How Do You Protect and Structure Private Money?

Question

I've done private money lending in the past with both contracts and promissory notes. If you're a private money lender how do you protect yourself while lending? What legal documentation do you use? How do you vet your lendee prior to transactions? Anything important you shouldn't leave out?

Don Konipol · Answer

COMMERCIAL LOAN DOCUMENTS

• 1. Closing Instructions 
2. Real Estate Lien Note
• 3. Open End Mortgage Deed and Security Agreement 
4. Absolute Assignment of Rents on Real Property
• 5. Guaranty Agreement
• 6. Security Agreement
• 7. UCC-1 Financing Statement - Connecticut Secretary of State
• 8. Authorization to Substitute Pages
• 9. Business Purpose Affidavit
• 10. Environmental Indemnity Agreement
• 11. Loan Agreement
• 12. Notices and Agreements
• a. No Oral Agreements
• b. Document Correction Agreement
• c. Escrow Agreement
• d. Attorney Representation Notice
• e. Funding Notice
• f. Agreement to Provide Insurance and Financial Information
• g. Collateral Protection Notice
• h. Patriot Act Representation
• 13. CIP Notification
• 14. Closing Affidavit
• 15. Waiver of Jury Trial
• 16. Consent to Loan
• 17. Loan Extension Agreement
• 18. ACH Form
• 19. Exhibit “A” Legal Description - all documents (Prepared and attached by Title Company)

• a. No Oral Agreements
• b. Document Correction Agreement
• c. Escrow Agreement
• d. Attorney Representation Notice
• e. Funding Notice
• f. Agreement to Provide Insurance and Financial Information
• g. Collateral Protection Notice
• h. Patriot Act Representation

This may seem like CRAZY OVERKILL.  But, a number of times (we’ve made about 500 loans in the last 20 years) when things have gone south for borrowers they’ve contacted one of a few well known attorneys who specialize in finding anything they can challenge in the loan closing documents; whether items “missing”, points not clarified, or contingencies unaccounted for.  Even if the lender EVENTUALLY proves victorious, the process costs a LOT of time - and money.  With the forms we use these attorneys take a hard look, review and have informed the borrowers that any action attacking the validity of the debt is futile.  The results have been that the borrowers are relieved of their fantasy that they will be able to eliminate debt either partially or totally or tie up the legal process through “lender liability”, and then are forced to confront the reality that they are going to have to satisfy us as to debt repayment and that we rightfully hold the upper hand.

Doug Smith · Answer

I actually just did a podcast for Advanta IRA on this subject. I've been lending for 32 years and we have an NMLS licensed mortgage company. I think most private lenders that don't have a formal credit background get too caught up in only Collateral and not the other 2 C's of credit - Capacity and Character. Capacity is the ability to pay the loan back. What documentation do you have that leads you to believe that the borrower has legit primary (income from the property), secondary (income from other sources), and finally tertiary (liquidation of the security including you recouping your colllection costs and the time value of money it will take for you to get it back if things get ugly). Character is sometimes mentioned as "Credit". Past predicts future. How has this borrower met obligations in the past...particularly when things aren't going well. Do they have a history if staying in there to meet their obligations or do they cut and run leaving the lender holding the bag. When we do contract underwriting for private lenders, we NEVER lend without pulling credit reports on the guarantors. There is a lot that goes into lending. Too many private lenders make loans because the borrower is "a good guy". It's both art and science. After 32 years, I'm still learning every day.

Chris Seveney · Answer

@Trevor DeSimone

1. We run a credit report and get a personal financial statement

2. Besides the typical mortgage and note, we have a loan agreement, assumption of rents/leases and a personal guaranty

We make sure the borrower has skin in the game and plenty of other assets we could go after should they default.

Lane Kawaoka · Answer

The following is all good but all the best documentation or PPMs does not protect again shady people. Best to know other passive investors who can verify track record.

Adam Schneider · Answer

@Trevor DeSimone

Most of these have been mentioned on your thread in parts, and I'll add a little.

You are underwriting the borrower and the property.

Underwriting the borrower is art as much as science. You'll want to understand the borrower's likelihood to complete the project and pay you back. So, look for experience, size of the rehab, market conditions, and borrower credit strength. A $200K loan with $190K acquisition and $10K rehab is totally different than a $200K loan with $10K acquisition and $190K rehab.

Underwriting the property.

1. LTV

2. Deed of Trust / Mortgage

3. Be listed as mortgagee / first payee (not additional insured) on insurance policy.

4. Title insurance. Get lender's title insurance.

5. Promissory Note

6. Detailed scope of work / photos

-----

Borrower's GC. If it's a large project, you'll want to understand the skill set, experience and license level of the GC, too. Check out other work that is similar to the subject project that the person has done.

Hope this helps.

Charley Gates · Answer

Hi Trevor,

@Ned Carey and @Chris Seveney have shared excellent thoughts on this topic.

A few additional thoguhts:

1. Hazard insurance.  Make sure that the coverage is adequate and that your company is listed as a loss payee.

2.  Documentation that the loan is a business loan meant for business purposes (and not a consumer loan).

3.  Bank statements if you have any doubts about their personal financial statement.  If you see any big deposits, you can ask where those funds came from to be sure that the deposit is not actually a liability from another account.

4.  Business entity documentation (OA, articles of incorporation, and EIN letter) for the entity to which you are making the loan.  Make sure that the person signing for the loan has the authority to do so.

Good luck.

Ned Carey · Answer

@Trevor DeSimone I am  not a private lender. you will get better advice from pros here like @Chris Seveney

Number one you need a note and deed of trust (or mortgage depending on your state) qwritten by a skilled att oney with experience in thes matters. i would want to include an "assignement of rents" and potentially a "confessed judgment"' clause.

The most important thing is to know the true value of the property both as is and the ARV. Then lend at a low enough LTV that no matter when you have to foreclose there is enough equity in the property for you to come out whole.  You also need to keep on top of the draw schedule to make sure, your equity is safe.

This is some basic stuff wich you may already know but if you don't these are some basice things you suld not miss.

Pierre E. · Answer

Theres a book called Lend To Live in the BP store, goes through a lot of detail. Might be too beginner, but may also have some points to cover or options or other ideas for you.

Beth Johnson · Answer

@Trevor DeSimone You should check out our book Lend to Live: Earn-Hassle Free Passive Income in Real Estate with Private Money Lending published by BP last year. It's a super comprehensive guide on how to protect your loan and the entire end-to-end process (we call it the C.P.R. Lending System) to finding and funding a loan in a safe and secure manner. While we don't dive into state specific legalities and requirements, it does cover all the documentation you'd want to consider as baseline for a private money loan opportunity. I have a Facebook group called: Lend2Live: A Private Lender Collaborative that you can join to connect with other truly private individuals and small business owners who do PML.

Trevor DeSimone · Answer

Reading a copy of the book currently!