Lending hard money loan, need advice

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Lending hard money loan, need advice

Jon Christian
Indianapolis, IN · Member since 2017 · 5 posts · 1 vote

Hi all. 

My real estate agent buddy, whom I've known for a long time, wants me to loan him $7500 for a max of 45 days to pay off his contractors while his investment property flip closes. I don't have any reason to distrust his intentions as he's helped me close on a few deals and he lives and owns right around the corner; ie: he's low risk for fleeing the state for this amount.

I had him write up a contract that says the following: 

This agreement covers the personal loan provided by (loaner) to (borrower), signed into effect on x x , 2020. The terms of the agreement are as follows:

-(loaner) will loan (borrower) $7,500 (principal loan)

-(borrower) will repay (loaner) the principal loan amount of $7,500 plus 10% interest of the principal loan ($750) which brings the total repayment to $8,250.

-(borrower) will have 45 days from the day the money is received to repay the loan & interest total of $8,250 to (loaner)

-The money will be used for (borrower)s investment property, at (address) for roofing, staging, lender dues, and materials/supplies

-If (borrower) is not able to pay the loan back within 45 days, an additional $500 penalty will be assessed for every 15 additional days it takes to repay the loan in full. For example, if it takes 60 days to pay the loan back for example, (borrower) will owe (loaner)$7,500 principal + $750 interest + $500 penalty = $8,750. If it takes 75 or less days there will be a $1,000 penalty. This penalty amount continues to increase by $500 for every 15 days outstanding until the loan is repaid.

We will both then sign the agreement.

Pretty straightforward but am I not considering something to protect me, like actual collateral? Any advice would helpful.

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Kyle J.
Rental Property Investor · Northern, CA · Member since 2012 · 5k+ posts · 5k+ votes
6y

@Jon Christian  A few thoughts off the top of my head.  The title of your post refers to this as a "hard money loan".  A hard money loan is typically secured by a "hard" asset, such as real property.  To be clear, this proposed loan is not that (even though it appears that it will contain the address of a real property in it).  This, as written, would be nothing more than an unsecured loan to a friend/acquaintance (which comes with all the risks typically associated with doing loans like that).

Being that it is unsecured, there is no collateral backing this loan.  If your buddy were to default, you'd have to take him to court and get a judgment and then attempt to collect/enforce it.  I don't know what sort of assets he has to collect from, though it's clear he does not have $7,500 in liquid assets or he would not be attempting to borrow this from you.  And I know no one wants to think about loans potentially going bad (especially when the borrower is a "buddy"), but the fact is they do and you have to at least consider it (and plan for it) on the front end otherwise it's too late.

Lastly, I think it's worth mentioning that this loan as written might not even be legal in your state.   I'm not an expert on Indiana law, but as best I can tell the usury laws in your state limits the maximum interest rate that can be charged on "non-supervised" consumer loans to 21 percent per annum.  Your loan is WAY over that.

Now, you're probably thinking to yourself, no it's not...it clearly says "10% interest".  But let me try to explain.  Your friend borrows $7,500 and he has up to 45 days to pay you back before incurring penalties.  For simple math, let's say he pays you back in full in exactly one month, for which he would apparently owe you $8,250 ($7,500 + $750).  You guys are saying that is 10% interest.  However, that is actually 120% interest per annum.  (10% interest collected in one month X 12 months in a year.)  And that's not even addressing if he were to go over the 45 days and start incurring those crazy high penalties.  

I get it, he's the one proposing this.  But a borrower cannot agree to a usurious loan.  Nor is one legally enforceable if the borrower were to challenge it. Again, I'm not an expert on Indiana law, but that's my interpretation of it after a quick read of your state's laws.  I'd consult with a local lawyer if you want to know for sure because the borrower has ALL the advantages in a usurious loan situation, and the lender has none (and is actually committing a Class A misdemeanor in your state).  So it's worth getting educated on.

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  • Kyle J.
    Rental Property Investor · Northern, CA · Member since 2012 · 5k+ posts · 5k+ votes
    6y

    @Jon Christian  A few thoughts off the top of my head.  The title of your post refers to this as a "hard money loan".  A hard money loan is typically secured by a "hard" asset, such as real property.  To be clear, this proposed loan is not that (even though it appears that it will contain the address of a real property in it).  This, as written, would be nothing more than an unsecured loan to a friend/acquaintance (which comes with all the risks typically associated with doing loans like that).

    Being that it is unsecured, there is no collateral backing this loan.  If your buddy were to default, you'd have to take him to court and get a judgment and then attempt to collect/enforce it.  I don't know what sort of assets he has to collect from, though it's clear he does not have $7,500 in liquid assets or he would not be attempting to borrow this from you.  And I know no one wants to think about loans potentially going bad (especially when the borrower is a "buddy"), but the fact is they do and you have to at least consider it (and plan for it) on the front end otherwise it's too late.

    Lastly, I think it's worth mentioning that this loan as written might not even be legal in your state.   I'm not an expert on Indiana law, but as best I can tell the usury laws in your state limits the maximum interest rate that can be charged on "non-supervised" consumer loans to 21 percent per annum.  Your loan is WAY over that.

    Now, you're probably thinking to yourself, no it's not...it clearly says "10% interest".  But let me try to explain.  Your friend borrows $7,500 and he has up to 45 days to pay you back before incurring penalties.  For simple math, let's say he pays you back in full in exactly one month, for which he would apparently owe you $8,250 ($7,500 + $750).  You guys are saying that is 10% interest.  However, that is actually 120% interest per annum.  (10% interest collected in one month X 12 months in a year.)  And that's not even addressing if he were to go over the 45 days and start incurring those crazy high penalties.  

    I get it, he's the one proposing this.  But a borrower cannot agree to a usurious loan.  Nor is one legally enforceable if the borrower were to challenge it. Again, I'm not an expert on Indiana law, but that's my interpretation of it after a quick read of your state's laws.  I'd consult with a local lawyer if you want to know for sure because the borrower has ALL the advantages in a usurious loan situation, and the lender has none (and is actually committing a Class A misdemeanor in your state).  So it's worth getting educated on.

    4Reply
  • Darius Ogloza
    Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes
    6y

    Commercial loans are usually outside the purview of state usury laws but it is worth checking to be sure. The APR proposed here is nose bleed level when annualized.

    2Reply
  • Daniel McNulty
    Financial Advisor · Indianapolis, IN · Member since 2018 · 294 posts · 165 votes
    6y

    @Jon Christian

    Collateral is certainly the best case scenario. You could try put a 2nd lien on it, but that may not even be a possibility depending on what he did to finance the original purchase. For that size and what appears to be a very time sensitive project, it may not be efficient on cost or time. 

    It is a little troubling that he clearly has gone over budget in his flip and has to ask around for additional funds to complete it, but things happen....

    I suppose you could try to put a lien on some other asset he owns, but again, it may not be worth the cost or time.

    Maybe hold his lawn mower hostage :) 

    0Reply
  • Shawn CouchBusiness Member
    Investor · Encinitas, CA · Member since 2013 · 116 posts · 48 votes
    6y

    A lawnmower may not be enough collateral.  Have him sign the pink slip on his car (assuming he owns and doesn't lease it) and old it until he pays you back, or ask for is Rolex as collateral.  Guys like this that have no money, often waste it on dumb "investments" like a Rolex.  Maybe consider less or a "penalty" every 15 days.  If this loan goes too long, he won't repay you because it will get too expensive.

    I would be careful with this scenario, even though you trust the guy.

    Also, a good thing to remember is that pigs get fat, but hogs get slaughtered.  You don't want to be the hog.

    1Reply
  • Kyle J.
    Rental Property Investor · Northern, CA · Member since 2012 · 5k+ posts · 5k+ votes
    6y
    Originally posted by @Darius Ogloza:

    Commercial loans are usually outside the purview of state usury laws but it is worth checking to be sure. The APR proposed here is nose bleed level when annualized.

    As described, this likely wouldn’t be a commercial loan. 

    Granted each state can define what meets the definition of a commercial loan, it wouldn’t meet the definition of a commercial loan in our state (California). And I’m fairly certain it wouldn’t meet the definition of a commercial loan in his state, especially considering the very first line of the proposed loan language refers to it as a “personal loan”.  :)

    0Reply
  • Darius Ogloza
    Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes
    6y

    California law provides pretty clearly that a loan to be used primarily for the purchase, construction or improvement of real property is not regarded as a loan for personal, family or household purposes, which is what qualifies under the statute.  If you have an authority that provides otherwise, please provide.   

    0Reply
  • Kyle J.
    Rental Property Investor · Northern, CA · Member since 2012 · 5k+ posts · 5k+ votes
    6y
    Originally posted by @Darius Ogloza:

    California law provides pretty clearly that a loan to be used primarily for the purchase, construction or improvement of real property is not regarded as a loan for personal, family or household purposes, which is what qualifies under the statute.  If you have an authority that provides otherwise, please provide.   

    I don’t want to get too far off track because this isn’t a thread about California usury law, but I’ll answer your question for the benefit of others who may be reading and wondering.

    Your comment essentially gives the headline, but not the full story. A loan can be exempt from California usury laws if it's to be used primarily for the purchase, construction, or improvement of real property, AND it's properly originated and negotiated by a licensed real estate broker and secured by real property.  (Source Calif Civil Code 1916.1.)

    The OP's loan does not appear to involve a broker and is not secured by any collateral whatsoever, hence the reason I made the comment I previously did.  And although he is not from California, this is still somewhat relevant because when I read his state usury laws,  I noticed they do reference consumer loans that are non-supervised having a different allowable interest rate than those that are supervised.  

    Ultimately, as I previously mentioned, I'm not an expert on his state's laws though, and I'll suggest again that he seek the advice of local legal counsel if he's going to be making loans that are even potentially usurious because all the risk is on the lender in those situations, not the borrower.

    1Reply
  • Beth JohnsonPro Member
    Lender · Renton, WA · Member since 2018 · 215 posts · 216 votes
    6y

    @Jon Christian

    I'd can it a business purpose loan since he's borrowing for an investment property. I would also recommend a deed against the property to make it secured rather than an unsecured loan. Additionally, I would suggest having more description around the actual interest rate, when installment payments are due and if there is default interest that's incurred. It mentions a balloon payment penalty but no mention of additional interest accrued from the maturity date until he actually pays off completely.

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