7 Tips For Being A Private Money Lender In Real Estate

If you have some extra funds to invest, in a savings or retirement account, you may be considering becoming a lender.  Here are some tips to help you negotiate this process.

1.  Know the person you are working with on the deal. You don’t have to be friends, but you do need to have mutual trust and good communication.  It is important to know what is expected from everyone through the entire process.

2. Understand the risks associated with first versus second position loans. The first position means that this lien will be paid first and all other loans and liens will be paid afterward if there are enough funds left to pay that lender.  While it is always best to be in the first position, there are times when being a lender in the second position may make sense.  The second position is much riskier and therefore, it should bring additional scrutiny to the deal and interest to the lender.

3. Analyze the deal yourself to be sure it makes sense.  Not only should the property “as is” be worth more than the loan, but you want to know the scope of the work and timeline the borrower plans to use on fixing and reselling the property.  It is probably best if both the borrower and lender have some investment or ”skin in the game”.  In other words, it is best not to loan 100 percent of the property purchase and the rehabilitation budget even if the after repair value looks promising.  Be aware of the recent comps in the area to be sure that the after repair value is accurate.

4. Have the proper documentation to protect yourself.  In California, we would suggest a Secured Promissory Note, a Deed of Trust with the correct legal description of the property, a Personal Guarantee from the borrower, and proof that the borrower has added you as the loss payee on the insurance for the property for the duration of the loan.

5. Negotiate the terms that work for all parties.  Interest rates and points associated with the loan are typically higher for private loans than for conventional bank loans.  Most private money lenders we have seen charge 8-14 percent in 2017 depending on the deal. Someone who has a track record with you or who you plan to do multiple deals with may want to negotiate more favorable terms.  While the terms of the loan are negotiable, some states have rules about what is considered appropriate interest rate caps.

6. Consider how it is best to set up both access to the funds and how the funds will be repaid.  Rather than giving the borrower the full amount of the loan, you can set up draws on the full loan amount as the borrower completes large chunks of the project.  Additionally, you need to consider if it is appropriate to have the borrower make monthly interest (or even interest and principal) payments on the loan or if the money can be repaid at the time that the property is sold or the loan term ends.  While no deal is risk free, you can reduce your risk with large loan amounts.

7. Have a professional look over your paperwork and get everything signed, notarized, recorded or registered properly.  If (for example), you do not record the deed of trust properly in California, you will not be properly protected.

Full disclosure:. While we are private money lenders, but we are not attorneys nor accountants.  It is very important to check out the laws and best practices for your state.