Wholesaling vs Private Money Lending When Starting Out
Beth JohnsonPro Member
Lender · Renton, WA · Member since 2018 · 227 posts · 216 votesWholesaling vs Private Money Lending When Starting Out
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votesQuote from @Beth Johnson:
@Jay Hinrichs In all cases where I've done 2nd lien positions, the CLTV was below 65-70% and 99% of them were behind conventional 30-year mortgages with banks/financial institutions that work A LOT slower than we can. There are a few advantages to doing it this way - 1) the bank doesn't actually figure out the default before we can so we can file a notice first before they have ever done, 2) the bank doesn't charge exorbitant default interest and penalties as a hard money lender might do, 3) the loan is 30-year so there is less risk of balloon payment penalties, 4) banks typically won't call the note due, or they haven't done so in the few instances we've had to foreclose, so we've never been required to pay off the existing 1st lien. Instead, the bank continues to accrue late fees and interest and we completed the foreclosure which can take anywhere from 5 months (best case scenario) to up to 18 months if a bankruptcy proceeding is involved. In the few that had a BK filing, none of the borrowers followed through with the required paperwork filings and the request for BK was dropped. So while it frustrated the process and made timelines longer, it didn't actually result in a trustee taking over the property and liquidating assets to pay off creditors. In WA state, not sure how it is in OR or if it's different, but secured creditors get paid before the debtor or unsecured creditors. So even if a BK were to come through to fruition, we would have been paid out AFTER the 1st lienholder.
I absolutely do not disagree with you that 1st liens are a more simplified way to start out in private lending. But I do want to point out the misconceptions people often have with 2nd liens, when done correctly.
@Nicholas L. - I'm curious where you think a solid starting point is for newbies in real estate investing. Even if neither of these are good entry points to you, both are contemplated by new and aspiring investors all the time which is what prompted this post in the first place. I am always surprised how many WANT to start in wholesaling because I think they romanticize how easy it might be and would infuse quick hits of cash to get them started. But it's definitely not that easy. But private money lending - typically with small amounts of money - people call me all the time because they tried to gap fund a deal on their own and got screwed because their was no equity buffer or no personal guaranty or worse off, not secured by real estate at all. I get calls like this weekly, unfortunately. Some recover their capital, many have not. Those that do end up working through us for a little bit to learn the ropes and have our due diligence done on the deals. Not totally sure what the answer is on this - it definitely depends on the individual investor's goals and capital available to them.
Beth , while I know you can spin these anyway you want.. fact remains junior position lending is far more risky than lending in first position that's why banks rarely do it. . Also I disagree with you on your point number 1. Generally, in a default situation the borrower pays the second since the payment is lower and stops paying on the first. There is no way for you to know if the first is not getting paid unless your borrower just tells you which would be EXTREMLY rare. The first time you realize the first is in default is when you get noticed of the foreclosure. And by then the first has grown substantially eroding your equity. Unless of course your borrower stops paying you first which can happen then I agree with you but it normally the exact opposite of what your describing in the real world. on your point 2 the bank will start a foreclosure if they are not paid so you if your allowed to as a junoir you will be advancing payments to avoid being wiped out. . some lenders will allow this some wont. This puts the second position lender into having to pay payments on the first and foreclosure costs , And if lender did this in their IRA and cost exceeded what they have in their IRA it can create a problem with your IRA big time . On your thoughts of BK that is not true second position does not always get paid ahead of unsecured. unfortunately, I have been through this personally which is why i say second position is VERY risky and is to be avoided unless the lender has LOTS of cash to bail themselves out which most beginner note investors either dont have or this is going to stress them out quite a bit..
34 Replies
- 4yNicholas L.Pro MemberFlipper/Rehabber · Pittsburgh · Member since 2018 · 6k+ posts · 5k+ votes
@Beth Johnson I think we're talking about two different groups of folks - you might be referring to HNWIs who are established in their careers and looking to enter into exposure to RE as an asset class. I'm fine with them putting some capital at risk. =-)
True beginners with minimal to no funds have no business doing anything but ( 1 ) saving up money and ( 2 ) house hacking.
That's all I'm saying - otherwise good post and good discussion.
- 4yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @Beth Johnson:
@Jay Hinrichs In all cases where I've done 2nd lien positions, the CLTV was below 65-70% and 99% of them were behind conventional 30-year mortgages with banks/financial institutions that work A LOT slower than we can. There are a few advantages to doing it this way - 1) the bank doesn't actually figure out the default before we can so we can file a notice first before they have ever done, 2) the bank doesn't charge exorbitant default interest and penalties as a hard money lender might do, 3) the loan is 30-year so there is less risk of balloon payment penalties, 4) banks typically won't call the note due, or they haven't done so in the few instances we've had to foreclose, so we've never been required to pay off the existing 1st lien. Instead, the bank continues to accrue late fees and interest and we completed the foreclosure which can take anywhere from 5 months (best case scenario) to up to 18 months if a bankruptcy proceeding is involved. In the few that had a BK filing, none of the borrowers followed through with the required paperwork filings and the request for BK was dropped. So while it frustrated the process and made timelines longer, it didn't actually result in a trustee taking over the property and liquidating assets to pay off creditors. In WA state, not sure how it is in OR or if it's different, but secured creditors get paid before the debtor or unsecured creditors. So even if a BK were to come through to fruition, we would have been paid out AFTER the 1st lienholder.
I absolutely do not disagree with you that 1st liens are a more simplified way to start out in private lending. But I do want to point out the misconceptions people often have with 2nd liens, when done correctly.
@Nicholas L. - I'm curious where you think a solid starting point is for newbies in real estate investing. Even if neither of these are good entry points to you, both are contemplated by new and aspiring investors all the time which is what prompted this post in the first place. I am always surprised how many WANT to start in wholesaling because I think they romanticize how easy it might be and would infuse quick hits of cash to get them started. But it's definitely not that easy. But private money lending - typically with small amounts of money - people call me all the time because they tried to gap fund a deal on their own and got screwed because their was no equity buffer or no personal guaranty or worse off, not secured by real estate at all. I get calls like this weekly, unfortunately. Some recover their capital, many have not. Those that do end up working through us for a little bit to learn the ropes and have our due diligence done on the deals. Not totally sure what the answer is on this - it definitely depends on the individual investor's goals and capital available to them.
Beth , while I know you can spin these anyway you want.. fact remains junior position lending is far more risky than lending in first position that's why banks rarely do it. . Also I disagree with you on your point number 1. Generally, in a default situation the borrower pays the second since the payment is lower and stops paying on the first. There is no way for you to know if the first is not getting paid unless your borrower just tells you which would be EXTREMLY rare. The first time you realize the first is in default is when you get noticed of the foreclosure. And by then the first has grown substantially eroding your equity. Unless of course your borrower stops paying you first which can happen then I agree with you but it normally the exact opposite of what your describing in the real world. on your point 2 the bank will start a foreclosure if they are not paid so you if your allowed to as a junoir you will be advancing payments to avoid being wiped out. . some lenders will allow this some wont. This puts the second position lender into having to pay payments on the first and foreclosure costs , And if lender did this in their IRA and cost exceeded what they have in their IRA it can create a problem with your IRA big time . On your thoughts of BK that is not true second position does not always get paid ahead of unsecured. unfortunately, I have been through this personally which is why i say second position is VERY risky and is to be avoided unless the lender has LOTS of cash to bail themselves out which most beginner note investors either dont have or this is going to stress them out quite a bit..
remind me again --- I don't do this enough (well, really not at all): in a foreclosure, do the liens behind the lienholder proceeding with foreclosure wiped out? Wasn't there a situation like this? Or, proceeds from the foreclosure "waterfall" and satisfy as many/much of the liens as possible.
I thought one of the "tricks" was to let the "other" lien holder file for foreclosure so they would incur the fees. You just hold on for dear life hoping there is enough equity to satisfy your lien. Or, am i mixing something up or is it State specific? Thanks.
- 4yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @David M.:
remind me again --- I don't do this enough (well, really not at all): in a foreclosure, do the liens behind the lienholder proceeding with foreclosure wiped out? Wasn't there a situation like this? Or, proceeds from the foreclosure "waterfall" and satisfy as many/much of the liens as possible.
I thought one of the "tricks" was to let the "other" lien holder file for foreclosure so they would incur the fees. You just hold on for dear life hoping there is enough equity to satisfy your lien. Or, am i mixing something up or is it State specific? Thanks.
Generally yes is the answer but not always in a BK situation. Beth might have another take on it than me though.
- Lender · PA · Member since 2019 · 535 posts · 461 votes4y
Wow, I am late to this party put I see it has stirred al very complex discussion. Lets start by keeping this simple. If you are new to real estate you have no business lending money to someone who is supposed to be more capable than you are. If I was going to involve myself in loaning my own funds on real estate deals I would start by taking some legal courses on lending in the State you want to lend in. I would also suggest working in a mortgage business for some period of time to understand the risks and problems which arise in the lending business. Now if your current life's experiences have made you literate and competent in those areas then go get it.
For instances 2nd lien positions in Pennsylvania are garbage unless you want to payoff the first lien holder? How much do you understand about the Mechanics lien laws in the state you want to lend in? Or tax and utilities lien rules?
If you have a relationship with a good attorney who can guide you through the process and sufficient excess operating capital, including reserves, maybe you could start in the business by financing someone else's deals. Not highly recommended.
- 4yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @Steven Goldman:
Wow, I am late to this party put I see it has stirred al very complex discussion. Lets start by keeping this simple. If you are new to real estate you have no business lending money to someone who is supposed to be more capable than you are. If I was going to involve myself in loaning my own funds on real estate deals I would start by taking some legal courses on lending in the State you want to lend in. I would also suggest working in a mortgage business for some period of time to understand the risks and problems which arise in the lending business. Now if your current life's experiences have made you literate and competent in those areas then go get it.
For instances 2nd lien positions in Pennsylvania are garbage unless you want to payoff the first lien holder? How much do you understand about the Mechanics lien laws in the state you want to lend in? Or tax and utilities lien rules?
If you have a relationship with a good attorney who can guide you through the process and sufficient excess operating capital, including reserves, maybe you could start in the business by financing someone else's deals. Not highly recommended.
good points its hard to spin how good and safe gap funding and second positions are no matter how smart you are.. If you are gap funding you should also get a lot of the equity upside along with a premium interest rate to mitigate the huge risk involved in those deals. as to mechanic liens or Materialmen liens . your right many simply have no clue on those either for instance in Oregon properly filed mech liens are super liens they jump in front of the mortgage .. So if deals do turtle and they will and they do.. very often you will have to not only settle the first but the flipper ran up thousands upon thousand's of mech liens. Just the little gotchas that are out there.
- Lender · Renton, WA · Member since 2018 · 227 posts · 216 votes4y
@David M. Yes, from what I know, they could potentially get wiped out. Proceeds of the foreclosure auction will not waterfall unless the winning bid is in excess of all liens/mortgages against the property. Jay's right that if the 1st forecloses before the 2nd or any other junior lien, then those creditors would be at risk unless they went to auction and bid on the property themselves for the amount owed to them. This would be worthless if you didn't have any equity to recover your investment capital, legal fees, and interest owed. So there are no "tricks" for the junior lienholder, just file first, should the scenario arise. And as far as BKs, it's my understanding in WA state at least that secured creditors will be paid out before unsecured. Though this has never actually come to fruition on my loans. I did have one loan go into receivership by the Courts recently with a 2nd lienholder (not my client) that filed a civil suit rather than foreclosure. The Court-appointed Receiver put the property on the market, got a sale approved by the judge, and liquidated the proceeds in order of lien priority on title.
@Jay Hinrichs and others (@Steven Goldman) are correct that lending money should not necessarily be a first entry point into real estate investing for everyone - especially without some foundational knowledge, legal support and other virtual team members to do it properly. The reality, though, is so many new investors with cash (perhaps mostly middle-aged but not necessarily HNWI) DO start out lending. I know this because they have come to me regularly in the past for advice. And unfortunately, many start with gap funding as Jay mentions because they don't have enough cash to do a real legitimate 1st lien position loan with low LTV. But to say that things I have shared aren't happening in the "real world" is a little arrogant. In all my instances mentioned, the 1st lien did not outgrow my equity buffer because it was a low interest bearing 30-year mortgage and I had sufficient equity to cover. I'm definitely not saying this is a prescribed path. It's just what happened to me on that one particular loan which happened to be my first. Your experiences are vastly different than mine and that's OK. Lenders - new and aspiring and even experienced ones like us - need to see all the consequences that could or might occur - the good ones, the bad ones, and the ugly. One of the great benefits of private lending is that it's not a one-size-fits-all. Each lender has their own guidelines and their own actual lending experiences. I've honestly not met two that have the same deal preferences and risk tolerance. Sure, some guidelines are better than others. But it's still a matter of personal choice and that's why people get into it.
I don't pretend to think 2nds are something everyone should entertain. It just happens to be my first loan story, for better or worse, so I shared it here not thinking it would light forest fires LOL. I was safeguarded by a ton of equity in the property that was stabilized, and no work being done to it and some experienced help from my boyfriend who had been in private lending and our attorney who understands private lending and usury law in WA state. Not promoting it, but it's still my story, nonetheless. And I get stories like this all the time from people who've ventured out on their own into lending, some fared well and some got burned.
So while we all keep saying on here that newbies shouldn't get into private lending, my OP was all about the contemplation one makes when determining if they want to wholesale or private lend (or get into syndication or some other part of real estate investing, for that matter). So ironically, we have a giant post now full of comments from well-experienced investors and lenders but very few, if any, from new-ish investors who recently went through this internal conversation before making the leap. @Nicholas L. - I ask this here in this forum because I had an acquaintance reach out last year after she lent out her life savings over100K (works in the airline industry and wants to retire and go full time in REI) to a guy she trusted and it wasn't secured or had a personal guaranty. I had a woman DM me on Facebook just last week who lent out 50K of her son's college education fund to a RE broker she knew and trusted and thought she could learn from but has no security or written documentation, which makes me sad. I have had a 30-something guy reach out years ago lending on deals only to his friends who were flipping and unfortunately gap-funded a few deals behind hard money and then he had to negotiate with the HML to reduce the principal balance to try and save some of his own principal investment. These types of situations happen all the time and it's heartbreaking. The point here has never been to promote lending but seek to understand why folks may choose one route or another.
Hopefully all these comments will help anyone contemplating private lending by showcasing a multitude of perspectives and choices made, and any resulting consequences as well. Thanks all for the good healthy discussions. Love it!
Thanks.
I think in some ways this forum is the wrong audience. "In general," I sit here recalling mostly threads of posters without money... Even the people doing a deal "with money," its somebody else's money where they are trying to "partner." Your examples, while definitely sad, sound like when people try to do a "deal" together. They also appear to be one-sides from an experience standpoint. Also, at first blush they appear to be very informal. I am guessing this might be part of the dichotomy: the "seasoned" investor who is looking to be even more passive vice an inexperienced investor with limited funds looking to invest and grow their limited wealth. It sounds more like some "opportunity" was presented to them as opposed to actively trying to invest...
- Lender · PA · Member since 2019 · 535 posts · 461 votes4y
I hope I was not misunderstood. Forming a team of people and being the down money contributor to that team could be a viable entry into the game. But you must have enough experience to understand the risks, to assemble a winning team and minimize the risk of being a quasi equity investor. Some people take a jr. position in the LLC with a buyout. Some team members who lend down payments only get a unrecorded note in exchange for their participation. So, it is a trust game and you need keen people skills to avoid getting into a situation where your capital is at risk.
If you have construction experience or a good credit score, you can be the experience or credit partner for a fix and flip loan. So their are many ways to enter. They all require strong people skills, vigilance and verification. I think it is better to actually do a few rehabs and hold or flips, before you start being a jr. investor or, experienced credit partner. It allows you to fully understand the process and thereby spot a situation were others may have enthusiasm for a deal when they should not.
Their is enough inventory around the country so that a new investor can buy a inexpensive property, and do the rehab for 35-40k all in. You are not going to get rich but you will get the necessary education.
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