Private Money Lending 101
As the name implies, private money lending is the business of lending money, usually secured by real estate, through private investors. These investors could be individuals with funds to invest or groups of individuals who pool their money to fund private loans and are generally secured by real estate.
Banks lend using the 3 Cs: credit, capacity and collateral. Credit is the borrower’s credit score and payment history, capacity is the borrower’s ability to make payments, and collateral is the asset pledged as security for the loan. Borrowers well suited for private loans usually do not fully qualify for the stringent credit and capacity requirements of a bank even though they have sufficient collateral. Private loans can be a great win-win scenario. The borrower wins because he or she gets the loan they desire, and the private money lender and the investor wins because they can create an opportunity to earn an above average return.
Finding the right private investor to fund your loan is tricky and difficult to do on your own. The important link that gets you the money you need from these private investors is the private money lender (PML). (In the banking world this individual is commonly called a loan officer.)
The PML is not an employee of any investor but rather a highly specialized entrepreneur who is in the business of matching borrowers with investors. The PML packages and coordinates your loan from start to finish and likely winds up servicing your loan as well. Because private loans are not “cookie cutter,” nor are the investors who provide the funds, every PML will have different private loans available at different terms because they each represent different investors. PMLs will typically also have a specialty such as construction loans, land loans, or multi-family loans, etc. Often the PMLs specialty is developed over many years in working with investors who may have a particular preference, or from personal past work experience in the specialty area.
So let’s say you know that your situation is “outside the box” of traditional lending and you are considering private lending. Here is the process that you should expect in contrast to working with a traditional lender, such as a bank:
Choose a Private Money Lender
While banks are on every corner, such is not the case with private money lenders. There are a few ways to find these lenders. You can use a directory service, ask around for referrals, or use a search engine on the internet. Once you find a PML, ask them for references from both recent and long term clients. Request the name under which their private loans are serviced and vested, then research online or at the county court house the number of foreclosures these parties have done. While most private money investors have no desire to take your property as they best profit from your continued payment on the loan, avoid lenders with high foreclosure rates as this may indicate investors with very low flexibility or tolerance for any breech in repayment terms.
Submit a Loan Application
Once you find a private lender, you will likely have to complete a loan application and the Statement of Information (SI) to give the lender a snapshot of your financial situation. Be sure to provide complete and full disclosure on these forms. These forms provide the lender with an initial “picture” of you and your financial standing. The SI form is vital in facilitating a thorough title search on the subject property. The documents you must 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 are tax returns, financial statements, bank statements, valuation information on other properties owned, and leases. Each private, or hard money lender will have specific supplementary documents their investors require based on the type of loan you require.
Review of Credit, Assets, Income to Determine Qualification
While the application process may seem cumbersome, prompt full disclosure will get you to a faster decision. Don’t be afraid to be up front about problems you may have on your credit report, on title, or with the collateral. PMLs are good at working with you to resolve problems. The more up front you are, the quicker you can get to a confident answer on the viability of your hard money real estate loan.
Choosing the Private Money Loan Program
The amount of funding available and the loan terms will vary depending on the strength of the file you assemble and how you present yourself. The assembled file should be professionally typed or neatly written and comprehensive. The PML wants to know you are an organized and competent business person. The presentation of yourself is significantly more important to obtain private loans. The lenders, representing the private investors across the table from you, will likely be a stakeholder in the loan, either as a financial participant or as a servicer. Be prepared, and be yourself. This doesn’t mean you should get all dressed up and pretend to be someone you are not. What it means is you must be able to 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 what your plans are, the type of properties you go after, a business plan on 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 in, and the loan and investor are identified, the private money lender gets the loan processing ball rolling. 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 report prepared by a licensed appraiser but in some cases other valuation methods are used. A Broker Price Opinion (BPO) prepared by a real estate broker or an Automated Valuation Model (AVM) created by a service who combines public data and specialized software to arrive at a value opinion are common alternatives. In many cases, the investor may do their own evaluation. Escrow companies are a neutral third party who oversee the closing & disburse all funds in accordance with the lender’s instructions. Then they also record 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 must be resolved before the loan can fund. Investors want title insurance to guarantee their loan will be in the desired lien position, most commonly first. Any outstanding liens or judgments threaten that position and therefore must be cleared (paid off) prior to or at loan 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 lienholder you paid off may not have recorded the appropriate release. You’ll be required to provide documentation showing the lien was paid, and/or contact the lienholder 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 will let you know the loan is approved and ready to “go to docs.” Sometimes the lender generates docs in their office and 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 PML’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 arranges 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 the documents are recorded, your PML 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 interest will be prepaid for 30 days or so to give the servicer time to get the loan boarded. Do 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 PML. Most often, the loan will be serviced by your PML and the person who originated and coordinated your loan will remain your main contact throughout the life of the loan.
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