Private Money Lending Guide

Executive Summary

In this guide, you will learn all you need to know to safely become a Private Lender in real estate. The majority of this guide provides detailed education on what you need to know prior to deciding to lend. The remainder of the guide details the actual Private Money Lending process steps and actions to take after you lend. Specifically, you will learn the following:

How you can significantly increase your returns over your current investment options

Everything to ask a real estate investor prior to lending

How to successfully do Private Lending step-by-step

Understand all the Private Lending key terms and documents

How to evaluate a real estate deal to ensure it meets the minimum Private Lending criteria

How others, right now, in your city are earning 5%, 8%, and 10% and more on their money as a Private Lender

If you are new to lending, be patient and as you read this guide. The opportunity Private Lending offers will start to make sense. If you have any questions along the way, don’t hesitate to contact me directly. My name is Victor, I am a full-time real estate investor and entrepreneur in Georgia and South Carolina.

Ok, get your popcorn ready and let’s get started!

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Prior to Lending

What is Private Lending?

Basically, Private Lending is your opportunity to become the bank and earn the higher interest rate that the bank is currently earning on your money. Your typical conservative bank investment vehicles are likely earning you anywhere from 0%-5% where Private money lending can earn you 5%-10% or even more. It’s your opportunity to eliminate the middleman and increase your returns.

In our case, we are going to breakdown Private Lending in real estate. So, that is when regular people like you and me lend our money to a real estate investor to buy a distressed property at a significant discount. The funds to close on the purchase and make repairs (your money) are secured by the real estate investor and collateralized by a 1st position mortgage (lien) against the property you choose for your investment.

What Kind of Interest Do Private Lenders Earn?

Well, it depends a little on you, the lender, and the real estate investor that you lend your money to.

In general, Private Lenders are paid anywhere between 5% and 12% interest for the money that they lend, depending on whether you, the lender wants to receive payments monthly, quarterly or upon the sale of a property.

Why Would Anyone Borrow Money at 5% to 12% Interest When Banks Charge Much Less?

Real estate investors commonly borrow money at these rates. Why? Well, because it’s not the cost of the money that is inherently important to successful real estate investors, rather, it is the speed and availability of the funds.

Here’s what that means.

Real estate investors buy distressed properties at a discount to make a profit. Many times, the properties purchased are in a condition needing repair and banks take a long time to evaluate a loan package. This can kill the deal.

Speed is a real estate investor’s best friend.

The best real estate deals are made when the real estate investor can close fast and pay cash. So, when banks delay and are too slow to fund, real estate investors can lose great deals. Because real estate investors buy for profit, paying a high return on money borrowed is akin to giving a little profit away to the lender that helps get the deal done.

It’s a win/win opportunity for both lender and borrower. The lender (you) gets the opportunity to earn high returns secured by the borrower (real estate investor) and collateralized against a great real estate property and deal. The real estate investor gets to keep their business profitable without the limitations and delays usually imposed by traditional banks.

How Do I Evaluate Whether a Private Money Loan is a Good Investment or Not?

It is fairly simple to evaluate the risk and the potential opportunity of a Private Money loan.

Let me explain.

Equity and your maximum loan-to-value (LTV) are your safety net and your primary point to consider in every deal. Here’s how you do that.

First, determine the After Repaired Value (ARV) of the property being considered for the loan. This value can be done by reviewing comparable properties provided by a real estate agent, property appraiser, or software applications.

Second, after you determine the ARV, you need to consider the estimated repair costs. This should be provided to you by the real estate investor you are considering making the loan to. Now, if you are unsure whether the estimate being provided to you is accurate; you should ask for a contractor to provide a bid. Once you figure out the ARV and the repair estimate, you’re almost there.

Third, you must consider the purchase price of the property. Once you know these three numbers, you can evaluate your total LTV which should not exceed 70% to 75%.

Remember: MAXIMUM LTV (Not to Exceed) = 75%

Example:

Purchase Price + Repairs = Loan Amount

Loan Amount divided by ARV = LTV%

ARV: $135,000

Repairs: $29,000

Purchase: $66,000

Your calculations: $66,000 + $29,000 = $95,000

Then, $95,000 divided by $135,000 = 70% LTV

If your loan satisfies the max LTV formula (75% plus or minus) your risks are significantly reduced and you are most likely making a good private money loan.

Now that you have the formula to evaluate whether your loan is a good investment or not, it’s time to explore several things to consider as you enter the world of Private Lending.

What Should My Maximum Loan-to-Value (LTV) Be?

As previously mentioned, your LTV, which is the ratio of the amount of money you lend to the ARV of the property, should generally not exceed 70% to 75%.

In some cases, it can be acceptable to deviate slightly from this range, however, as a Private Lender, it is important to remember your biggest security (your safety net) is the fact that you lend much less than the ARV of the property. So, the higher your LTV, the “riskier” the loan.

Traditional banks, i.e. first mortgage lenders usually lend up to 80% LTV. As a Private Lender it is usually in your best interest to lend at a lower LTV. When you find a good real estate investor to make Private Loans to, you will rarely find highly leveraged (high LTV) deals. If you do, you should reconsider the true strength of the deal and the skill of the real estate investor. Real estate investors that find “deals” that require higher LTV loans from Private Lenders are usually not deals at all. Find an experienced real estate investor that knows how to buy the right discounted deals. Do this and the inherent risk of this investment goes down considerably.

What Additional Factors Should I Consider When I Make a Private Loan?

There are two basic things to consider as part of your funding package aside from the LTV to properly collateralize your loan.

First, when you fund the loan, you should receive a Lenders Title Policy. This protects you and your loan against defects in title. Because all of your private loans will be funded at an attorney’s office or title company, getting a lenders policy is a very simple process. Simply ask the real estate investor to include this as part of the funding package. You can read more on this under the Title Company section below.

Second, you should be named as Loss Payee on the real estate investor’s property casualty insurance. This protects you in the event of an insurance claim loss. In order to claim the loss and cash the check from the insurance company, the real estate investor may need your signature. Ask the real estate investor to make this a part of the closing packet with the insurance company.

What is Title Insurance and Do I Need It?

When a real estate deal closes, there generally two types of title insurance issued – an Owners Policy and a Lenders Policy.

Title policies are essentially insurance policies that protect the owners and lenders on real estate transaction against possible problems with title. Remember, no matter how carefully the title is researched, it is possible that problems can arise after the fact. In rare cases, a closing is performed, a loan is made and then some time in the future someone discovers a problem with the title. That could affect the legitimacy of the closing and potentially cause a problem.

However, with a title policy both the owner (with the Owners Policy) and you as the Private Lender (with the Lenders Policy) are protected against problems missed at closing.

When traditional banks fund loans, it is a standard part of their long and complicated closing instructions that they require the title company to include a Lenders Policy.

This is often overlooked in private money loans because they are “cash deals” and many times the private lender doesn’t ask for a lender policy.

Now, the real estate investor should suggest and make sure a Lender Policy is in place to protect your loan. An experienced real estate investor will get an owners policy and may not get a lenders policy. If they don’t, you should know the risks and benefits of having or not having this policy. Here are several things that can cause a title defect (problem missed at closing) and would be covered under the title policy:

• Forged and fraudulent signature or signatures obtained under duress

• False impersonations

• Paperwork completed under expired, revoked or false powers of attorney

• Conveyance after the death of an owner

• Homestead rights of a spouse

• Improperly probated wills and/or undisclosed heirs

• Mistakes in the interpretation of wills and/or trusts

• Deed by corporations without property legal authority

• Misrepresentation of marital status by seller

• Clerical errors in preparing and recording legal documents

• Survey and easement errors

An insured title, i.e. when an Owners and/or Lenders Title Insurance Policy is in place protects against future attacks on title and protects the rights of the insured. Title insurance ensures that you have ‘clear and marketable’ title to the property and if there are any problems any costs associated with resolving the problems are borne by the insurance company. Any loss resulting from defects in title are paid by the insurance company up to the limits defined in the policy.

Title insurance is bought with a one-time fee or insurance premium and paid for at closing. When this premium is paid, the risk of title defects is transferred to the insurance company.

This is important because no matter how well a title is researched, it is possible that certain title defects are missed, misinterpreted or fraudulently conveyed. With a Lenders Title Insurance Policy, you are protected.

So, the advantages to you when the real estate investor buys title insurance are:

• You receive no fault recovery of loss

• All claim costs are paid for you to repair any found defects

• You receive broad coverage including coverage over neglect by the closing agent or attorney

• The cost is a reasonable one time premium and can be paid by the real estate investor

What Type of Insurance Needs to Be In Place When I Fund the Loan?

Property, casualty, and fire insurance are absolute necessities for real estate investment transactions. In general, the policy will protect you in the case of a loss or damage to the property if the damage is the result of the following type of events:

• Fire

• Lightning

• Explosion

• Earthquake

• Impact

• Collision

• Riot

• Theft or malicious acts

• Subsidence

The policy must be a “Landlords” policy to cover vacant property while under construction. This is a much more expensive policy than the traditional landlord policy because of the greater risk to the insurance company associated with vacant property. Insurance premiums are usually paid for the first 3-6 months and then paid quarterly or semi-annually thereafter.

After construction is complete and the property is sold, the policy is cancelled. If the property is rented, the policy is converted to a traditional occupied policy and the monthly costs are reduced. For example, the policy of an occupied property might be $500 to 700 per year whereas a vacant property policy may total as high as $2,000 per year.

A good real estate investor will account for this cost, known as a carry cost, when they evaluate and present a potential property for a private loan.

As noted above, you should be named as the lender, Loss Payee on the policy. If the policy expires, you as the lender can force the activation of the policy, maintain coverage and can charge the expense back to the real estate investor.

Your risk here is if you do not have insurance and the property burns down, you are potentially at risk of loss. Make sure you and/or your real estate investor have the appropriate insurance in place when you make private loans.

Do I Need to Close with a Title Company or Attorney?

For your protection and for the reasons noted above under the title insurance section, it is highly recommended that you only fund a private money loan when the real estate transaction closing is being held by a professional. Some states use attorneys to close real estate transactions and other use title companies. Depending on the state in which you are making the loan, you will close with one or the other. For example, Georgia is a closing attorney state.

How Can I Determine the ARV of a Property Before I Make a Loan So I Really Know My LTV?

A professional appraisal or Comparative Market Analysis (CMA) must be ordered and complete on each property by a licensed property appraiser or licensed professional real estate agent. An appraisal/CMA is a written estimation of the properties fair market value in a fully repaired condition. This report or an equivalent should be provided to you by the real estate investor.

By obtaining this estimate of the repaired fair market value, you will have access to the relevant and important facts of the property. This report will make both you and the real estate investor well equipped to handle the private money loan. In some cases, when you are working with an experienced real estate investor and their team of licensed sales agent professionals, it is acceptable to review a thorough CMA in lieu of an appraisal. If you have any question in evaluating the validity of the value estimate provided to you ask the real estate investor for a thorough explanation. And, when in doubt have a third-party real estate agent perform a “spot check” on value and give their best estimate.

What Do I Need in Order to Feel Comfortable with the Repairs to the Property?

One of the first things to help get comfortable with the repairs is to build confidence with the real estate investor you plan to make the loan to. Ask questions to see other projects the real estate investor has completed, including before and after pictures of their projects.

You can also ask for a construction scope of work and a construction estimate before you make the loan. The scope of work should identify what work will be done and the estimated timeframe.

You can ask for an inspection. Many real estate investors perform their own inspections. When the real estate investor is buying at deep discounts and is buying significantly distressed properties, there are often “problems” with most of the property. The main concerns as a private lender are not whether the water heater or furnace works, the real estate investor is likely estimating the costs of replacing these items in most purchases. However, structural problems are usually the big red flags in a real estate investment deal that require substantial repairs.

If the real estate investor is experienced, they will often inspect the foundation and roof on their own, however, sometimes it is might be worthwhile to have a contractor and/or property inspector do another third-party inspection. You can request that your real estate investor have a third party inspect the property before you make the loan, especially when you are just starting or if you have concerns that the real estate investor unable to adequately inspect the property on their own. The cost of this inspection should be assumed by the real estate investor.

Remember, it is the job of the real estate investor to show you the deal is good, it is not your job to work hard and figure it out on your own. If your real estate investor doesn’t have the system or ability to earn your confidence by clearly showing you the current condition of the property and the needed repairs – reconsider making the loan.

Before making the loan, you should feel 100% confident that your real estate investor knows construction (or has a contractor engaged as part of their team that knows construction) and can show you exactly how they’ll get the job done.

Will the Real Estate Investor Make Any Money Before the Property is Fixed Up or Do All the Profits Come at the Sale or Lease?

That depends. Successful real estate investors build profit centers into each real estate deal in order so their real estate business cash flows to support overhead and operating expenses. It costs money to run a successful real estate investing business. Most real estate investors build additional profit centers in acquisitions, construction, and management. This is something that you as the private lender want your real estate investor to do.

Why?

Because real estate investors that make money will be in business long term. When you make a private money loan, make a loan to a real estate investor that knows how to make money by operating efficiently and profitably while creating consistent cash flow in their business. A business without cash flow is a business on the verge of failure. Make sure you are dealing with a real estate investor that knows how to create regular and repeatable income to enhance your success as a private lender.

Private Lending Process

What Paperwork Is Involved in Becoming a Private Money Lender?

The paperwork is quite simple and provides strong legal protection for your private money loan. There are two documents that set up your loan terms and additional security.

First, a Promissory Note is signed by the real estate investor as evidence of their promise to pay your loan back. The Promissory Note identifies the terms of the repayment to include: interest rate, payment schedule, duration of loan, etc...

Second, the Mortgage or Deed of Trust is signed by the real estate investor and recorded in the public record by the closing attorney or title company to further secure your loan against the property. Some states use mortgages and other states use deeds of trust.

Now, just so you don’t get confused. A “Deed of Trust” is NOT the same as the Deed. The Deed is the evidence of ownership. It is recorded in the public records and shows that the real estate investor owns the property.

The Deed of Trust is the second document that is recorded along with the Deed and shows evidence that you have money invested and collateralized against the property. It’s is your safety net for when the real estate investor sells the property. Your stake in the deal is documented on record and notifies the world that you are owed money and you get paid as part of the transaction.

How Do I Actually Fund the Private Loan – Where Does My Money Go?

Let’s start the answer to this question with a statement: You almost never want to give money directly to the real estate investor. It’s just poor business practice. Unless, you have completed previous deals together and have a great relationship with your real estate investor.

When you are ready to make a private loan, your money will go from your bank account directly to the closing agent (Attorney or Title Company) most likely with a wire or cashier’s check. The real estate investor will not touch the money until after all of your funds have been further secured by the real estate. The closing company will guide and ensure this process happens.

At closing, the closing attorney will make sure the real estate investor signs the Promissory Note, Deed of Trust, and that everything is properly documented.

What if I am Unable to Fund the Entire Purchase Price, Rehab, and Carry Cost?

In this case ask the real estate investor if you can fund part of the deal. Typically, the investor will still let you come in on the deal, however it is likely that you will only receive a promissory note and your investment will not be tied directly to the property through the Deed of Trust. This can seem concerning at first, however, if you have a good relationship with an experienced real estate investor who is willing to put your money to work it can still be a good fit for you both.

After Lending

What Do I Need to Do to Monitor My Private Loan?

The main thing you want to do is make sure that when you fund the loan, that is when you

actually part with your money, that your funds are being secured with a Promissory Note signed by the real estate investor and that the closing attorney or title company is recording a Deed of Trust on your behalf for funding the deal. As this process completes your money is immediately collateralized against the property.

The next thing you want to do is make sure that the real estate investor that you made the loan to is actually doing the repairs. To do this, drive-by every so often to see the progress. There is no need to schedule this drive by with the real estate investor. A good investor will send you, either formally or informally, pictures of relevant updates and progress notes.

Surprise inspections keep you comfortable and the real estate investor honest. Do a visual inspection of the property in person or you can have a friend, family member or someone else do that for you.

How Do I Get Paid When the Loan is Due or the Property is Sold?

A pay-off letter will be prepared, by the real estate investor or closing attorney (approved by you) stating the final pay-off of your loan. This pay-off letter is sent to the closing company handling either the sale of the property so that they can collect and disburse funds directly to you at closing.

Here’s an example of how the numbers on a typical private loan work:

After Repaired Value (ARV): $135,000

Purchase Price: $66,000

Estimated Repairs: $28,000

Closing / Holding Costs: $2,500

Total Private Loan: $96,500

LTV: 71% ($96,500/$135,000)

Loan Terms 10% (annual interest rate for 6 months)

Total Interest Paid to You: $4,825 [$96,500*(10%*(6/12))]

Your Total Payoff: $101,325 ($96,500 + $4,825)

So, in this case, you provided a loan for $96,500 to the real estate investor. The real estate investor paid you a 10% annual interest rate for the loan that was out for 6 months to complete the project. Each month you earned $804 for a total of $4,825 over 6 months. Your final payout of $101,325, is $96,500 principle and $4,825 interest.

Did the Real Estate Investor Still Make a Profit?

You bet, the real estate investor still made a handsome profit even after paying you a high interest rate for your private loan. A good real estate investor should contact you 30 days prior to the sale of the property to inform you that the total deal is near completion. A great real estate investor will already have another deal ready for you to potentially fund. Almost immediately after closing this private loan, the Private Lender usually makes another loan with the same real estate investor, earning a great cash return and ensuring another win/win deal.