Becoming A Private Money Lender (Part 2): Breaking Down A Private Money Loan
The average real estate investor relies on a steady flow of private money to supplement their respective deals. Not only are institutional loans lengthy and cumbersome, but they can also impede the progress of a residential redeveloper. Conversely, private money can afford investors the ability to grow their business at a steady pace. The following illustrates the most important aspects of a private money loan:
- Speed of Purchase: On average, a private lender can underwrite and fund a loan in as little as 7-21 days. Banks can take up to 90 days to accomplish the same thing. The timeframe offered by a private money lender is, more or less, conducive to the deals a typical investor wants to finance.
- Asset-based Lending: Private lending is primarily driven by the underlying value of the subject property. Therefore, a borrower does not need to rely on their credit to secure a loan.
- Control & Profitability: Borrowers receiving private money have more control over their loan. Borrowers of private money do not need to take on equity partners.
- Shorter Term Loans: Private money loans typically have a shorter loan period than those of a conventional nature, which reduces the risk of accruing late penalties.
- Guarantee of Capital: Private money allows borrowers, independent investors in particular, to expand their business. A predictable source of funds is necessary for such an endeavor.
Understanding The Lender
At the risk of sounding too cliché, money and experience are the most important aspects a private money investor needs to exhibit. Essentially, when it comes down to it, the most successful private lenders have an increased propensity for the real estate industry and a proven track record of identifying powerful lending opportunities. Perhaps even more importantly, however, is a their tendency to remain hyper localized, as a working knowledge of a region is absolutely critical to success. Understanding a particular market, and in particular the direction it is headed, is an invaluable asset.
Determining Deal Viability: 8 Key Factors
Private lenders are in the business of making money. Therefore, mitigating risk is a top priority. There are essentially eight factors to consider when deciding whether or not a potential loan opportunity is viable. They are as follows:
- Market Value
- Borrower Credit
- Borrower Equity
- Additional Collateral
- Lien Priority
- Pricing Strategy
- Exit Strategy
- Due Diligence
Each of these factors must be taken into consideration when determining whether or not to pursue a loan opportunity. Failure to mind due diligence and neglect either one of these could result in harsh consequences. Due yourself a favor and navigate the process with precision.
Without question, proper documentation of a private money loan is of the utmost importance. However, what many may be unaware of is the fact that the paperwork involved in a private money loan is not all that different from a conventional loan. Accordingly, the borrower in question will be required to sign a promissory note (a written promise to repay the loan under specific terms) and a mortgage (documentation that will be used as collateral for the lender). In addition, residential loans may require an appraisal from an outside party: a property inspection report, a geology inspection and the borrower’s financial record. An in-person inspection of the property is almost always part of the decision-making process, which is why the majority of private money lenders tend to focus on a local level.
While a hard money lender’s requirements may vary, there are standard documents associated with every transaction. Typical loan documents include, but are not limited to:
- Letter of Intent (LOI): The LOI is essentially a formal document that acknowledges all of the parties involved are on the same page. It outlines an agreement between two or more parties before the agreement is finalized. While it is not legally binding, it serves as a preventative measure for miscommunication.
- Purchase & Sale Agreement: The purchase and sale agreement, otherwise referred to as the P&S agreement, is the document received after mutual acceptance on an offer, which states the final sale price and all terms of the purchase. Some of the items covered in the P&S agreement include: final sale price, earnest money details, closing date, title condition, contingencies and more. Inclusions on the P&S agreement will differ from state to state.
- Preliminary Title Report: A title is a legal document listing the history of ownership of a home. After the buyer and seller have reached mutual acceptance, an attorney or title company will review the home’s title to look for any problems that might prevent the home from being legally sold. The results are written up for the buyer in a preliminary title report. In other words, a report of this nature will reveal if anyone other than the seller has legal claim to the property.
- Title Insurance: Title insurance, as its name suggests, is a preventative measure that protects a buyer from anyone that challenges the ownership of a property.
- Proof of Funds: Proof of funds represents a buyers intent. It is a way for borrowers to prove that they have access to sufficient funds to complete a transaction. Typically a bank statement, retirement account statement or other legal form is acceptable.
- Proof of Insurance: Proof of insurance is required for either a purchase or refinance to avoid a devastating loss.
- Personal Guarantee: A personal guarantee places some skin in the game for the borrower. In other words, the borrower puts their own assets (real estate, savings, etc.) on the line. This is only in cases where the borrower can’t pay back the loan.
- Mortgage Note: A mortgage note is a promissory note secured by the mortgage loan. The structure of the loan is agreed upon and document signed by the borrower.
A traditional one-page form note and two-page form deed of trust no longer addresses the myriad of issues
in today’s legal environment. Environmental issues need to be addressed, along with lending issues, and enforceability of securities and protections. Legal documentation should be at a level consistent with that employed by institutional lenders, only eliminating provisions that may not be relevant or not needed. Additionally, special consideration needs to be given to a well-drafted broker’s affidavit, especially in states that a licensed real estate broker must broker an otherwise unethical loan.