First real estate deal as a lender

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First real estate deal as a lender

Ken T.
Dallas, TX · Member since 2016 · 78 posts · 31 votes

Hello BP! I am one step closer to officially being an investor. I have been presented with a promissory note secured by real estate by a borrower, but I am very nervous about how to proceed with the drafted note provided by the borrower.

Could you guys glance over this note and tell me if there is another note I should use or if I should spend the whopping $3,000 consultation with a real estate attorney.

-----------------------

TERMS

FOR VALUE RECEIVED, the Borrower promises to pay to the order of Lender, at its principal office located at ________ or at such other place that is designated in writing by the holder hereof, the principal sum of XXX Dollars ($XXX), together with all charges and interest herein provided, payable at the rate and in the manner hereinafter set forth:

Borrower shall make the payments of principal and interest at the rate of TWELVE PERCENT(12%) per annum based upon a twelve (12) month term with the period starting from the day the amount borrowers has been deposited into the Borrower's bank account estimated to be on 2/20/17 and the term will end 6 months after on 7/20/17. The total interests amount will be paid at the close of escrow when the property is resold to a new buyer. There will be no monthly payments and no points or loan fees.

This Note is and will be secured by a priority security interest in the real estate property of the Borrower. The Borrower, Huong Tran will personal guarantee the principal sum amount and the interest due by securing and collateralizing the following properties owned under the corporation named XXX, LLC and under (INDIVIDUAL)..

i. Property 1

ii. Property 2

iii. Property 3

iii.Property 4

iiii. Property 5

The initial term of this Straight Note Agreement shall be for the term of Six Months (6) (the "Initial Term") commencing on the date this Promissory Note Agreement is executed by authorized officers of XXX, LLC and Lender (individual name)

Borrower shall have the right to prepay all (but not a portion) of the indebtedness evidenced by this Note at any time, by paying the Lender an amount equal to the sum of (I) the principal balance then outstanding and (ii) all interest accrued to the date of such prepayment.

Lender and Borrower intend that the relationship created and evidenced by this Note and the Loan Documents shall be solely that of debtor and creditor. Nothing in this Note shall be construed as creating a joint venture, partnership, tenancy in common, or joint tenancy between Lender and Borrower.

In the event that the holder wish to withdraw any portions (with prior notice) of the principal amount during the term of this note, Holder will waive any/all interests earned and only the initial principal amount will be returned to the Holder. This note is subject to Section 2966 of the Civil Code, which provides that the LENDER of this note shall give written notice to the BORROWER, or his successor in interest, of prescribed information at least 90 days and not more than 150 days before any balloon payment is due upon requests.

All payments under this Note shall be made in lawful money of the United States of America. The principal amount of this Note may be prepaid, in whole or in part, at any time without penalty.

Should suit be commenced to collect this note or any portion thereof, such sum as the Court may deem reasonable shall be added hereto as attorney’s fees, the LENDER agrees to pay the costs of such additional sums as a court may adjudge reasonable as attorney's fees in any suit.

Documents shall be construed under the laws of the state CALIFORNIA of the UNITED STATES. Any alteration, change or modification of or to this Note, In order to become effective, shall be made by written instrument executed by both the Lender and the Borrower.


SIGNATRES AND NOTARIZATION BELOW

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I showed this to my attorney, not specialized in REI, and she said it's missing a ton of other aspects. Does anyone have any advice for me before I pay a RE attorney a grip of cash? Much appreciated!

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Account Closed
Lender · Los Angeles, CA · Member since 2015 · 399 posts · 174 votes
9y

Not a lawyer but 12% is usury in CA, unless you're licensed.  I presume the loan is in CA since your profile says San Jose.

Also, if it were me as lender I'd not agree up front to pay attorneys fees like your are, I would have borrower pay atty fees if collection is necessary.

Also, you better make darn sure know what the loan money is used for.  If the money is used for consumer purpose there are a boat load of disclosures, licenses and regulations you need to comply with.

Also, what is the value of the collateral, if should be substantially more than the loan amount or you could become partially unsecured both as a practical matter and subject to cram down or lien stripping if borrower decides to file BK.

Also, if you don't have a deed of trust to go with this note it's unsecured, it then becomes expensive toilet paper.

Also, you should get the deed of trust insured with a ALTA lenders policy.

Also, this may be a personal thing but I like monthly payments, not everything at the end.  Believe it or not borrowers tend to fall asleep at the wheel unless they have to write a check each month.

Also, you don't need to pay $3k to have this reviewed by a RE atty.  For $600-1000 a loan servicer or lending atty will draw docs (in your favor) for you, and charge it to the borrower.

Also, a RE attorney likely doesn't know jack about lending laws in CA, you need a lending atty.

Also, you should know, the state of CA has determined you cannot lend more than 10% of your net worth (exclusive of your house and auto) should you decide to go through a RE broker.  I personally don't agree with the 10% but you should probably make sure the loan amount isn't more than you are will to lose.

Other than that you're likely good to go.

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  • Stephanie MedellinBusiness Member
    Mortgage Broker · CA · Member since 2014 · 1k+ posts · 644 votes
    9y

    @Ken T.  I am not even going to attempt to give legal advice about this, and I don't think you should rely on anything on here as a basis for drawing up legal papers for a loan.

    The only thing I can say is hire a real estate lawyer who handles owner financed transactions to prepare your note and deed of trust, and any other disclosures needed for your transaction.  I don't know what a competitive fee is for CA because I've never used an attorney there for a real estate transaction - the CAR forms have always been sufficient.  They should have fairly standard forms that they use and not start from scratch. 

    Again, if you're going to get into holding the note or lending, you want to make sure you're protecting your investment (your cash) completely!

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  • Account Closed
    Lender · Los Angeles, CA · Member since 2015 · 399 posts · 174 votes
    9y

    Not a lawyer but 12% is usury in CA, unless you're licensed.  I presume the loan is in CA since your profile says San Jose.

    Also, if it were me as lender I'd not agree up front to pay attorneys fees like your are, I would have borrower pay atty fees if collection is necessary.

    Also, you better make darn sure know what the loan money is used for.  If the money is used for consumer purpose there are a boat load of disclosures, licenses and regulations you need to comply with.

    Also, what is the value of the collateral, if should be substantially more than the loan amount or you could become partially unsecured both as a practical matter and subject to cram down or lien stripping if borrower decides to file BK.

    Also, if you don't have a deed of trust to go with this note it's unsecured, it then becomes expensive toilet paper.

    Also, you should get the deed of trust insured with a ALTA lenders policy.

    Also, this may be a personal thing but I like monthly payments, not everything at the end.  Believe it or not borrowers tend to fall asleep at the wheel unless they have to write a check each month.

    Also, you don't need to pay $3k to have this reviewed by a RE atty.  For $600-1000 a loan servicer or lending atty will draw docs (in your favor) for you, and charge it to the borrower.

    Also, a RE attorney likely doesn't know jack about lending laws in CA, you need a lending atty.

    Also, you should know, the state of CA has determined you cannot lend more than 10% of your net worth (exclusive of your house and auto) should you decide to go through a RE broker.  I personally don't agree with the 10% but you should probably make sure the loan amount isn't more than you are will to lose.

    Other than that you're likely good to go.

    5Reply
  • Ryan Landis
    Residential Real Estate Broker · San Mateo, CA · Member since 2013 · 585 posts · 264 votes
    9y

    @Ken T. I imagine this loan is for more than $100K. If that is the case, make sure to have people professionally review it if this is your first time doing it. As @Account Closed mentioned you probably can get it from a solid source, but I would highly recommend getting one more set of eyes on it - you want this to be the first of many I imagine? If so, it is better to make sure you have your i's dotted and t's crossed before writing the check.

    2Reply
  • Account Closed
    Real Estate Agent · Las Vegas, NV · Member since 2015 · 2k+ posts · 1k+ votes
    9y

    are you buying 5 properties? or are you using 5 properties as collateral for a flip? If you are doing a flip I would extend the note to 12 months for some breathing room

    1Reply
  • Ken T.
    OP
    Dallas, TX · Member since 2016 · 78 posts · 31 votes
    9y

    Stephanie - Thank you, I will look into the CAR forms.

    David - Thank you for your detailed post. I just got informed about the usury, the deed of trust. i'm going to call 4 lending lawyers tomorrow.

    Ryan - yes this is going to be the first of many. And yes it's quite an amount. Big money big questions!

    Steven - No the borrower is putting up five other properties as collateral. This loan is being used towards another property though.

    0Reply
  • Ed S.
    Investor · Oskaloosa, IA · Member since 2014 · 126 posts · 65 votes
    9y
    You stated this is your first time, I would strongly suggest legal counsel. This will be learning experience, no matter if goes smoothly. Protect your "assets" the first time. Hit a base hit your first time at bat.
    1Reply
  • Chris MasonPro Member
    Moderator
    Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes
    9y

    Hi @Ken T.,

    Here's a boilerplate Note and Deed of Trust if you want something to compare it to.

    I am not a lawyer. What you posted has some glaring issues, to wit clear a contradiction on prepayment: 

    and

    Early payments and prepayment penalties are a HUGE part of where folks in the HML borrowing/lending space push back and forth, vying for advantage. And, here, I don't really have the faintest clue what the agreement actually is on this particular point. Honestly, with a glaring error that big, I'd be inclined to throw this paperwork away and start from scratch, fresh.

    3Reply
  • Ken T.
    OP
    Dallas, TX · Member since 2016 · 78 posts · 31 votes
    9y

    Thank you Chris! 

    To my understanding I will toss this contract, contact the escrow company the borrower is going through and.... setup a deed of trust, complete a CAR lender form, and obtain a ALTA lender policy. Does this sound pretty good? Skip out the lawyers who want about $1000 for their work?

    0Reply
  • Juline R.
    Investor · traveling · Member since 2016 · 16 posts · 1 vote
    9y
    Ken Truong I'm also researching my first lend for a flip in CA.... based on what you learn, perhaps we could split attorney cost to get the forms and info we need? Keep me up on what you find out...so far I only googled around for a night and lending seems risky and complex. In my case I haven't set up a LLC yet either- also looking for a CPA for that. Are you lending under your name or an entity? Juline
    1Reply
  • Ken T.
    OP
    Dallas, TX · Member since 2016 · 78 posts · 31 votes
    9y

    Juline, as soon as I learn and successfully complete a lend, I will post the outcome on here for you to learn.

    I don't think you need a CPA to create an LLC, there are other service providers that will help you with that. I paid some shady fella that I met from a guru workshop to set mine up....

    0Reply
  • Chris MasonPro Member
    Moderator
    Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes
    9y
    Originally posted by @Ken T.:

    Thank you Chris! 

    To my understanding I will toss this contract, contact the escrow company the borrower is going through and.... setup a deed of trust, complete a CAR lender form, and obtain a ALTA lender policy. Does this sound pretty good? Skip out the lawyers who want about $1000 for their work?

     Personally I would still hire a lawyer. And I wouldn't just shop fee, I'd shop competence. You're doing a blanket mortgage here, and if it goes to litigation and there is any doubt, you should assume the court will side withe the "innocent consumer"/borrower, not you the "evil predator"/lender. 

    1Reply
  • Ken T.
    OP
    Dallas, TX · Member since 2016 · 78 posts · 31 votes
    9y

    Thank you Chris for advice and the perspective.  I will definitely have a lawyer create this contract. 

    Is this how real estate loans typically go when people partner up as lenders? There are quite a lot of attorney fees involved if every transaction went this way.

    0Reply
  • Naseer Khan
    Attorney · Bay Area, CA · Member since 2016 · 164 posts · 135 votes
    9y

    @Ken T.

    You can pass some of the cost along to the borrower as Document Preparation fees, or Legal Fees, etc.  But it is a good idea to use an attorney to draft the documents to ensure you are protected. 

    Be sure you know how a Deed of Trust works.  It is not like a mortgage. You must designate a trustee (generally, a third party not affiliated with lender and borrower) who holds title as a surety for the loan.  Lenders in California use third party companies such as title companies that act as trustees and they handle the default and foreclosure process for you -  all for a fee of course.  There must be specific "power of sale" language in the Deed of trust, which allows you to conduct non judicial foreclosures. 

    On the other hand, a mortgage acts more like a lien against the property and generally require a judicial foreclosure. 

    1Reply
  • George DespotopoulosBusiness Member
    Lender · New York, NY · Member since 2016 · 936 posts · 287 votes
    9y

    As an attorney who handles the drafting and review of all loan documents, prior to and for closing, I would highly suggest retaining counsel for this. 

    I don't know who or what kind of attorney would charge $3,000 for merely a consultation...I think there may have been some sort of miscommunication there. Perhaps they meant a $3,000 retainer that they will bill against at their hourly rate. 

    Regardless, if you're lending money I would think you'd want that to be a secure investment. Each dollar I lend I make sure I understand fully the risk associated with that transaction and do what I can to protect myself. 

    In the wording you provided there are many issues and things you have not provided for. Instead of going through and detailing the shortcomings, which would take significant time here, you should talk to an attorney asap. You always have to plan for the worst case scenario. Here it would be a default. You do not want to pray that the docs you drafted on your own or with input from online strangers holds up in court. 

    Also, to save on legal fees, usually you talk to the initial attorney who drafts the docs with them and ask him how they will charge you to handle subsequent loans. Usually they will give you a reduction in hourly rate to make small edits.

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  • Ken T.
    OP
    Dallas, TX · Member since 2016 · 78 posts · 31 votes
    9y

    Sounds like I will need to go with the attorney for sure.

    Considering that > 10% is usury, could I still charge points and then 10% interest?

    0Reply
  • Stephanie MedellinBusiness Member
    Mortgage Broker · CA · Member since 2014 · 1k+ posts · 644 votes
    9y

    @Ken T.  I don't think CAR has forms for loans, only real estate transactions.  I was saying that I've never used an attorney for a transaction in CA because CAR forms are sufficient for the real estate side of the transaction.  Sorry that's not very helpful!

    Just make sure whatever you're doing doesn't require a license.  Since it doesn't sound like you're doing an owner financed transaction, different rules probably apply.

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  • Account Closed
    Investor · West Los Angeles, CA · Member since 2014 · 230 posts · 239 votes
    9y

    @Ken T.

    Ok as everyone has said before make sure you get an attorney to review this.  My first lending deal I lost $100k and it almost took me out of the game.  Had I paid $3000k to have an attorney review it believe me it would have been money well spent.  Don't shop for cost shop for competence.  

    As @Account Closed said you need to get monthly payments.  No way in heck would I lend my money as debt and not get monthly payments.  I will do it on an equity deal but not debt.  I don't know how much money you're lending but at 12% you better be damm sure you're in first position.  No gap funding no second lien position no exceptions otherwise you're interest rate is waaay too low.  (Hint think 20%).  Furthermore as a newbie anything other than first position is not for you.  I've loaned over 1MM and will not lend in anything other than first.

    Finally take a look at the equity both in the property you're lending against.  If there's no equity in the property you're lending against then there better be enough equity in the 5 properties he's giving you as cross collateral.  This includes researching if he has other liens after the first for EACH property.

    Personally I don't like the loan and would pass on this one.  I don't like the terms & I don't like the complication (6 properties total seriously?).  Imagine the headache having to foreclose on 6 properties no thanks.  But if you are going to push forward it needs to be reworked to your advantage.  Remember no hard feelings or emotions just go back to the negotiation table and tell him your terms.  If you can't come to an agreement wish him the best of luck & move on.  There's plenty of deals out there.

    Good luck

    2Reply
  • Timothy Tung
    San Jose, CA · Member since 2016 · 1 post · 1 vote
    9y
    Originally posted by @Account Closed:

    @Ken T.

    Ok as everyone has said before make sure you get an attorney to review this.  My first lending deal I lost $100k and it almost took me out of the game.  Had I paid $3000k to have an attorney review it believe me it would have been money well spent.  Don't shop for cost shop for competence.  

    As @Account Closed said you need to get monthly payments.  No way in heck would I lend my money as debt and not get monthly payments.  I will do it on an equity deal but not debt.  I don't know how much money you're lending but at 12% you better be damm sure you're in first position.  No gap funding no second lien position no exceptions otherwise you're interest rate is waaay too low.  (Hint think 20%).  Furthermore as a newbie anything other than first position is not for you.  I've loaned over 1MM and will not lend in anything other than first.

    Finally take a look at the equity both in the property you're lending against.  If there's no equity in the property you're lending against then there better be enough equity in the 5 properties he's giving you as cross collateral.  This includes researching if he has other liens after the first for EACH property.

    Personally I don't like the loan and would pass on this one.  I don't like the terms & I don't like the complication (6 properties total seriously?).  Imagine the headache having to foreclose on 6 properties no thanks.  But if you are going to push forward it needs to be reworked to your advantage.  Remember no hard feelings or emotions just go back to the negotiation table and tell him your terms.  If you can't come to an agreement wish him the best of luck & move on.  There's plenty of deals out there.

    Good luck

     Hi Jeanette,

    Can you elaborate how you lost so much money in your deal?  

    Also, I thought by california usury laws as a private lender, you cannot lend more than 10% unlicensed.  If Ken was to have a deed of trust, does that not provide enough protection on the loan?

    1Reply
  • Account Closed
    Lender · Los Angeles, CA · Member since 2015 · 399 posts · 174 votes
    9y
    Originally posted by @Ken T.:

    Sounds like I will need to go with the attorney for sure.

    Considering that > 10% is usury, could I still charge points and then 10% interest?

     No.  Points and fees will be folded into the interest in determining usury.

    I've heard it said that if you charge 9% and two points on a two year loan it averages out to be 10%/yr thus not usurious but I have doubts about that.

    1Reply
  • Aaron Pfeffer
    Lender · Los Angeles, CA · Member since 2015 · 127 posts · 82 votes
    9y

    First, this is over 10% rate in CA so a broker should be involved. Second, the borrower should be paying every dollar of every part of the transaction...so what you should really consider doing is ripping this note up and using an attorney specializing in hard money/private money loans to draft a new note and deed from scratch at the borrowers expense. Third, having five other properties to cross-collateralize is wonderful, and an appropriate contiguous DOT in your favor is fantastic added security. Fourth, it's not terrible to defer all payments until the very end, but make sure you set up the servicing with a great third party company who specializes in deferred payment. Fifth, yeah, I'm curious to know what position lien-wise you're really in here. Sixth, this whole transaction better clearly be business purpose.

    2Reply
  • Ken T.
    OP
    Dallas, TX · Member since 2016 · 78 posts · 31 votes
    9y

    So I have been in contact with his escrow agent, and she said she can draft a promissory note and secure a DOT for $150. I am very tempted to ask again, is it still necessary to go through an attorney to draft it? I will have my cousin who is an attorney review it, but not draft it.

    I will be second on the lien. This will all be confirmed w/ the escrow agent.

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  • Diane G.
    CA · Member since 2016 · 1k+ posts · 1k+ votes
    9y

    @Account Closed

    when you first started out, how much money did you have to lend? and how was that $100K lost? Thanks

    1Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    9y

    @Aaron Pfeffer  junior lenders in rehab deals are very frequently separated from their money.

    there is more to this than what your saying.. I suspect the risk is quite high and the rate of return is quite low.

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  • Rick Pozos
    Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
    9y

    The farther I got down the posts, the more I cringed.

    I am not sure how things are done in CA, I am in Texas. Here I close all my transactions at a title company. There is lender insurance, title insurance so everyone is covered. The title company hires an attorney to draft the docs that have the terms that we agreed to (borrower and lender). There is a Deed of Trust and Note. Only the deed of trust is recorded. 

    I would be very leery of a 2nd lien position. PASS on the deal. They should have gotten everything taken care of with the first loan. It has probably gotten to an emergency situation. If it is an emergency, 12% is NOT an emergency interest rate.

    3Reply
  • Account Closed
    Lender · Los Angeles, CA · Member since 2015 · 399 posts · 174 votes
    9y
    Originally posted by @Ken T.:

    So I have been in contact with his escrow agent, and she said she can draft a promissory note and secure a DOT for $150. I am very tempted to ask again, is it still necessary to go through an attorney to draft it? I will have my cousin who is an attorney review it, but not draft it.

    I will be second on the lien. This will all be confirmed w/ the escrow agent.

    $150 sounds about right, but your going to get a very simple note and DOT, usually downloadable at the title companies website. The note has about 5 sentences, that's it.

    If I read your OP correctly you have 5 pieces of real property as security. Determine the LTV for each and what liens are going to be senior to yours. If there is a ton of combined equity you might be fine. If for example if you will be in second position on one of them, as you stated, and the other are free and clear then you could be golden.

    If borrower is really giving you 5 properties as collateral you should get 5 prelims from the title company, all 5 APN's will go on one DOT creating a lien on all 5 in whatever position the prelim tells you.

    Your statement that you will be in second position only relates to one of the 5, what position will you be in on the other 4?

    Your statement that this will be confirmed w/escrow is risky, you should not depend on others, they make mistakes, title insurance is insuring the prelim, not what the escrow agent says ... read the prelim(s). It's of no consequence because nothing went sideways but I'm refinancing a 1st on a rehab right now. The DOT that I'm refinancing has two APN's on it, one property titled in the same entity as the DOT thus creating a lien, the other in some other entity thus not creating a lien. Lender depended on title and escrow agents to create liens on both, didn't happen ... read the prelim(s).

    BTW, if I were you reading this thread I'd be so confused right now.  At the end of the day I'm guessing your head will be spinning.

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