Structuring/terms of small unsecured promissory note

10 Replies

Hi BP!

I'm new to investing and have joined my local REIA. Learned a lot and have done some great networking to help me get into this business and learn.

I came across an opportunity  to work with another investor in our group to provide a private loan. Investing is somewhat new to me, although I've leanted a lot, but lending is even newer! I'm comfortable with the people, their experience, and their deal. I just want to make sure my bases are covered so I can get repaid and to know I'm getting a good return. 

I need help structuring the Promissory Note and verbiage. It's a small loan, $10k, that has a Promissory Note tied to a current flip they're almost done with. Expects to go on market in 1 week. Loan would be for 6 months. 

My questions are: 

1. This would be unsecured, first lender for entire project has 1st mortgage. And my Promissory Note wouldn't be recorded. It says in our Note that I will be repaid in full upon sale of this property. Is that enough to protect myself? Should I have other wording in it or take other actions to better protect myself, like have the property as collateral (even though I'm not the main lender) or a Personal Guarantee (loan is to their LLC)?

2. What is a typical Interest rate for this size loan that is unsecured and for 6 month terms? Interest only, no points, and no payments. Just principle and interest repaid when property is sold (up to 6 month terms) and then it jumps to the legal limit of 18%. 

Any help or advice on structuring this or wording it would be greatly appreciated!

That's more or less equivalent to a credit card cash advance.  Mid double digits.

Some banks and credit unions do still offer unsecured personal loans.  You might shop around and find money much cheaper.

Jon Holdman, Flying Phoenix LLC

Brian, I've been lending private money for nearly 20 years. You're setting yourself up for failure with your current structure with no recourse to recoup your investment. You need to secure your investment with either a notice of interest filed against the property (at minimum), to even get repaid, or a 2nd mortgage, or a joint venture with the first private lender and a new LLC to lend to the borrower in 1st position. Also, not having a payment each month sets a bad precedence for getting repaid. Make the payments start 30 days from the day you lend money at 12% interest rate, or higher, and make the penalties stiff if they do not pay on time, or early. I've "given" too much money away to know that even a deal that "sounds" good will turn ugly without the correct documentation and leverage.

Medium spf jpegDarren Eady, Secure Private Funding | [email protected] | http://www.secureprivatefunding.com

thanks guys! @Darren Eady I don't think the 1st lender would JV with me but option 2 to hold a second mortgage would be. A good way to secure it and a secured note makes me feel a lot more comfortable.

I presume I can file this and hold a 2nd mortgage right behind the 1st lender? 

Do you think 10%/year with a 6 month term is to low? (I'm in FL if that matters) l like the idea of higher rate for no payments or lower rate with interest only payments. 

also, is there a way to have a lien or security without recording an actual mortgage? Can I record aomethingng else that says they can't sell the house without paying me? Other than the terms we wrote in "lender will be repaid in full when property is sold". Note also has ending date and defaults to 18% after that date. 

Oh, I didn't catch you're the lender in this situation.  Here's my advice:

RUN AWAY AS FAST AS YOU CAN!! I wouldn't do a loan like this at 25% or even 100%. I've been the lender on a 70% LTV hard money loan where the lender defaulted and still ended up losing money. There is a very real possibility of a 100% loss on this loan. STAY AWAY. Lend ONLY in first position, with real security interest (mortgage or deed of trust) and only at a reasonable LTV (under 70%)

Jon Holdman, Flying Phoenix LLC

@Brian Alterman

You've raised a # of questions.  Not necessarily in order of your questions:

1) With regards to filing a 2nd mortgage - do you know if the 1st mortgage lender permits or prohibits other liens?  If it prohibits, you may be setting yourself up and causing the borrower to be in default on the 1st mortgage.  Depending on the equity situation, this might backfire on you, depending on how the 1st mortgage lender responds.

2) You may already know this, but in FL the borrower will have to pay doc stamps on the mortgage you record, which I believe is separate from the recording fees.  Might not be a lot of $, but it's an expense nonetheless.

3) With regards to not recording a mortgage, others gave some examples, but those also require recording.  Bottom line, if you're wanting to 'cloud' the title to protect yourself and so that you get repaid (otherwise the title company won't insure for the buyer), you'll have to record something.  You could have a mortgage executed and not filed... hold it in a drawer and then file if there's a default; however, if it's reached the point where you want to file it's highly likely that others have already taken action and what you think will be a 2nd mortgage could turn out to be something far worse.

4) I wouldn't recommend a structure with no payments, except upon sale of the property.  The borrower needs to be disciplined into making payments and have some pressure on it to sell the property.  Plus, you're telling the borrower in advance that you're OK with the loan (and no payments) until the property sells... setting an expectation that at the end of the 6 months, you'll roll the loan if the property didn't sell.

5) Absolutely you should get a PG. There's a reason the individual owns the property through an LLC - to protect himself/herself. Most likely the LLC is a single asset entity and then your only recourse would be to sue an LLC that's sole asset is pledged to the 1st mortgage holder.

Based on the info you provided, I agree with several others in the thread that there's a better place than this for your capital.

Disclaimer: I'm not an attorney and nothing contained herein should be construed as legal advice.

Originally posted by @Brian Alterman :

... And my Promissory Note wouldn't be recorded. It says in our Note that I will be repaid in full upon sale of this property. Is that enough to protect myself? Should I have other wording in it or take other actions to better protect myself, like have the property as collateral (even though I'm not the main lender) or a Personal Guarantee (loan is to their LLC)?

...

Any help or advice on structuring this or wording it would be greatly appreciated!

Where are you getting your advice for this, Brian? Promissory notes never get recorded. They also don't get notarized. (I saw your related post, indicating this is to a relatively new rehabber getting advice from a "highly recommended" coach. Argh.) Take Jon's advice above, and run from this one. You don’t' know what you don't know and are about to get your lunch eaten.

In addition to a well-crafted note (i.e. not written by you or your borrower or words requested from an internet forum), the only way to remotely protect yourself here would be to record a mortgage and get a personal guarantee and even then it's an obscenely risky deal. Though they are often not worth the paper they are printed on, a personal guarantee should be mandatory because this will be a subordinate loan to an LLC. Right now, could your borrower legally distance himself or herself from you any further?

You realize that even many experienced HML's won't do seconds, don't you? Some also won't let their first position borrower take out a second. You should inquire about this with your potential borrower and read their other loan docs. Also, how do you know there are no additional unrecorded loans out there? For a $10k loan, I imagine you will not be requiring a lenders title policy? Normally, you would -- more protection you're missing.

If the borrower expects this property to go on the market in one week, why will it take six months to pay you back? Do they really intend to pay you back when the property is sold? Since this loan is not secured by the property, what evidence do you have that they will have the money in six months?

Why does a flipper need $10k to complete a deal one week from going to market? Whether they need the money for this property or for something else, to me this sounds like a rescue loan to someone who is out of cash. These are never good deals for the lender. The only time a lender might do this is to protect their interest in a property. You currently have no interest in the property.

Last, who will originate this loan for you? Even with bulletproof paperwork, improperly originated loans could be difficult to collect on.

Too many red flags and too many unanswered questions, Brian. This is not a deal I would touch with a ten-foot pole and I suggest you avoid it like the plague, as well. 

First, Jeff S Na THANK YOU VERY MUCH FOR YOUR DETAILED AND THOROUGH RESPONSES AND ADVICE!  THAT'S WHAT I LOVE ABOUT BP!

Some of your questions and concerns are rightfully so especially since I haven't given  you those answers already. And even then when answered they're still great concerns that I need to consider.

1. I do not know if the 1st lender will prohibit a 2nd mortgage on the property and I'm assuming (from the borrowers mouth) that I'm 2nd in line, so I need to do my own research to determine that truth.  Any idea how I can do that?  The property is owned in a Land Trust.

2. I did hear/read if filing the 2nd mortgage, Doc Stamps may be charged which I would surely pass on to the borrower and depending on what those would be, it's up to them if it makes sense to pay them on a $10k loan.

3. I'm not familiar with having the mortgage executed, but not filed and filing when necessary down the road.  By doing that, when the property is sold, would it even show up that I have a lien on the property?  Presumably not since nothing was filed.  So, the only purpose would be so that I have some harder docs as recourse if needed in court.

4. Totally get the not asking for payment concerns and after re-thinking it, I would prefer to have them.  Or (and this is just hypothetically thinking out loud when more comfortable with a borrower)... give them options.  X % with no payments (higher) or X % (lower rate) with payments.

5. Very true about the Personal Guarantee/ LLC only having 1 asset that's already pledged to 1st lender. That was my thoughts are that the sole purpose of the LLC is to protect you personally.... so why would anyone then also give you a Personal Guarantee for something controlled through the LLC.... I know I wouldn't.

6. I know the Promissory Note doesn't get recorded, but I have it as recourse should I go to court.  Not sure about the notary part, because I thought that's what would make it legally binding along with both lender/borrower signatures.  So, that I'd want to confirm with an attorney.  

7. I won't waste time trying to convince you to feel comfortable with the buyer because you aren't involved. I totally get your concern about me referencing them having a "highly recommended coach". However, I am in the same REIA group as the coach, borrower, and lots of others. They are new rehabbers, I'd say they have about 8-10 deals under their belt in the past 2 years and their coach looks over their shoulder on all of them. So, I trust the "deal". And I too believe in their coach, but again I'm not trying to sell him/them to you. That's for me to decide if I'm comfortable with them.

8. I've learned now the only way to protect myself is have the property as collateral (have a mortgage tied to my note).  And I also know that even if I did get 2nd mortgage on this (assuming it's ok with the 1st lender), I'm still not guaranteed anything since I'm sitting behind the 1st lender... and rightfully so since I'm only putting up $10k and he's closer to $90k.

9. I also was told today that the Promissory Note (even notarized... if what you said above isn't true)... still might not hold up in the courts even though it says I would be repaid when property sells.  Basically a Promissory Note alone doesn't mean much at all in a court battle, if anything, no matter what it says or who signs it.  Even more reason to have it secured by the property with a mortgage (1st, 2nd, anything).

10. The reason for the longer payback period in relation to the property being LISTED is... on average in Orange county (Orlando) it takes 60 days to get an offer on the MLS... in this buyers experience it's taken 4-5 months to get a house sold and if the new buyer has traditional financing that could take 30-45-60 days to close... So, going by that and his past experience, we set it at 6 months maturity date. I firmly believe they have every intention to pay me back right when the house sells (just my gut feeling for the type of people they are). However, without being tied to a mortgage on the property... I don't have a way of knowing if the property sells... other than me watching it like a hawk from day 1 of it being listed. No title company will be calling me to pay me off since I'm not anywhere on the records. I just have my Promissory Note in my drawer (which now I'm learning is almost useless for protection purposes). So, trust me on this one... this part alone of not knowing makes me a little uneasy even though I do think these people are good people and act in good faith.

11. Very good point to wonder why they need $10k for a property going onto the market in 1 week. This money is not bailout money, it's to be used to further grow their business. They want it to ramp up marketing and for deposits on offers they're currently putting in. The Promissory Note would be tied to the sale of the current project though. So, it's basically a Personal Loan (to the LLC) and promise to be repaid once a specific property sells (the most current one).

I'm not saying me explaining myself or answering your red flag questions now justifies this being a good deal for me, but hopefully those details give you some more insight to it.  HOWEVER, I've decided I'd feel more comfortable doing a loan that is more secure.  So, I plan on doing something with the same people down the road, but in a more secured fashion as Joint Venture where I put some equity into the deal and would be secured by a mortgage.

BUT, even doing it that way, by me being the smaller lender, I would presumably have 2nd mortgage (assuming 1st lender agrees). So, I now that a 2nd mortgage isn't the best guarantee, but it's better than just a Promissory Note because with 2nd mortgage I'm still behind 1st lender. Reality is, I don't have money yet and not comfortable being 1st lender on a project. But, starting small with something like this $10k to put up some rehab money on a project is a way I can get into the biz. So, do you have any advice for doing a JV deal with a partner who is only putting in this smaller amount when another bigger lender is covering the majority of the project? Or just don't do it at all unless you are the big lender with 1st mortgage?

Thanks again, you guys are great!

@Brian Alterman  

Regarding liens - most counties now have their info online and you should be able to search the county's records (ROD - register of deeds) to see if there are any other filings against the property.  As another poster mentioned, this isn't a substitute for title insurance, but does allow for a quick look as to the reasonableness of a verbal comment.

With an unrecorded, but executed mortgage you're essentially in the same position as an unsecured lender at origination; however, have the ability to record the mortgage at some future point to become a secured lender (ignoring BK look back rules).  Your risk is that at the time of recording you have no assurance that the position you thought you'd be in at execution is the same, as someone else since then could have filed.  It's not a concept used very often, but is an option.  You're correct... if everything goes fine and the borrower repays you, the unrecorded mortgage won't ever show up to cloud the title as you never perfected your lien (and the borrower should require that the lender return the executed unrecorded mortgage upon full pay off to protect himself/herself).

With regards to the PG, many individuals sign them daily when dealing with a traditional lender, as traditional lenders aren't collateral lenders. There are non-recourse deals done, but those are usually done through the life companies and on Class A properties with strong tenants on long term leases. Anyway, individuals don't set up LLC solely in an effort to protect them from lenders, but other liabilities.

Your #8 - correct, you holding a 2nd mortgage doesn't guaranty you anything.  If something goes wrong with the project and the 1st mortgagor takes action, they have no responsibility to you or your 2nd mortgage.  There are many different scenarios that could be played out here.

With regards to your comments about 1st vs. 2nd and 'big money' vs. 'small money', there's absolutely no correlation between the lien position and the $ amount.  Yes, the preponderance of 1st mortgages are the larger, but there's no legal requirement for it.  Typically the 1st is larger as it's the purchase money.