The Best Way to Properly Manage a Private Money Loan

“How much do you need?” Aren’t those the most beautiful words to hear if you’re a real estate investor and a private money lender is talking to you?

I remember when I was first doing my own deals and needed money to fund the deal. I went to the first person I knew who I thought would lend on the deal because of our relationship and because he had the funds to invest.

I remember calling him on the phone and being pretty nervous—this was the first time I was asking for funds for a property. I told him about the deal, and at the end of the call, he said those sweet words, “How much do you need?”

I told him, and he proceeded to wire the funds for the purchase. I knew then, I had a deep responsibility to make good on that lender’s funds.

When first entering the real estate investing world, I recognized right away it is all about relationships. If you have the right relationships, you can go a lot further than if you try to slog it out all on your own. You need relationships with good attorneys, title companies, Realtors, contractors, wholesalers, buyers, private lenders, the list goes on and on.

Once you build up those relationships, it unlocks a lot of doors in the investing world—just like when I was able to secure funds from my first private lender. It opened a whole new world to me at the time. I knew at that point that I could do as many deals as I could find if I kept building relationships with private lenders and making sure I took care of them in the best way possible.

Once you start growing your business and have private lenders funding your deals, it is WAY too easy to lose sight of everything that is going on in your business. As real estate investors, one of the last things we want to do is manage finances. In fact, most often, no one has really taught us in a simple way how to manage funds. So, we think as long as we have an accountant or bookkeeper, everything will turn out all right.

WRONG.

The Importance of Understanding the Fundamentals of Finance

In order to keep growing your business and make sure you’re protecting your lenders’ funds and the health of the business, you need to learn to manage all things finance. Too many investors get trapped in the cycle of robbing Peter to pay Paul.

You have one main bank account that all of the money you make from your deals goes into—the money you spend on your business comes out of, the private money you receive goes into it, and so on. You are on a high when that account has a lot of money in it and on a low when that account is running on fumes.

If managing finances by looking at one bank account, that means you have no idea what money is yours and what money is your private lenders’. I have worked with so many investors who, through ignorance, are spending their lenders’ funds on so many expenses other than what that money is earmarked to be spent on.

When you get a private lender to fund a rehab, that money is for that rehab. It’s not to cover the expenses of your business or to go out and blow on yourself.

It’s a dangerous cycle to take in money, put it into your one main bank account, then go about business as normal. Because what you’ll end up doing is looking at that account, seeing all the money in it, and saying that you can buy that deal or you can invest in that course or you have plenty of money to spend this month. When in reality, if you took out the funds earmarked for your rehabs, you’d be looking at a totally different number.

How to Stop the Ponzi Scheme

What safeguards do you have in place to protect your private lenders’ funds?

I will tell you that one of the best things you can do is open up a totally new bank account specifically for your private lenders’ funds. When you get funds from a private lender, put them into a different bank account than the one you use to pay your bills or receive money from the sale of deals. That way, you can clearly see how much is private lenders’ funds and how much is your own money in your bank accounts.

Once you run out of private money, that is a clear indicator that you are going over budget or didn’t ask for enough money up front from the lender. Now, you have to use your own money to finish the rehab or you have to go back to the private lender and ask for more funds. It’s helping you manage your money just by having another bank account.

This is also how you can protect yourself and your relationships with your private lenders. Just think about your next conversation with a private lender and telling them that you have an account specifically set up for their money to make sure you are protecting them. How do you think that will make them feel?

It shows them several things:

That you care about them
That you manage your finances differently than most investors
That you have thought about their finances ahead of time and how to protect them
That you are probably more trustworthy than the average investor

Do you see the power of setting up just one more bank account, specifically for your private lenders. Do you see how it can revolutionize how you attract money and how it puts the power back in your hands in terms of knowing what is going on in your business?

Go out today and open that bank account. You won’t regret it.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.