Legal contract needed for private money?

17 Replies

I'm about to start making offers on some properties for my first fix and flip! I have already spoken to some friends and family members about partnering/lending the cash to do the purchase and rehab. Is there a standard contract or form that I should present to them when I have a property under contract and and am ready to buy?

For example, let's say I am purchasing a property for $60,000. I expect to spend about $30,000 on the rehab, and another $10,000 on inspections, closing costs, etc. The ARV is at least $125,000. My friend has agreed to loan me $100,000 on the condition that I repay him $110,000, due when the property sells or after 12 months (whichever comes first).

What's the best way to do this transaction "correctly"? Do I need to get a lawyer involved to draw up a contract, or would a simple typed-up document stating the above and signed by both of us be acceptable? Is there a standard form available online? (I'm in California, if that matters.)  I had planned to get a property under contract, then seek out the cash, but is it better to have it in writing first? Any complications if I split the loan by having Friend #1 loan only $70k, and Friend #2 loan the remaining $30k?

Obviously I trust this person and they trust me with their money, but I'd rather do this in a professional manner and not informally as neither of us has ever lent or borrowed money that wasn't through a bank before. Any of your tips and suggestions are welcome!

@Jessica Sorensen  

Check with your title company.  I know in Texas the title companies will have their attorney prepare and prep all the necessary documents for the type of transaction you're looking to do.  We pay about $400 for them to provide this service.

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@Jessica Sorensen  

It shouldn't have any impact on finding the deal and contracting.   

But....

Personally, I would find the title company you would like to work with as you're looking for deals.  This way you're not under pressure.  Try and find the title companies that local investors are using and interview them.  If they are good, you should feel that you are in good hands and they've done this a million times.  Not all title companies are the same - most don't do this everyday and you don't want to be teaching them.    

Bottomline:  You don't want to come down to the wire and realize your title company has no idea what you're talking about.  It would be sad to lose a deal that way.  

@Jessica Sorensen , you don't need a lawyer to draw up a loan agreement and as long as the funds are paid back and everyone is happy there may not be any issues. If there are problems with the repayment an improperly drafted agreement will be up to interpretation by a judge (if courts are necessary.) Results are not always easily predictable when left up to judges.

However, your lender will not be very well protected with just a loan document. In order to protect them you should file a mortgage against the property. That way, if there is ever an issue your friend would be able to foreclose on the property to recover their money. If you decide to do this (and you should) you will need a mortgage (this is filed with the County and gives the lender the right to foreclose) and a note (this spells out the interest rate, the term of the loan, and if payments are required it specifies how much they are and when they are due.) You could probably find templates for these. You may not need a lawyer to draw these up but it may be prudent that you speak to one so you are familiar with the issues involved. Since you are in California it is best to seek local opinion.

@Jeff Rabinowitz  

Thanks for the advice. Is it typical for the person doing the borrowing to approach a potential lender with the mortgage and note, or is that something the lender should look into for themselves? Maybe I recommend to my friend (or a potential lender) that THEY can come up with those documents? Or would it be more "professional" for me to provide them up front?

The lender generally has more control of the terms and would provide the documents. He who has the gold makes the rules. However, in this case it seems that your friend is helping you out, that you need them more than they need you. Don't make them work too hard. Get the templates yourself, discuss the details with them and then fill out the documents together. 

At the absolute bare minimum, @Jessica Sorensen , in California you will need a Note and a recorded Deed-of-Trust. With little exception, these will have to be originated by a licensed California Real Estate Broker. Don't attempt this by yourself.

You could get lucky, but I've seen some of the documents offered by title and escrow and I strongly suggest you avoid them for both your protection and that of your lender. It should be fairly easy for you to find a licensed broker, used to dealing with investors, who could provide decent paperwork, work with escrow and title, and originate the loan for your lender friend to protect the two of you.

You can often find experienced brokers at local real estate clubs and you can find these at Meetup.com.

Thank you Jeff S Na That's helpful information. I have spoken with a realtor who works regularly with other investors, so maybe he can point me towards a broker. 

What if I'm purchasing a property through a wholesaler? Are realtors/brokers usually involved in that process?

I agree with Jeff S, if your lender is a friend, you might check exceptions to family related transactions. I'd say $400 is a rip for a note and DOT, here title companies use to peel them off for free.

As a loan, do not make any other agreements other than a note and DOT, dreaming up things on your own can be more of a problem (that's saying with non-family types), a note and DOT is all you should use unless your state has standard disclosures required, a title company or your bank can probably give you those.

As to a partnership, the money is taken into the business entity and used as a capital contribution, the split or loan arrangement is described in the partnership agreement and accounting records to control funds, a note may be used but may not be necessary. If the entity owns the property you wouldn't use a DOT, the security is described in corporate documents between partners. See an attorney! :)

Originally posted by @Jessica Sorensen :

Thanks @Bill G. 

All these "getting started with no money down" guides just say "borrow from friends and family"! They never really get into how complicated of a process this can actually be!

It's not hard, best thing, see your attorney, probably cheaper in the long run and that should make family or friend feel much better. Good luck. :)

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@Jessica Sorensen  In my opinion, those no or low money down articles are majority for wholesale, in a wholesale transaction -- mostly but not necessarily, its a cash to cash basis and its finding the deals and just having the authority to market them. if you are buying from a wholesaler, its not necessary to get an agent to buy, but you need to make sure that the buy is legit at the least -- i would suggest that at least get an agent to help you with that, but they will have the listing when you will be selling to compensate for their time.

@Jessica Sorensen What you are trying to do is very easy to do here in CA. First, I am confused on the numbers? You are getting a private party loan that needs to be paid back at $110,000. The ARV is $125,000. Assuming you must pay commissons to sell, you are say 5% (2.5% each side), which is $6,250 and CA has a mandatory 3 1/3% off the purchase price to Franchise Tax Board that is another $3,750. Granted you may get some of that tax money back the following year when you do your taxes. In the lower price range, almost all buyers want a seller credit of 2-3% for closing costs, but let's say you have already included that in the $10,000 you mentioned. This deal seems really narrow, with a higher probability that you could lose money.

I can tell you that virtually all flips come in over budget, unless you are really experienced, because stuff just comes up or there are delays. In addition, i find that many investors and most Realtors over-estimate the end ARV value of the home. Your numbers are so narrow, that if anything is off, you will lose money.

I saw that you are coming to my next meetup group in Roseville, so let's talk if you need more help.  On the issue of structuring the NOTE. I always do this through title. They can draw up the NOTE, with your terms, which can be almost anything you both agree to and sign.  It will be recorded in first trust deed position, which protects the lender loaning you the money.  The lawyer and trust are nice but not needed.  The lender doesn't have to trust you, they just need to believe that you are going to get the work done and that after completion, the home will be worth at least the $110,000 they are owed.  I loan my own money all the time on flips and partner with people, but I would structure the NOTE wit "draws", so I only pay for construction work as it gets completed.  I hope this helps, look forward to seeing you at the next meeting!

Originally posted by @Jessica Sorensen :

Thanks @Bill Gulley  

All these "getting started with no money down" guides just say "borrow from friends and family"! They never really get into how complicated of a process this can actually be!

 When you borrow from or partner with your friends with just a hand shake it is simple but then 10 years later when one party wants out and the other doesn't it gets very complicated.

Spending the money on a lawyer at the beginning is better than giving all of the profits to two lawyers later...

@David Oldenburg You're right. If the ARV was that tight, I probably wouldn't go for this deal. I just threw out some numbers for an example. My main concern was if I borrow $100k @ 10% (owe $110k back) how that would be structured. Thank you for the tips! I'm looking forward to the meetup.