Beginner's Question for Investing with Private Money

11 Replies

Hello BP community! This is my first post, so set your expectations low! Here goes ...

Rather than save my way to down payments using my W-2 income, it is easy to imagine how using private loans could accelerate my REI goals. Perhaps this is a bit naive, but are there any legal or financing concerns with using a private loan from friends/family for the down payment of an investment property (SEC regulations, underwriting difficulties, etc.)?

- Hypothetically, if I were to borrow $100,000 from my folks and try to buy a $100,000 house entirely with cash, will I run into any issues?

- How about if I borrowed $20,000 at 5% interest over 30 years - can I use that private loan to fund the down payment for this $100,000 house?

The thought process here is that I may be able to make a 15% (for example) return on my own cash while accepting the risks associated with real estate investing, whereas a private party may not want the risks or fluctuations in income and be perfectly happy with a 5% return on their loan. They could give me a loan with a guaranteed return (i.e. 5%), and I could use the loan to go after higher returns (i.e. 15%). They get their guaranteed income, and I get cash flow with no/low money down. Win-Win!

Can I do this?! If so, is it as simple as, "Hey Dad, can I borrow $20,000?"  

Oh- you're dad's private money adds a lot of complexities.  I for one wouldn't borrow from family.   Awkward t-giving dinner coming up!  Once you borrow his money, he will flinch at that vacation you're taking or that car payment you have in your drive or that selfie at starbucks.  'Why doesn't he just brew his own coffee like the rest of us?" he'll ask himself.

But a private lender, being someone you know, shouldn't skirt any SEC rules.  You just can't put an ad out or something soliciting money.

My private lenders like 6% fixed rate terms for 10 yrs at about 60% or less LTV. I bring them in to pay off commercial loans that keep bothering me or refinance higher rate stuff I've had a while.

For flips I could get other lenders but don't like people in my business, making me check in and get approval.  I'll stick with the old guys that want steady 6% monthly checks @Doug Karkow

"The only ship not meant to sail is a partnership"  -  experienced investor

@Steve Vaughan  Thanks for your thoughts, Steve! And don't worry, I would tip-toe very carefully with anyone's money, and this certainly includes funds from family/friends. I would do my best to make sure the terms of the deal are sweeter than those of the loan so that the loan is basically producing it's own payments (i.e. loan fund deal, and the cash flow repays the loan plus extra).

Any other considerations besides potential family disputes? 

Will lenders balk at financing the remainder of a deal if the down payment funds come from a private loan? 

Does the IRS care how properties are purchased?

Are there any limits to the amount of private money that may be loaned from (or to) a non-accredited investor?

Originally posted by @Doug Karkow :

Will lenders balk at financing the remainder of a deal if the down payment funds come from a private loan? 

Does the IRS care how properties are purchased?

Are there any limits to the amount of private money that may be loaned from (or to) a non-accredited investor?

 Yes, lenders will balk at borrowing the down payment, but gifts are acceptable.  If your dad were to 'gift' you the $20k down payment and put it in writing that it is a gift that doesn't need to be repaid, it should be accepted once it has seasoned in your acct for 2 months or so.   That's my understanding anyway, but I'm not a lender.

The IRS only cares that all interest is accounted for.  Be sure your lender(s) report receiving the exact dollar amount of interest you report paying at end of year.  That's my understanding anyway, but I'm not a tax pro.

There may be limits with non-accredited investors, but it will be a lot more than you're talking about.  That's my understanding anyway, but I'm not a syndicator.   

@Doug Karkow , of your original hypotheticals, the most straightforward one is: "if you were to borrow $100,000 from your folks and try to buy a $100,000 house entirely with cash", your only issue might be - paying back your folks!

But yes, there would likely be income/tax implications. The main thing to keep in mind is: never lie on any forms you sign for the IRS, or for Banks (or to anyone). It's probably time you got out there and had a chat with some Lenders, right?

I believe you'll find Lenders will not be in the habit of being happy to learn that all of your deposit is also borrowed. They'll certainly aim to ensure that you can afford the repayments of all your debt, not just the one you're asking them to grant you. And regarding the Title for the property you're buying, the Lender you have the mortgage with will have put themselves in first position (thus retaining control over the Title), so that if everything goes belly up, so your folks for example, will not get any proceeds of the sale of your foreclosed property until all the Bank's debt is covered!

Afaik, if you're declaring "gifts", that means: you've genuinely been told by the givers - it's yours, forever! Get it? My 2c...

Account Closed For your first statement, this is what I had assumed. Cash is cash, and there's no lender obstacle. However, back to the scalability issue, I can't keep borrowing $100k at a time from my folks. That well will run dry quickly too, unless I do some delayed financing tricks or something. But you're absolutely right, I don't want to lie to anyone about anything. I'm looking for a creative, yet LEGAL, solution for scalability. Like I said above to Steve, I guess my next step will be to let my lender weigh in on this topic ...

Thanks for your help everyone!!!

@Doug Karkow , absolutely it's a good idea: Become an expert on the "Delayed Financing Exception"! That way, if you do have access to your folks' $100k (and, each property buy can be fully paid for out of that), you should never need more. You'd be able to use the same $100k amount over and over again, without needing your folks to give you any extra!

You can see why, right?

[But, you'd be repaying your folks all the while per any agreement, right?]

The trick is: Buying property for 70% (or less) what a Lender appraises them at!

@Brent Coombs That's what I was hoping for - recycling the same pile of cash over and over. I'll have to do more research on the exception, but I hope to try it out soon!

Account Closed  Good question. My poor answer at this point is that I haven't really considered it until recently. After a little research and familiarity with the process, I think I will try this strategy!