Becoming A Hard Money Lender

[Sherri Southwell]

I have been considering rolling my employer-sponsored 401K into a checkbook/self directed IRA for the purpose of providing hard money loans because I am DISGUSTED by the low ROR I get now. What advice do veteran lenders have to keep me out of trouble? What kind of vetting do you do with your borrowers? Due diligence process with properties?

Thanks in advance! 

[Jon Holdman]

First, very few employer sponsored 401k program will let you do anything with the money until you're no longer an employee.  Will your's even let you do this?  Or, have you left this company?

I've been doing this for a number of years. I work with a local hard money lender who actually makes the loans. In the past I've done direct loans where I (and, I really mean my IRA) made a loan directly to the borrower. These days, the broker runs a pool and a bunch of us have money in that pool and he makes loans from it.

If you're doing it on you own, start with verifying the regulations governing what you're doing.  You may be able to lend this money out, but you may still be subject to regulations.  Or, you may have to work through a broker.  This is a heavily regulated business and you will need to comply.

My advice is to get a full blown loan package - 1003 loan application, banks statements, etc.  Just like you would have to produce if applying for a long.  Hire an appraiser of your choice, at the borrowers expense.  If you're unfamilar with construction, hire a general contractor to evaluate the proposed scope of work.

Loan an absolute max of 70% of the ARV of the property. And ONLY in first position. Forbid any additional encumbrances (i.e., start foreclosure if the borrower further encumbers the property, which, even being in first position weakens the collateral.)

You must work with an attorney to prepare the paperwork.

Do closings at a title company.  Record everything that should be recorded.

Hold rehab money in escrow until work is completed and inspected by you.  The way I used to do this was to have the title company issue checks made out to the borrower for the rehab money.  One check for each "draw".  Those were given to me at closing.  As I did inspections, I handed these over.

If the borrower has money into the deal, their money goes in up front.

Borrower must absolutely not move into property.  This should be a default condition in your promissory note.