All Forum Posts by: Beth Johnson

I was placing private capital for clients for nearly a decade before moving over to a private debt fund model, as we grew too big for individual whole notes. A few things you need to consider with respects to brokers: 

 - How do they fund the deals? There are three different approaches to consider - whole trust deed investing, fractionalized trust deeds, and loan participations or hypothecations. My preference is whole trust deeds since you are named on the legal documents and have security with real property. 

- What is their underwriting process and lending guidelines? Do they have conservative LTVs and lending practices or are they doing 80% LTV + 100% rehab, immediately funding deals with little to no equity to protect your loan (and completely speculative on the ARV, I might add).

 - What is their default rate and principal loss to date? Ask them about their most recent defaults and how they played out. They are not all created equally. We have a sub 3% default rate but the most telling metric is that we have essentially zero principal losses and have been able to fully recover all legal fees, default interest, late fees, interest and full principal on any defaults that went into foreclosure. Most didn't even hit the auction block and we supported our trust deed investor every step of the way in that process so they didn't feel alone and not know what to do. Most of the time, we would manage the workout with the borrower to avoid auction. 

- Who services the loan. I prefer this not be done in-house and preferably through a 3rd party contract servicer since they can do the ACH pull and deposit directly into my account. Leaving servicing up to the lender could potentially put your installment payments at risk and in many states servicers need to be licensed anyways so double-check that part as well. 

This is just the tip of the iceberg. I've actually prepared a blog post for BP that will come out soon about how to vet trust deed brokers. A few months ago, I did the same for private debt fund managers. Which brings up the question, have you considered this route as an alternative? 

I've built my private lending business around 2nd lien position loans - it accounts for roughly 45-50% of my loan volume. Here's some thoughts: 

- Don't lend in 2nd position behind hard money or any short-term loan like construction loans. Even if you aren't gap funding, you could lose any equity stake with punitive default interest and also risk the HML calling the note due because they disallow 2nds without an intercreditor subordination agreement.

- On the subject of gap funding, just don't. There isn't any equity stake to protect your principal capital investment. So unless you add additional collateral from their SoRE, then don't do it. Period.

- Request and verify their schedule of real estate (SoRE). You need to understand how much their network is if you are going to request a Personal Guaranty. These PGs mean NOTHING without a high net worth and are only meant to be used in cases of deficiency - meaning the collateralized subject property doesn't have enough equity to make the creditor whole. It's what you would do AFTER a foreclosure proceeding, in most cases, not prior. 

- Be sure you vet out the borrower's multiple exit strategies beyond resale. Do they have cash position to come to close in case they can't sell for what they owe? Do they have the ability to refinance or is the CLTV too high or their credit not great? Do they qualify for a DSCR loan with estimated market rents (use long term average rents, not suped up STR or MTR rental income to be safe). Can the property repay with cashflow (not typically looked at for SFR but for 2nds we do on properties like mobile home parks with super low LTV, we have to know they can pay off with property income and not a refi since most bank loans I've seen on these asset classes is closer to the 50-55% LTV mark.)

Just a few thoughts off the top of my head. There's a lot of ways to lose on 2nds but there is also a lot of ways to generate solid returns and higher interest yields with this strategy. In nearly 10 years of doing PML, we have a sub 3% default ratio with a near zero principal loss (lost 2K on 9-figures funded in my tenure, which isn't too shabby given our stance on junior liens.)

@Marina Wong No. we just charge the servicing set-up fee at close. A monthly fee (typically around $5-20/mo) is added on to the payment. So if your interest payment is $1000 then the servicer automatically ACH debits your account that plus the servicing fee (assuming you set up automatic payments as @Christian Ehlers suggests). Any other fees such as close out fees or payoff demands are paid out on the back end when your loan is refinanced or paid off. You can see these charges added into your payoff demand by line item. They are all servicer charges and not lender fees.

We pass all loan servicing charges through to the borrower including set-up fee, monthly fees, and any servicing charges such as payoff demand generation, and loan close out fees. 

@Dewayne Perry - Usury limit in WA is 12% which would include points and some, but not all, other fees. However, in *most* cases, usury applies to consumer/personal loans and not business or commercial purpose loans. So, most private lenders tend to lend to a business entity (doesn't always make it a business loan with just entity vesting, though) and on non-owner occupied properties. But as many others mentioned, you should consult an attorney who specializes not just in RE transactions but private money loans as well. You can read up more on the WA DFI website.

@James Doren so glad you found it useful! Really appreciate the positive feedback!

I've had this happen on a few deals over the years and that is why it's important to obtain an ALTA extended lender title policy as well as ensure that a date down supplement is obtained before doing any loan modifications or extensions, too. Too many issues can happen without this. One deal, funded back in 2017, is still being prosecuted by the financial crimes division here locally when the borrower deeded the property over to his sister's LLC and she obtained 250K that landed in 2nd position behind our loan. There was fraud involved in the transfer of ownership but there was also an issue on the title company not performing a date down prior to closing during the "gap period" between loan docs being signed and loan docs being recorded. Fortunately, the HML who erroneously was placed into 2nd was able to file a title insurance claim and get paid back but it was messy!!

On another deal, the borrower took out "secured loans" with private lenders (none were my client) but she didn't record them with the county as she promised then. Eventually 6 months later after being nagged, she would file them but they went into 2nd, 4th, and 5th position. The 5th lost her entire principal and, sadly enough, she was a title rep and friend of the borrower and didn't take her own advice to get title insurance on her principal loan amount. 

This is why we bet on the horse, not the jockey, all day every day. People disappoint me, properties (with equity buffer protection), do not. Would love to hear more about the specific case you were talking about in your OP.

@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. 

@Gil NA - You should reach out to Geraci LLP out of Irvine. They specialize in private lender and securities law. They have excellent content online on their website as well and also have legal documents available (for most states, too, not just California). Generally speaking, you need to be licensed to private lend in CA. There may be carve-outs that you fall under, but I would contact a RE attorney experienced in lender law in your state as they have some pretty tough laws and regulations in your state, not just on licensing and usury but also when it comes to foreclosures, which has recently gone under legal changes that are not to the benefit of the loan broker or originator.

In addition to what others have mentioned, I would also establish non-owner occupancy which the borrower would sign and I would obtain a hazard insurance binder as well as obtain a lender's title policy for the full amount of your principal at a minimum - or 125% of your principal, if you are able to. 

Check out the book I co-authored last year called: Lend to Live: Earn-Hassle Free, Passive Income in Real Estate with Private Money Lending. It's available on BiggerPockets.com/lendtolive and is a comprehensive guide on all key considerations and risks you should be aware of before funding a private money loan for passive income. Too many things can go wrong so you will want to prepare yourself upfront before proceeding forward. 

Best of luck and feel free to connect with me over DM if you have any specific questions. 

I don't recommend lending from borrowed capital for first time private money lenders. There are many more considerations to take into account when using this type of strategy. Variable rate HELOCs vs fixed rate, arbitrage of interest for a reasonable enough return in today's high cost of capital, keeping aside capital for any missed borrower payments or defaulting loans, etc. 

Since you are just starting to look into this type of investment strategy, you may want to check out my book Lend to Live published by BiggerPockets last year. It is a comprehensive guide on how to find and fund a private money loan for passive income. 

Good luck and let me know if you have any questions!