Return on money for private money lenders

[Erin Butler]

This is a concept that confuses me, so I'll ask the community. 

Obviously- if you have private money on your side, that'll add rocket fuel to your  buisness. Here's my question, how does return on investment work for the private money lenders on buy and holds, whether it's single family or multifamily? 

Do you agree on the percentage return they recieve? Do you split the cashflow 50/50? Exactly how does this work for the private money lendors?

[Tracy Kelly]

I am a PML in California, so it may be different elsewhere. But when I fund a buy and hold loan, for the borrower it’s much like getting a loan from a bank. We agree on the amount, the type of loan (interest only or amortized over some period), the length, and the interest rate. There is often a broker involved and there are loan origination costs much like with a bank. All I get are the loan payments.

The loans are typically set to between three and five years. This gives the borrower time to purchase the property, get a renter and show that they can make the loan payments.

After some time, generally a year or two, the borrower will go to a bank, show that the property is making money and that they are paying the private money loan. Then they will get a conventional long-term mortgage, with a lower interest rate. I am then paid off and a conventional loan is in place. At no time do I receive any cash flow from the property; just the loan payments.

If the borrower cannot get a conventional loan, they may go to another private money lender, but they will be able to show that the property is profitable and they have been paying the loan. This can help to get a lower interest rate, as well.

The interest I get will depend entirely on the parameters of the loan request. Is it a first or a second mortgage? What is the LTV or CLTV? What is the borrower's FICO score? Is the property in an area where it will rent easily? Is it a SFR that will produce one rental stream or a multi-family which will produce several? Etc.

In California, the interest I receive is between 9.5% and 12%, but the borrower generally pays 1% more that is taken by the servicing company. I only make loans that I feel are fairly low risk, so the rates go up as risks increase. I personally have not seen rates higher than about 14% (not counting servicing fees). They may be out there, but I hope that gives you an idea of rates.

Again, this is just my experience in California and it may be different where you are. But I know it is confusing when you are first starting out, so I hope this helps.