How does private lending actually work? (Legally, taxes, etc)

[Ramsey Persing]

Hi, 

I'm new BP and getting things together for my first BRRRR. One thing I'm a little confused on is how Private Lending works. I have a few people that have indicated an interest to help me with financing in this, but I know there are limits on cash gifts you can receive so someone can't just give me $50,000 to buy a house and I return it to them in a few months with interest. So how is this usually done?

Do both parties co-sign on the deal then refinance to only one name in a few months? Does just the investor sign for the house then I buy it back it back with a conventional loan later at 75% of the value? 

I'd love to know how this works and what others do before I sit down and have the second conversation with the potential investors to make a clear plan. 

- Ramsey

[Kyle J.]

@Ramsey Persing  Well, money from a private lender is certainly no gift since there's an expectation of it being paid back.  And, if done properly, the borrower would never actually be in possession of it.

Here's how it the actual funding would work from a very high level overview:

- The purchase agreement between the buyer (you) & the seller get taken to the escrow/closing agent (whoever that is in your state) 

- A bunch of stuff will happen (e.g. inspections, title searches, etc), and at some point right before closing your private lender will be contacted by the escrow/closing agent and told to wire the amount of the purchase price they agreed to fund to the escrow/title company.  You will also have to wire whatever your portion is (unless your private lender is funding 100%, which is usually not the case.)  Then the closing takes place a day or two later and you own the house.  

Now fast forward 3-9 months (or however long it is until you sell the flip, or refi if you'll be holding onto the property as a rental).  Here's how the private lender now gets paid off (again, just a high level overview):

- At some point, the lender will be requested to fill out a "Demand" where they list how much they are still owed in terms of outstanding principal balance and any remaining accrued/unpaid interest that is due.  (The lender will also be asked for other information such as how much the interest is accruing on a daily basis since it is likely unknown exactly what day the loan will be paid off at that point; wiring instructions; notarized reconveyance paperwork; etc.)

- Once the home is sold or refinanced, the lender will then be paid off in accordance with the "Demand" and wiring instructions he/she previously provided.  (Note: I usually receive the funds the same day, or the next day at the latest, from the escrow/title company.  It depends on what time of the day they initiate the wire.)

That's about it from a high level.  Keep in mind this wasn't meant to be a detailed description of the entire real estate sales/closing process.  I'm just trying to help give you an idea of how the funding portion of it works.  Additionally, who actually handles the escrow/closings varies state-to-state, and sometimes within a state.  For example, some states use attorneys, some do not.  In some places, escrow/title companies are two separate offices, and in others, these are in the same office.  Hopefully you focus on the idea/process I'm explaining to you, not the terminology used (since that can vary so much.)

Ultimately, I wish you the best of luck in your future deals!