How does private money work - how to structure it with a deal?

Question

Hi All,

I'm looking at a rehab / flip deal and after doing my calculations I can offer 375K for the property and the plan is to do it with private and hard money loan - the hard money lender requires 25% down so I would finance  $281,250 with the hard money lender and would like to find a private money lender for the $93,750.  I plan on rehabbing and selling the property and am giving myself 6 months to complete.   I have a private money lender in mind but not sure how I should structure this - I know there are plenty of creative ways to lay this out but just want to get the bare bones on how I structure this private money loan - can anyone share steps on how to do this?  What steps are involved, what legal documentation do I draw up...baby steps appreciated :)

Thanks for any advice !

Dolores

Sam Erickson · Answer

@Dolores Waldron there are many possible scenario, but essentially you are just putting together terms that both parties are comfortable with.  What the terms are going to be is going to be based on many factors.

On of my last private lending deals I put together broke down this way.  I'm paying my private lender 7% interest (annually) on all his money invested.  Its important to know the term of the interest.  Mine is annually so if I get the project down in 6 months, i'm only paying them 3.5%.  This particularly project was a higher dollar amount (then this private lender typically does) and had really good margins.  Because they were investing more and I could afford to do so I also did a profit split with them of 60/40, they got the 40%.

Here are how the numbers are projected to break down.

PP $125,000

Rehab $20,000

ARV $220,000

Term 6 months

With out getting into all the expenses, I'm projecting a net profit of $51,000, this is net after interest charges.

So at the end of the day my lender will get $20,000 from their share of profits and $5061 for their interest.  Brings their total to ~$25,000.

I'll then get $30,600.

So as you can see the lender is making out well on this deal, but I am too.  It is a quicker project and I always try to keep my lenders happy.  The other reason I gave them more is because the project totals are higher then they typically do.  However if I can make them $25,000 in a few months, I'm hopeful that this will open the door to more higher dollar amount properties with higher margins.

So when talking about interest rates, points, profit share, it isn't one size fits all.  You need to know your lender, what their risk tolerance is and what terms it will take to get them in the deal.  IF the project can warrant those terms it can be a good win for all.  The last thing you want to do though is give away all the profit, just to get the deal done.  If that happens you just spun your wheels for a few months for nothing.

Charlie Fitzgerald · Answer

You also will not likely find many lenders that are willing to have you bring nothing to the table in terms of your own cash.  The 1st lien holder is not going to feel very secure knowing that you are borrowing all of the down payment and closing costs.  The 2nd lien holder will feel even less secure.

Sam Erickson · Answer

I think the 1st step would be to approach your private money lender and make sure they are interested. Since your also using Hard Money, your private money lender will need to be comfortable taking a second position on the property....not sure if they will like that or not.

Once you work all that out and negotiate your interest rate, points, profit share (if any), etc.  Then its just a simple promissory note with the property being the collateral.  The title company I use has an in-house lawyer who drafts all the documents needed.

Sam Erickson · Answer

"Points" are percentage of the loan.  For example if  the loan is for $100,000 and a lender is charging you "2 points", what they are charing you is 2% of the loan, or $2,000.

Your more traditional lenders will charge you points in order to buy down your interest rate.  They may say you can pay "x" points and then your interest rate will be 4% rather then 4.5%.

Hard money  lenders charge points basically because they can, its just one more way for them to make money.  Its also upfront money so it gives them a little insurance.

Dolores Waldron · Answer

Thank you @Sam Erickson, this is really helpful, I appreciate you taking time to respond.  Why do lenders charge points and why do they call it points? This seems to throw me off.

Michael Evans · Answer

What is the ARV?

Dolores Waldron · Answer

@Sam Erickson, thank you for your feedback - could you clarify and break down about the points, profit share etc. - perhaps give a possible scenario?

@Charlie fit

@Charlie Fitzgerald, thank you also, the first lender is open to me having a private money lender as second as long as the numbers work, it's negotiating and securing this second I need to figure out.

Thanks!

How does private money work - how to structure it with a deal?

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