As the name implies, private money lending is the business of lending capital for investments secured through various vehicles, such as real estate. There are 2 ways to obtain capital: through personal investors or through private lenders. Personal investors could be individuals with direct capital (ie- friends and family) or groups of individuals who pool their money together to fund loans. Private lenders are companies who manage their capital and issue loans, similar to a bank.
THE PERSPECTIVE OF BANKS
Banks will lend capital using the 3 C’s:
- Credit: The borrower’s credit score and payment history.
- Capacity: The borrower’s ability to make payments.
- Collateral: The asset pledged as security for the loan.
Often times, borrowers do not fully qualify for the stringent credit and capacity requirements of a bank, even though they have sufficient collateral. In this case, private loans can be a great win-win option for both parties. The borrower wins because he or she gets the loan they desire, and the private money lender, or investor, win because they can create an opportunity to earn above-average returns.
FINDING the right loan
Although private lenders/companies are easier to find, their rates and terms are often higher –which is some call them hard money lenders. However, finding a private investor can be tricky and difficult to do on your own. Mostly found through word-of-mouth referrals, private investors can also be found through a real estate mortgage broker.
The real estate mortgage broker is not an employee of the investor, but rather a highly specialized entrepreneur who is in the business of matching right borrowers with right investors. They will package and coordinate your loan from start to finish, and maintain constant communication throughout.
Private loans are never “cookie cutter,” and the investors who provide capital are very sophisticated and savvy individuals. Therefore, each broker will have different private loan programs available at different terms because the lending criteria of each investor is different. The best thing you can do is to build a good relationship to determine exactly what projects brokers can refer capital for and the specific requirements their investors desire.
Let’s take for example that your situation is “outside the box” of traditional bank lending and you consider engaging a private lender. The following is a process that you should expect:
A QUICK PROCESS BREAKDOWN
Though banks are on every corner, such is not the case with private money lenders and investors. But there are a few great ways to find these lenders! For example, you can use a directory service (i.e. PMLG), ask around for referrals, or a quick web search. Once you find someone, ask them for references from both recent and long term clients. Also, to avoid those with high foreclosure rates, make sure to request who services their private loans. From there, you can research through your county court’s online portal or visit the courthouse in-person to track their number of foreclosures. While most private money lenders and investors have no desire to take your property as they best profit from your continued payment on the loan, do your best to stay away from those with higher than normal foreclosure rates as this may indicate they have very low flexibility or tolerance for any breech in repayment terms.
Submit Your Loan Application
Once you find a private lender, or investor, you may have to complete a loan application and the Statement of Information to give a snapshot of your financial situation and capacity. Be sure to provide complete and full disclosure on these forms, as these forms provide the lender or investor with an initial “picture” of you and your financial standing.
The Statement of Information form is crucial in facilitating a thorough title search on the subject property. The documents you provide to support the information in these forms varies on your financial status, the type of loan you are seeking, and the collateral property involved. Examples of documents you may be asked to provide are (but not limited to): tax returns, financial statements, bank statements, valuation information on other properties owned, and leases. Each lender or investor will have specific supplementary documents they require based on the type of loan.
Do You Qualify? Review of Credit, Assets, & Income
While the application process may seem cumbersome, you will receive a quicker decision with prompt communication and full disclosure. Don’t be afraid to be up front about problems you may have on your credit report, title, or with the collateral. Private money lenders and private investors are good at working with you to resolve these problems. The more up-front you are, the quicker you can get to a confident answer on the viability of your real estate loan.
Choose a Loan Program
The amount of funding available and the loan terms is dependent on the strength of the file you assemble and how you present yourself. The assembled file should be typed or neatly written and as comprehensive as possible. The key to remember is the lender wants to know that you are an organized, competent business person as they will likely be a stakeholder in the loan, either as a financial participant or as a servicer. Be prepared, and be yourself. Speak intelligently and thoughtfully about your project and your plan for the loan proceeds. If you’re applying for a rehab loan, for example, be prepared to talk about your plans, the types of properties you consider, a business plan regarding your profitability, etc. Once an application has been completed and a loan program identified, the terms and state and federal disclosures will be provided for your review.
Title, Appraisal, and Escrow
Once the documents are submitted, and the loan type identified, the private money lender or investor will start to process the loan. Your involvement will generally be limited to providing access to an appraiser, or providing other supplementary requests as determined by the lender and/or the investor.
A preliminary title report will be ordered from a title company who researches the property and the entity under which the loan is vested for liens, judgments, and other encumbrances.
The value of the property will most likely be determined by an appraisal prepared by a licensed appraiser. If an appraiser is not available, a Broker Price Opinion (BPO) may be prepared by a real estate broker or an Automated Valuation Model (AVM) is created by compiling and crunching public data using specialized software to arrive at a value opinion. In many cases, the investor may do their own evaluation of the property to confirm the numbers.
Escrow companies are a neutral third party who oversee the closing and disburse all funds in accordance with the lender’s instructions. They are also responsible for recording all applicable deeds, mortgage, or trust deeds, and other required documents after loan closing.
Review of Documents
Unexpected liens or judgments against the property or yourself, or the entity under which the loan is vested, are required to be resolved prior to funding the loan. Investors want title insurance to guarantee their loan will be in the desired lien position, often first position. Any outstanding liens or judgments do threaten that position and therefore must be cleared (paid off) prior to or at closing in order for a title insurance company to offer coverage. Often times, a lien is still showing even though you paid it off. This happens because the lien-holder you paid off may not have recorded the appropriate release. In this case, you will be required to provide documentation proving the lien was satisfied, and/or contact the lien-holder and ask them to provide the appropriate document to be recorded.
Final Private Money Loan Approval
After property valuation and title is reviewed by the investor, the private money lender or private investor will let you know the loan is approved and ready to “go to docs.” Sometimes they can generate docs in their office or sometimes they use an outside company. Expect a few days for this process, and give yourself a day to go through them before your signing to make sure everything is in order and that the terms match what you were previously offered.
Once the real estate loan is approved to close, you may sign your documents at the escrow company, in the lender’s office, or arrangements may be made to use a notary service to come to you at your home or office to execute the closing package.
Once documents are signed, the private money lender will arrange to have the funds wired to the escrow company and the loan proceeds will be disbursed at the direction of the investor.
The escrow company will arrange for the appropriate documents (deeds, mortgages, or trust deeds) to be recorded with the county which makes the new loan a lien against your property until it is paid in full. When these documents are recorded, your lender and/or escrow agent will let you know that “recording is confirmed.” Once recording is confirmed, escrow will disburse funds.
Payments to Loan Servicer
After funds are disbursed, the loan servicing company “boards the loan.” This means the loan is added to the servicer’s loan system so they can accept payments, send statements to you, etc. As part of your disclosure packet, you will be given instructions on where to make the first payment. Often times, interest will be prepaid for 30 days to give the servicer time to get the loan boarded. A key to remember is to not wait for your first statement. Be sure to send the amount as directed to the appropriate company so your first payment is not considered late. If you are unsure, ask your private money lender or investor. Most often, the loan will be serviced by your lender and the person who originated and coordinated your loan will remain your main contact throughout the life of the loan.