Considerations Before Becoming a Private Money Lender Part 2

In Part 1, we discussed mistakes to avoid when private money lending. In Part 2, we discuss guidelines for successful private money lending.

The top two reasons I lend on deals like all things come down to time and money. Most of the deals I lend on I am also the realtor or wholesaler, which means I am making an additional commission. If I know a deal is a good deal, it makes sense for me to make money on it in more than one way and spend less time chasing more deals. I have a deal I am making $16,900 on between my commission and the interest on the loan that I spent about 3 hours on. Most of my time was spent evaluating the deal to give my opinion of value and to explain to potential buyers the best route of execution on the deal. Because I had already underwritten the deal, all I had to do was make a couple of phone calls to get the deal sold by saying I would lend 95-100% of the purchase price and they said yes.

Other times it’s because we have clients looking for houses and they keep getting outbid. There is no secret that sellers prefer cash offers to financed offers, so a lot of times the discount by offering cash is more than what I charge my clients for interest. A deal I lent on recently, we got a $15,000 discount to offer cash on the property and my client is paying me $4300 in interest. For the client to save $15,000, they could care less what I am charging them for interest because the discount was so steep as a result of the cash offer itself. Even if I did not make any money lending on this deal, it would be worth my time alone to not have to spend time showing another 30-40 properties and writing offers that likely will get beat out by a cash offer.

The other reason I may lend on a deal is simply I know the investor is very qualified to execute and I want to learn more about the real estate strategy. So, if you’ve always wanted to invest in storage facilities what better way to learn about it than being the lender. The borrower provides you financials and a plan to execute just like they would any other lender. You end up getting a better look at it even more so than a passive equity investor because you are evaluating the deal from the perspective of the borrower. Now the following are absolute musts when lending:

EVERYTHING THAT IS AGREED TO IS ENFORCED AND IN WRITING

One of the mistakes that investors make is they don’t enforce deadlines. Just like your tenants if you have any, you give them an inch they take it a mile. If they owe you your money back in 45 days, that is not your fault there is extenuating circumstances. If the deal does not work with the borrower paying you back on the terms agreed upon then it’s not a deal. I had a deal where the borrower told me they would have my money back in 60 days and before I knew it the investor was past due, and they said they needed 20 more days. I didn’t want to foreclose on them because I did not want to take the property back, so I let them go. Eventually, I needed the money for another deal, and they had another excuse. I found out later, they had borrowed money from a dozen other people, so they were trying to keep the next lender happy meanwhile burning bridges with all the lenders they had active deals on. This goes back to the point from the previous article, DO NOT LEND IF YOU ARE NOT WILLING TO FORECLOSE!

SET A DEADLINE

I never lend on flips. While I am not against others doing so and think it can be smart to do, it’s just my preference and I have so many deals to look at I don’t need to. The issue I have with lending to flippers let alone experienced flippers is they are always looking for the next deal. If I am not lending to them on every deal, then I have to compete with their other lenders on whose deal they prioritize to pay back. In the previous paragraph I mentioned the flipper that had a dozen deals with other investors. Our terms were that she would pay me back within six months, but the problem is my penalty for her to pay me back was not clearly written in so after six months she continued to owe me interest. With her other lenders they had fees written in where she paid them a hefty penalty if she did not pay them back on time. So of course, she wanted to avoid the penalty. Flippers that flip a lot can have a lot of things come up, from losing one of their contractors to another company, unexpected repairs on the project, or getting tied up on other projects. Even in this market with labor at an all-time high a lot of flippers are dealing with all time high materials costs and material shortages changing their plans and lengthening their project times. Now when a flipper tells me they will have my money back in 60 days I say “ok, and if you don’t pay me back in 60 days every seven days you go past, you owe me 1 point and we got a deal.” Guess what? Everybody pays me on time or gives me their real timeline. If I follow all my rules where I only lend on deals I’m willing to foreclose on, at the end of 60 days I can go back and tell them I’m taking the property or I can make sure I get paid that penalty. Make sure you have the options, not the borrower. If they cooperate, I may still lend to them on future deals, if they don’t then I never lend again. If I want, I can offer them some type of a deal where they can walk away and still be happy if the numbers still work in my favor.

REMEMBER PRIVATE MONEY IS ALMOST ALWAYS CHEAPER THAN A BANK

Let’s use an example:

Purchase price: $120,000

Appraised as-is: $143,000

Private money lender loaned $88,000, with another $30,000 left in escrow for repairs

Draws took a week to get and another 3 days to schedule and there was a $150 fee for draws in addition to interest on the $30,000 BEFORE it was received. Now let’s dive into the fees

Origination Charge: $2000

Prepaid interest: $412.75

Tax Service $17.50

Flood Certification $9.50

Valuation CMA Fee $275

Valuation AVE Fee $25

Flood Certification another company $25

Valuation AVM Fee $9.50

Doc Prep Fee $10

Wire Fee $25

Broker Fee $2857.50

Construction Draw Escrow Fee $350

Notice of Commencement $20

Title Lenders Policy $487.35

TOTAL COSTS TO CLOSE 6533.60

Now let’s use this same example with terms almost any private money lender would offer. We’ll use 3 points and 12% interest, no payments due until loan matures in 60 days.

Loan amount $118,000 all funded up front. The as-is value already supports the purchase amount so if the lender forecloses, they should still be able to make their money back.

3 points of $118,000 purchase price: $3540

Depending on the deal I may or may not require the lenders policy as we often just close with the exact same company that issued the owners policy. When you look at both deals. On the surface one deal looks cheaper when the broker quoted 2.5 points and 12% interest, but when you look at all the fees added on, it was basically almost twice as expensive as the private money lender.

Even when you look at a conventional bank loan on an investment property there is a good chance this is what your loan costs will be.

Processing Fee $600

Underwriting Fee $715

Appraisal $550

Credit Report $70

Flood Certification $5

Title Fee approximately $200 higher.

Total Costs to Close: $2140

Now while the closing costs would be lower than a private money loan, in the same transaction you would be stuck buying with 20% down of the purchase price which was 88,000, and paying the entire whole sale fee of $24,500 as banks will only lend what is on the purchase agreement and not on wholesale fees. With a loan amount of 70,400 the borrower is still stuck coming up with 47,600 to bring to close and have for repairs. While the rate savings is very large at approximately 4-5% given it’s a short turnaround of 1-2 months and the likelihood of getting a financed offer accepted over a cash offer, it’s likely the private money route is the best route for a borrower to go on short term financing in this situation.

We’ve covered a lot, and if you are following most of this article, I can tell you that you are probably ready to lend if you want to. If you aren’t and you have to read this article multiple times to understand, I’d suggest you take a little more time to consider your position. Private money lending can be very lucrative and stressful at the same time so hopefully this helps you on your path to being a private money lender.