

@Michael Clay You should absolutely make the purchaser go through a credit and background check before you lend money. Contact a local attorney that does real estate and have them draft a loan package on your behalf. You need to have a Note and Mortgage signed at closing and have the Mortgage recorded on title by the title company. 

In this scenario, I would want to see some type of verification from the buyer that they have funds to make the down payment and execute the rehab. Request a scope of work with expected expenses for each line item and find out how the purchaser plans to fund the work. Couldn't hurt to get a cma from a local agent on expected value of the completed project. 

It doesn't happen often, but I've seen investors purchaser a property with no rehab plan or funds set aside and the property ends up sitting for several years.

[Michael Clay]

@Account Closed Thank you all so much for the feedback! All of these tips make this new business venture far less daunting. 

I have a couple of different closing attorneys that I do a lot of business with, it sounds like they will be able to take the point on the specific contract forms? Also, would I make sure the deal closes through my attorney or does that not matter?

[Account Closed]

@Michael Clay

Working with your attorney you will most likely need the following:

1) Loan Agreement

2) Promissory note (if lending to a LLC)

3) Personal Guarantee (if you require one)

4) Mortgage / Deed of Trust (depending on local laws)

One important point is to ensure the property has a clear title (title company will do this, but ensure you have proof before wiring money). Closing will most likely be done through the title company, your attorney needs to draft the docs and ensure they are enforceable. 

[Michael Clay]

@Account Closed Great information. I should be good to go as of now. Thanks again!

[Jeff S.]

All lenders have their own criteria, which I suppose works for them, @Michael Clay. I'm not sure we would know what to do with a borrower's credit report if it hit us in the head.

There is absolutely nothing in a credit report or background check that tells us a borrower knows how to flip a house, make money, and pay you back. These are business purpose loans, not consumer credit.

You didn't mention your relationship with this individual or their experience. The last thing you want to do is loan to someone you hardly know who has an 800 FICO score and has either never flipped a house or has minimal experience. Do you really want someone learning on your dime?

Several years ago, a few of us detailed our lending processes step-by-step here:

I would like to become a Hard Money Lender. Any resources?

My contribution to this thread is still about 90% accurate for us. You'll read that getting to know the borrower a little, as well as their experience, is paramount in our view. We won't loan to someone we've never met in advance or who doesn't do this full time. To know, like, and trust is an overused real estate cliché, but we've run a successful business around it.

Once you vet your borrower I strongly suggest you not try to re-invent the wheel. After you've spoken to a lending attorney in your state (NOT a real estate attorney who does closings), to get a glimpse of the law, I recommend you contact one of the larger hard money lenders in your area and have them originate the loan for you. It shouldn't be hard to find one if you attend a few local real estate clubs.

An experienced HML will have vetted paperwork and will know how to evaluate the deal, the borrower, and navigate within the law. Compliance can be a huge issue. We personally don't use appraisals because we can do our own comps. Your HML and you might want to though (and state law could require it). We also have one rate structure and never make anything up on the fly or use broad ranges. Rates are always local and no one here can give you the prevailing HML rates in Charlotte unless they are local. Plus, you never want a borrower to guess what you might charge. If they have a deal that fits, they'll call you.

Alternately, some HML's sell their loans and you could get into the business that way. Charlotte is a large city with plenty of business. It's just too easy to stay close to home when you loan money, Michael, so be careful and good luck.

Jeff S. Private Lender in Los Angeles

[James Palassis]

I like to put a term on the loan, longer than the estimated project time. For a 6 month project, I’d put a 12 month term on the loan. Balloon payment at 12 months, regardless if the property is sold. If the project is not completed in 12 months, you have the option to renegotiate the rate, foreclose on the collateral, or the borrower can go with someone else and pay you off with your interest.

[David Seroy]

All the above advice is good. One thing that wasn't mentioned, which is North Carolina specific, at the very least you absolutely must ensure the borrower takes title to the property as an LLC, or just not as an individual AND the property is non-owner occupied.

Otherwise, your loan will be classified as a Residential Mortgage Loan. This is easy stuff, but definitely make sure you at least ask your attorney and they’re familiar with this.

Not complying with this is puts your loan under a much more massively regulated set of laws.

[Chris Purcell]

@Michael Clay

Off topic

But if you have the capital for lend for deals, why are you not just buying them yourself?

[Van Blackman]

@Michael Clay

Good morning sir!

You'll absolutely want an inspection done, along with an appraisal done by a THIRD PARTY appraiser before closing. In other words, do not get one from your borrower. I would hire one out independently so that the results are not biased.

Secondly, you should absolutely get your borrower's financial information: recent pay stubs, last year's tax return, any other retirement accounts, or IRA accounts, etc. that your borrower can show. You'll also want to run their credit. More important than credit, however, in my opinion, will be their cash on hand. They should have significant funds of their own in case something happens. And make sure that the funds have been in their account for a while. That's called "seasoning". If all their money was gifted by a relative last week, I wouldn't feel safe doing the loan, if it were me.

Are you putting the borrower on a draw system, or are you giving them 100% of the loan up front? Most HML's do the draw. In other words, you'll provide 100% of the rehab amount, but your borrower will come out of their own pocket initially to start the repairs. As repairs are made, you will reimburse the rehab funds from your loan as needed. Make sense? If you give all your money up front, your borrower might just go buy a car with it.

It looks like you're getting a lot of great advice on this thread. Just make sure you think this through, and hire professional help. I'm sure there's a lot of money to be made as a lender, but you don't want to take a bath on your first go-round.

Good luck!

[Glenn Hull]

A lot of good advice in this thread. I previously worked in risk analytics at a large hard money lender and 3 of the most important things are:

1) Experience. Flipping can be difficult and people who have flipped at least one time before perform significantly better than first-timers. The more experience the better.

2) Location matters a lot. Some areas have very tough permitting conditions which take a long time to navigate. There's a reason most large hard money lenders don't originate loans in Cook County. Further, some areas are more saturated/generally more difficult to profit in.

3) Personal details. Credit score, background checks, past foreclosures, etc. You need to be sure that the flipper has nothing questionable.

In general people tend to underestimate the time it takes to flip a home (especially people who are new) and all of the potential problems that can pop up. Between permitting processes, construction issues, and time-to-sale there's a lot that can lead the project astray. Best of luck!

[Jay Hinrichs]

Originally posted by @Chris Purcell:

@Michael Clay

Off topic

But if you have the capital for lend for deals, why are you not just buying them yourself?

since I deal in the position of the bank for my day job.. I can tell you from hundreds of my clients perspective.

they don't want to have the burden and work that goes into being a landlord.. they want mail box money and more passive investment that is secured by the same asset that a landlord owns.. there is a reason those banks have those big shinny buildings.. its massively profitable and done right less risk in many cases of being a landlord or at least let me say a ton less work.. your not dealing with the day to day.. even if you have PM you have to manage them.

My note buyers are almost all experienced landlords and as their days of landlord burn out come to fruition they switch to being the bank.. keep in mind unless the house is sold for cash.. everyone buying a rental has two steps  equity and debt  IE their equity and the bank or  lenders debt.

Along with shorter term holds.. and if done right no cash calls.

[Michael Clay]

@Jeff S. Very helpful insight. I put up an ad advertising hard money and the potential lendee reached out to me. I met her at the property yesterday. Her and her husband have their GC license so they have done some flips in the past. I asked her for a credit and background check, a copy of her financials, examples of a few of their previous projects, a breakdown of their scope of work including prices on each portion and comps to justify their expected sales price after the flip.

I'm an agent so I've already looked into the comps and I'm satisfied with the deal. 

Reaching out to a lending attorney is excellent advice, otherwise, I would've just called a closing attorney. 

Thank you very much!

[Michael Clay]

@James Palassis Thanks. I'm going to put a balloon payment on the loan. They expect to be done in 6 months so I'll do the balloon at 12 months.

[Michael Clay]

@Chris Purcell I like to diversify so I've been wanting to test out HML for a couple of years now. I'll still be able to buy my own deals.

[Michael Clay]

@Van BlackmanThanks for the knowledge/advice, sir! 

I'm only providing the money to purchase the property, they will be funding the rehab. Because of this I asked the them for all of their financial info to prove they can fund the entire rehab with a good chunk of money left over in case something unexpected comes up. 

[Michael Clay]

@Glenn Hull Thank you very much for the advice! Very helpful!

[Shiloh Lundahl]

@Michael Clay I have worked with 5 different hard money lenders in the past few years. Here is what they did. They lent money on the asset. When I first started using hard money I partnered with someone who had a relationship with the hard money lender. Then they got to know me and knew that I had done some deals and then they started with lending me 80% of purchase price. Then, over time as I developed a track record, they started feeling more comfortable lending me a higher percentage of the purchase price. 

My experience and the asset were more important than my credit. In fact, I don't think that they ever ran my credit to give me a hard money loan. They just looked at the asset and they looked at the ARV and asked me for my estimated repair budget and if the numbers work for them, then they lent me the money through title. They all had their own lending docs that were professionally created by their their lawyers.

[Michael Clay]

@Shiloh Lundahl Great to hear from someone on the other side of the transaction. Much appreciated!

[Frank Y.]

There are so many comments and points here. As a private lender, I would add that make sure you are the 1st lien holder. Make sure your name listed on property insurance policy as first mortgagee. Good luck.

[Jeff Rabinowitz]

Originally posted by @Michael Clay:

@Jeff S. Very helpful insight. I put up an ad advertising hard money and the potential lendee reached out to me. I met her at the property yesterday. Her and her husband have their GC license so they have done some flips in the past. I asked her for a credit and background check, a copy of her financials, examples of a few of their previous projects, a breakdown of their scope of work including prices on each portion and comps to justify their expected sales price after the flip.

I'm an agent so I've already looked into the comps and I'm satisfied with the deal. 

Reaching out to a lending attorney is excellent advice, otherwise, I would've just called a closing attorney. 

Thank you very much!

That ad can get you in a lot of trouble if it is worded incorrectly. You must not offer specifics (rate, term, amount, etc.) to people with whom you do not have a relationship. If your ad is on the internet, you may be violating the lending and securities laws of all 50 States and the SEC simultaneously. Have you spoken to an attorney yet? 

[Adam Schneider]

@Michael Clay When you say a balloon payment, are you meaning to say you are calling the note due? You are a broker, and have run the comps, so you know the ARV. You are only doing the acquisition, so you don't have to worry about draws. You are (I assume) doing a first lien, so you are protected there. You want to be named as mortgagee (not additional insured) on the insurance policy, and you want to be on the title insurance. There are two camps of advisors on this thread...I'm in the camp that the asset and the borrower experience are significantly more important than the borrower's credit score (excepting an extreme outlier / recent bankruptcy type stuff), W2, proof of employment history. As a recommendation for the future, I would attend a private lending convention. The AAPL has one in Vegas where they do a good beginner class, as an example. NC is a great place to do HMLs.

[Account Closed]

@Michael Clay There are a ton of other factors you should take into account. I'd say some asset based lenders couldn't care less about credit score. but they will ask for previous huds to verify experience. I personally wouldn't lend to anyone that doesn't have any experience. And assuming they have experience,I'd still make sure they have adequate cash reserves in case things go south. 

You want to know the SOW and wether or not the estimate matches the SOW. I'd maybe go as far as finding out who's going to be the GC working on the project. Is she financing the repairs? Is this a cosmetic project or a full gut? And why is this person not financing the deal through a HML? I'd hope he/she is trying to get a better rate. If another HML, doesn't want to finance it then it's a red flag.

[Michael Clay]

@Frank Y. Great tip!