Lending Private Money to Real Estate Investors

I’m sure you’ve heard about how hard money lenders are just making a killing on interests and points. And, maybe this has piqued your interest in getting into the same business?

Well, if you do decide to, here’s some information on how you can become a private money lender or a pseudo hard money lender, and serve real estate investors.

So, what is a private money lender?

Basically, it is an individual, who lends money generally to real estate investors to help them fund their deal.

Here are some things to look out for and to help you potentially maximize your returns if you're going to engage in private money lending.

1. Interest Rates

Let’s start with interest rates. Usually, they are going to be higher than the 30-year mortgage rates that you see out there. But you can go as low as the rates you're comfortable with.

Typically, for experienced real estate investors, I've seen rates go as low as 6.5%, and then for new investors, you can go up to 15%. When you're negotiating with these investors, feel them out because maybe you can charge even more.

2. Points

Points are a percentage of the loan amount that you will charge the borrower at the beginning of the loan. Though, sometimes, they are paid at the end.

If I was doing this myself, I would prefer to charge them at the beginning of the loan. In this way, it would reduce the cash I'll need to wire over to them.

So, how do points affect your return?

The points depend on the length of the term of the loan. For example, let's take a $100,000 loan that is payable in six months. You charge them two points, which is $2,000 over the six months.

If you annualize it, it is going to be $4,000 over a 12-month period. So, the $4,000 divided by $100,000(Amount of the Loan), leaves you at 4% return in a year.

On an annualized basis, the two points that you were charging equals a 4% interest rate. Add that onto your interest rate, say you charged them a 12% interest rate, you're looking at a 16% annualized return.

When dealing with experienced investors, you may be at zero points or somewhere close. But with new investors, you may be able to get away with up to four or five points.

3. Length of Loan

The third is the length of the loan or the term. Usually, these private money loans are around 12 months. Some private money lenders want their money back in six months. Some of them will give you up to 24 months.

It all depends on what the market is commanding. Preferably, I would set it up as a six-month or a nine-month loan with the ability to do an extension. Then, charge the borrower for the extension, maybe a couple of hundred bucks or half a point or something. In this way, you can boost your return.

4. Underwriting Fees

Other ways to boost your income are underwriting fees, which includes but are not limited to Application Fees, Appraisal Fee, and Paperwork Fee.

a. Application Fee -  Private lenders charge an application fee to do the underwriting. You can charge like a $200 or $500 application fee. If you look at hard money lenders, they're usually anywhere from $200 to $1,500, depending on the lender.

You want to be careful with this because most investors are going away from hard money lenders to private money lenders so they can avoid all these so-called “junk fees”. However, there are some situations where you will still be able to charge this.

b. Appraisal Fee - The Appraisal Fee is often charged by lenders. You will need to hire an appraiser during the course of the loan so it makes sense that you collect a fee for it. Some hard money lenders will mark it up. Some will just pass the cost along without doing a markup. Appraisals for houses typically range from $350 to about $650 depending on the area and the appraiser.

c. Paperwork Fee - Underwriters and some private money lenders will charge a paperwork fee, which is another so-called junk fee charged to real estate investors. However, you can justify by saying that, "Hey, we have to prepare the mortgage, the promissory note, guarantee, all that. And we have to do a legal review of your LLC documents, this and that."

5. The Process

Now, in terms of the process itself, when you are looking at deals, you want to look at the experience of the borrower.

The more experienced they are, the safer the investment. If they're new, then you have to adjust for the risk with higher interest rates, higher points, and such.

Another thing, besides the experience with the borrower, is to review the deal itself. The main thing you want to look for is the ARV or the after-repair value of the property. Find the value of the property after everything has been done, like adding a new kitchen, bath, floors, paint, all the mechanicals are working, and everything else.

If you're inexperienced with real estate, you can hire an appraiser who specializes in these rehab properties. And what they do is give you the ARV, the after repair value, and an as-is value.

You need to find out these values so that if something were to happen and you need to foreclose, you will have an idea of the risk involved. Are you going to be losing money or is your equity in there to keep you safe?

Usually, when you are doing these loans, you cap what you're willing to loan at a certain percentage of the ARV or a certain percentage of the as-is value.

In most cases, it's a hundred percent of the as-is value and 65% to 75% of the ARV, whichever is lower.

6. Construction

Another portion of a hard money loan is the construction. To get from the as-is condition to the After-Repair Condition or the ARV, you're going to have to do some work on it. You'll want to get a scope of work from the lender. To be safe, you may want to request a scope of work prepared by a contractor with prices. This is done so you can understand what kind of work it'll take to go from as is to the finished product.

Most private lenders will offer to lend that amount to them, either upfront or on a draw basis. You can choose to put the money in escrow, as most hard money lenders do.

There are also a lot of private money lenders that will just write the check upfront. As a real estate investor, one of the benefits of working with a private money lender: getting the entire check for the construction costs upfront.

Now, on the paperwork, you'll need some specific documents to keep you and your money safe. Generally, you’ll need the promissory note and the mortgage, while some require additional docs.

The promissory note is the borrower's promise to pay you back. They execute it and give it to you. And then, to tie the promissory note to the real estate, the borrower signs a mortgage over to you.

If they fail to comply with the promissory note, then you have the right to foreclose on them using the mortgage.

Another layer of protection is getting a personal guarantee from them. It is a separate document. This guarantees that however the deal does, you will still get the money that's owed to you, and you can go after them personally.

7. Payment Terms

So, usually how hard money is set up, once you make the loan to them, you're going to be paid back in interest-only payments on a monthly basis. Then, the principal that's owed to you will be paid at the end.

There are some private lenders out there that don't want the monthly interest payments, and they would rather capitalize on it. The interest that's owed to them actually earns more interest, and they’d rather have that paid back at the end of the loan.

Either you're getting monthly interest payments or your interest is getting capitalized, when the borrower is done with the project and they sell it, you get paid back all your interests.

Finally, once all of that is done, you will need to record a satisfaction piece, which basically tells the public that the investor no longer owes you money or that the loan is paid off.

That's it. There are a lot of considerations but a lot of lenders have seen success in this method. Hope these basics will help you get started in private money lending.