Is this a hard money loan?

Question

What are the legal ramifications for a private party to  borrow from a private lender at 8% and then turning around and lending that to a rehabber for 14%?

John Thedford · Answer

If they are giving you a signature loan and then you lend it secured by RE, that might be a great way to make some money. Banks do it all the time. They give you nothing and then lend it out at 5% or so. Private money at 8% is not bad IMO, I am paying 6.25%-7% depending on the lender and then buying rentals. I would caution you to be 100% sure that your borrower has the ability to repay or that you do. What if you lend it and they default? How will your lender accept late or defaulted loan payments? If borrowing from a family member, that could create a LOT of stress. Your plan is not bad but make sure you can cover your obligations.

Deano Vulcano · Answer

Thank you John, Charlie and especially Jeff for taking the time to be so specific.

These bigger pockets forums never cease to amaze me, such great advice and information and the replies are so quick.

Jeff S. · Answer

Obviously subject to state law, these are done all the time and are generally completely legal, @Deano Vulcano.  It's called hypothecation.  Your private lender would make a personal loan to you, which is secured by the loan you create to the rehabber.  That is, you are "hypothecating" your rehab loan.

Your personal loan is not a real estate loan.  If you default here, your private lender would take ownership of the loan you made to the rehabber. That is, they would then own the Note and Deed of Trust or Mortgage made between you and the rehabber, and would then collect the 14% payments.

This could be accomplished with a simple straight note between you and your lender with a clause that says, in effect, if you default, they get to replace their name with yours on your loan docs to the rehabber.  You would typically pre-sign an assignment of  mortgage or DOT and an allonge (documents that transfer ownership of a mortgage and note, respectively).  These would be held by an escrow company or neutral attorney, with instructions to record the mortgage/DOT assignment and provide the associated documents to your lender, if you default.

If things go well, you would pay your lender, your rehabber would pay you, and everything would get paid off when the flip is sold.  You obviously keep the difference.  Very common.

As you can imagine, this is a total oversimplification and there are many devils in the details. You need a good lending attorney to write these documents.  You are becoming both a borrower and a lender and need to comply with all lending laws. This is a good process for you to learn that there is no difference between calling yourself a private or hard money lender.  They are both non-institutional loans.  There are many legal differences between personal loans and loans secured by real estate, so be careful, but don't get hung up on what you call yourself.  The law doesn't care.

Due diligence dictates that your lender checks out your borrower (i.e. their collateral) since they might get to know one another more than they want at some time in the future.  Similarly, you are now a real estate lender in the eyes of the law and must strictly comply with all laws.  For a nominal fee, a good, appropriately licensed hard money lender could probably help you originate your loan to the rehabber and even provide those loan documents to you.

Good luck, Deano.

Charlie Fitzgerald · Answer

Make sure you are not required to have licensing in your state to do this also, and you also need to check into the servicing requirements of beinh a lender.

Is this a hard money loan?

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