Private money lending to "secondary circle"

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Private money lending to "secondary circle"

Tim Johnson
Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes

Morning all,

I am thinking about lending on a private money opportunity in the Tulsa, OK area. The investor has already purchased the home, done a few months of work on it, and needs money to finish rehabbing - asking $12k but I think they may need up to $20k based on my observations of the property. The term would be 3-4 months and they are hoping to get money within a couple of weeks.

The investor is in my "secondary circle" - I am friends with one of their friends. I am comfortable with the person's character and background and consider them trustworthy. 

Who else has experience with private money lending like this? What kind of due-diligence did you put into the deal ahead of time? What kind of protections did you put into the deal? How long did it take to arrange -- what would you do if you only had a couple of weeks of prep time?

Thanks!

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Jeff Rabinowitz
Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
10y

This rehabber has underestimated the amount of money they would need to complete the job when they purchased the home. You now think they are underestimating the amount needed to complete the job again. What will you do if you are correct? Are you able to step in and finish the job? Will your lien be in second position so you must negotiate with the first lien holder in order to step in? The "investor" is in a difficult situation--why do you wish to join them there?

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  • Jeff Rabinowitz
    Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
    10y

    This rehabber has underestimated the amount of money they would need to complete the job when they purchased the home. You now think they are underestimating the amount needed to complete the job again. What will you do if you are correct? Are you able to step in and finish the job? Will your lien be in second position so you must negotiate with the first lien holder in order to step in? The "investor" is in a difficult situation--why do you wish to join them there?

    2Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    As Jeff asked, would this be a 1st or 2nd position? Even if a 1st, the loan is so small there is hardly any profit to be had. Many lenders want a minimum of 50K and some even more. I used to do these very small loans but realized there was not enough money in it to be worthwhile. 

    2Reply
  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    10y

    @Jeff Rabinowitz @John Thedford

    Appreciate your guys' feedback.

    Apparently it was their plan from the beginning to seek out private money to complete the rehab. I presume they thought they'd be in a better negotiating position after already completing most of the work. This is their first flip deal, although they have a successful rental property that they rehabbed. I looked at their estimates again with a more experienced colleague and it looks like they can get everything done with $12-15k. Also, the term would be 6 months not 3-4 months.

    They currently have no note on this deal. They financed the purchase of $55k with a HELOC on the rental property and then $12k out of pocket for rehab so far.

    However they are asking me to do the loan unsecured, at 10% APR, and there's no way I am agreeing to that. I have sent back a counter-offer... 12% in 6 months for an unsecured deal - which would be $1800 on $15,000 which is appealing enough to me to offset the risk. If they are willing to give me a first lien, I would be open to a lower rate... although I worry about the legal expense of getting a mortgage note set up properly and additional complication given their desired time frame.

    For due diligence, I would want them to get the place inspected for any serious issues before I lend. They already caught foundation issues which they got repaired, and I don't want any other hidden surprises that would prevent a sale. They bought the place at auction with a warranty deed so my rookie opinion is I wouldn't need to get any title protection... what do you guys think?

    Their other options / exit strategies here are to work the bank route some more, or go with an institutional hard money lender. They have been trying to avoid both due to the longer time frame and hopes for a lower interest rate from private money.

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  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    @Tim Johnson

    Borrowers typically pay all legal and closing costs when they borrow. If you do the loan, insist on 1st position, take it through a title company, and have them pay all expenses. 

    1Reply
  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    10y
    Originally posted by @John Thedford:

    @Tim Johnson

    Borrowers typically pay all legal and closing costs when they borrow. If you do the loan, insist on 1st position, take it through a title company, and have them pay all expenses. 

    Hey John, this may be a stupid question -- what does it mean to "take it through a title company?" Does that just mean getting title insurance?

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  • John DeVito
    Investor · Campbell Hall, NY · Member since 2016 · 30 posts · 10 votes
    10y

    If they have no note, than why not do a promissoryy note as deed of trust. That puts you in first position. As a contractor doing a flip, that is exactly what I would offer a private lender. I don't think I would do it any other way and certainly wouldn't expect a private lender to do otherwise

    1Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    @Tim Johnson

    Not a stupid question. What I mean is going through a title company to close (if that is how they do it in OK). This protects the lender and yes, title insurance is a good idea. I always get a lenders title policy.

    1Reply
  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    10y
    Originally posted by @John DeVito:

    If they have no note, than why not do a promissoryy note as deed of trust. That puts you in first position. As a contractor doing a flip, that is exactly what I would offer a private lender. I don't think I would do it any other way and certainly wouldn't expect a private lender to do otherwise

    Thank you for this advice... Do you use a template for the promissory note / deed of trust? Or do you have a lawyer draft one for you? How much does that cost? 

    I thought this deal was dead in the water last week. They never responded after I countered their lowball interest rate / no security offer. But sounds like they are now willing to give me a first position lien and we are meeting today to get the ball rolling. Plan to just write a letter of intent and allow a week or so to get proper documentation before closing. 

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  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    10y
    Originally posted by @John Thedford:

    @Tim Johnson

    Not a stupid question. What I mean is going through a title company to close (if that is how they do it in OK). This protects the lender and yes, title insurance is a good idea. I always get a lenders title policy.

     How quickly do you think a title company could turn-around on a deal like this? 

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  • John DeVito
    Investor · Campbell Hall, NY · Member since 2016 · 30 posts · 10 votes
    10y

    I have my attorney do anything like that based on what I ask for. My attorney charges Around 250 to draft. The house my wife and I just sold, my attorney charged me 850 to close. The one we are purchasing ( private residence ) not too sure. 

    Done the owners have clear title. I would have your attorney check that out 

    1Reply
  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    10y
    Originally posted by @John DeVito:

    I have my attorney do anything like that based on what I ask for. My attorney charges Around 250 to draft. The house my wife and I just sold, my attorney charged me 850 to close. The one we are purchasing ( private residence ) not too sure. 

    Done the owners have clear title. I would have your attorney check that out 

    They bought the place at a foreclosure auction earlier this year and received some confirmation of clear title from the bank or auction house. I will get some documentation from them on that... Thinking I may not need to get title insurance if their story checks out. I don't imagine that any title issues could survive a foreclosure auction... I'd hate to be wrong though. 

    0Reply
  • John DeVito
    Investor · Campbell Hall, NY · Member since 2016 · 30 posts · 10 votes
    10y

    wouldnt go to this one without your attorney. 

    0Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    @Tim Johnson

    Some liens may transfer even at foreclosure. 

    1Reply
  • Al Wilson
    Investor · Daphne, AL · Member since 2014 · 1k+ posts · 242 votes
    10y
    Would not consider doing this without a first lien and title insurance. Good luck.
    1Reply
  • Rick H.
    Lender · Greater LA/Orange County area, CA · Member since 2012 · 3k+ posts · 3k+ votes
    10y

    Title insurance companies often provide escrow settlement services to handle money and paperwork from counter parties during the course until the transaction is completed.

    Sure, go ahead. Do the deal. You'll learn a lot.  But it'll probably be the last like it that you'll want to do for a few dollars of interest revenue.

    In addition to questions already posted, your neophyte rehabber is going to make other errors of miscalculation of time, costs, resale buyer expectations, etc. a long list of delays. And you don't know what your market will be like, post elections.

    Also, I don't know lender licensing requirements for your state. I do know that many brokers do not produce a fully compliant package of lender docs for non-O/O business real estate loans in my state, CA. 

    Putting these things together, what happens if your borrower really screws up? Are you ok with foreclosing? Despite relationships, a frightened borrower will still act in fear and may avoid cooperation. It only then that you learn the value of the relationship because it's reverted to "all business" to justify their behavior.

    If you look at it from the 10,000 foot level, determine if the upside is worth the downside. If yes, do the deal. If no, refer it to someone who does not know the other party who will use their own criteria for decision making, unencumbered by personal knowledge of the borrower.

    1Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    10y

    you need to check usury laws in your state.. many states have them for loans under 50k ergo why you see so many lenders with a 50k minimum.

    this could work as Rick mentioned for a learning experience for you.

    but you do have this.

    neophyte rehabber... lender with no practical experience ergo asking all these questions that are really lending 101....

    you have a property bought at a foreclosure sale.. and no title inruance.. this could be a huge issue when they go to sell.

    I personally do not do ANYTHING without Title insurance... unless I am buying a Deep distressed property with HUGE upside and I don't mean 1,800 dollars of upside..

    Also as stated 1,800 is just not really worth the time and brain drain your going through here.. and you could lose all  your money.. if you lose the dough and its a OK  no big deal then that's one thing if your going to be pissed you lost it and or made no money then you should cover yourself.

    1st lien with title insurance that the borrower pays all costs.

    its a cardinal rule for most lenders to NEVER step in on a 3/4 finish project and rescue someone. especially if they went into this undercapitalized in the first place..

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    1Reply
  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    10y

    @John DeVito

    @John Thedford

    @Al Wilson

    @Rick H.

    @Jay Hinrichs

    Thanks all for your feedback and advice it is really greatly appreciated... from 10,000ft level the 12% return is worth the risk for me considering that it will be secured. I also do not have any other investment opportunities on my immediate horizon, and it's passive money... But most importantly, it's a learning opportunity. I don't know many others my age who've had a chance like this and 5 / 15 / 30 yrs from now I think I'll be happy I went for it even if it becomes more difficult than expected. There would be foreclosure on the back end if it goes really, really bad... that's a risk I have to take to do the deal.

    I'm definitely getting a first lien on the property to protect myself. I also asked more questions and looks like they do have a title insurance policy on the property. Would it be overkill to get my own lender's policy as well? 

    I am doing a manual title search on my own with the county clerk's office and I have not found any liens or encumbrances other than mortgages. All property taxes were paid in full per the county treasurer's office, and any IRS liens would have expired 120 days after the foreclosure / auction. I'll dive deeper into the title search results this evening to ensure that there are no additional mortgages that would not have been cleared at foreclosure (e.g. senior lien to the foreclosed note).

    Biggest unknown right now is figuring out how to get the documents properly drawn up and recorded. Sounds like it just needs to be a note and a mortgage to place the lien. We plan to have a lawyer or title company take a look at what we prepare.

    Hoping to close next week...

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  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    your borrower should pay for all your legal expenses to have the note and mortgage prepared as well as all closing costs

    1Reply
  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    10y

    Promissory note and mortgage documents are prepared and they are paying for a lawyer to examine them... deal is moving forward and target closing date is next week. I've put in some solid hours of due diligence on this one... feel good about the counterparties... will be getting a first lien on their property and a decent return. Hope it works out. You guys will hear from me either way. :)

    0Reply
  • Tim Johnson
    OP
    Investor · Houston, TX · Member since 2015 · 109 posts · 40 votes
    9y

    @John Thedford @Jay Hinrichs @Rick H. @Al Wilson @Jeff Rabinowitz 

    Thanks all of you for your input on this deal last year... it turned out successful! Check out my post: https://www.biggerpockets.com/forums/223/topics/47...

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