Collateralized Hard Money Loan - Help Please!

[Tyler Byrnes]

I'm new to the hard money lending business and have just done a few deals with a good friend. I know enough to be VERY dangerous, hence my outreach to my much more experienced peers.

A local builder in my area is looking for short term (12 month) financing to get a small housing project off the ground. They want to cash out 4-5 single family lots so they can use cash to build the first couple of homes and then keep their project going by their own cash after the first sale or two.

I don't feel comfortaable lending on just the dirt. It was mentioned that they could collateralize the loan with other real estate they own free and clear. This is way out of my league. Is this common and are there any traps I need to be aware of?

If it is a residential property that would be an easy re-sale, I'd be ok, but I could really use some guidance.

They are hoping for $200,000 and are willing to pay 10-12% and a few points, but I didn't go too far with it because I'd like to have a lot more information from other experienced people. The builder is well known and has completed many projects over the years, but did get caught up in the downturn and lost a lot of his capital. Apparently he has completed 4-5 hard money deals in the past 3 years and has a strong payment history.

Where do I start with this???

[Ann Bellamy]

From my perspective, this is much more doable than the previous scenario. If you are confident in the 160-175K number, then 100K is about 60% of 170K. That's a comfortable margin from the lender perspective, because you are likely to recover all your funds if you have to foreclose. We take 60% of ARV if it's a rehab deal, and that includes the construction funds, because the value of the property increases as we disburse funds. In this case there is no construction component, so we would use 60% of quick-sale, not 60% of retail or 60% of foreclosure sale price.

Although you didn't exactly ask, below are more considerations when determining your comfort level. Especially with a borrower you haven't done business with before. Bear in mind there are more costs to foreclosure than just the legal.

Here are a few things to know about and look into:
1. Public notices when you are foreclosing run 400-700 each in my area, and you have to do three of them.
2. Auctioneer costs if someone besides the lender takes the property at foreclosure auction. Check with your local auctioneer to understand his fee structure. For us, it's 3% of selling price if someone besides the lender purchases at auction.
3. Auctioneer advertising costs
4. If you start foreclosure, it's likely that the borrower won't be paying property taxes. They will accrue while you get to the auction. And become the responsibility of the successful bidder at auction, which is you if no one bids.
5. Insurance: Same thing. If the borrower stops paying insurance, you will need to force place insurance on the property or continue paying the premiums for the borrower's policy. Forced place insurance is expensive.
6. If the borrower declares bankruptcy, it holds up the whole process, while your legal, tax and insurance costs continue to mount. You may also have to re-advertise because of the delay
7. then there are unknown variables such as municipal requirements, tenant complaints, tenant damage to unit, vandalism of an empty building, freeze damage, the list goes on and on.

Welcome to the lending world, which is not quite as simple and automatically profitable as most people think.