Private Lending Questions

17 Replies

I have a potential deal in the making, and have a private lender lined up.

I, and the lender, are new to the private lending game, so what sort of paperwork/contracts need to be in place before the deal happens?

Really would appreciate any and all advice

Originally posted by @Jake Stuttgen :

I have a potential deal in the making, and have a private lender lined up.

I, and the lender, are new to the private lending game, so what sort of paperwork/contracts need to be in place before the deal happens?

Really would appreciate any and all advice

 That is actually a "depends" type of question. The amount of the loan matters. How well you know the lender matters. How much the property is worth matters. Your time frame matters. How you are going to pay the loan back matters. Will it be amortized or interest only or lump sum with accumulated interest. Generally you should have a promissory note and an agreement as to what happens in the event you don't pay it off when due.

@Mike M. The lender is a family friend, I know him well. Itll probably be a 1 yr, interest only loan.

Okay, so I will start with a promissory note and an agreement. Should a lawyer draft that up, or are their templates available?

I appreciate it!!

You need a promissory note (which outlines all the details of the loan) and either a mortgage or deed of trust, depending on which is used in your state.  The lender (not you) should have these prepared by their attorney, though a title company may have samples.  The mortgage or deed of trust is recorded.  Promissory note is not.

@Jon Holdman Thank you! Ill dig into this. Doesn't sound too complicated!

Do they need to be present at closing? (the lender)

They can be, but the lender typically is not.  They would send their money to the title company the day before or morning of closing.

Originally posted by @Jake Stuttgen :

@Mike M. The lender is a family friend, I know him well. Itll probably be a 1 yr, interest only loan.

Okay, so I will start with a promissory note and an agreement. Should a lawyer draft that up, or are their templates available?

I appreciate it!!

 Have a title company provide you with a report on the property so you know that the person selling it to you has the right to sell it and also that there aren't any outstanding liens against the property he didn't tell you about. This protects you and your lender from a serious misunderstanding if there are title problems or outstanding liens.

Make sure you take out insurance on the property.

In my case, when lending to someone I know well, I use an agreement and a promissory note and if the amount is $50k or less I don't do a Deed of Trust. Some people do, but I don't. I just do the agreement and note.

If I don't know the person or if the property is in a different state, I do the Deed of Trust (Mortgage). Compare costs and risks and let your tolerance for risk be your guide.  

Another way you might want to think about is to just set it up as a line of credit that you make payments on every month for but as one project finishes you can pay off the loc or if you have another house ready to go you draw on the loc to fund it. If your lender is looking for ongoing cash flow it makes things a lot easier.

Originally posted by @Mike M. :
Originally posted by @Jake Stuttgen:

@Mike M. The lender is a family friend, I know him well. Itll probably be a 1 yr, interest only loan.

Okay, so I will start with a promissory note and an agreement. Should a lawyer draft that up, or are their templates available?

I appreciate it!!

 Have a title company provide you with a report on the property so you know that the person selling it to you has the right to sell it and also that there aren't any outstanding liens against the property he didn't tell you about. This protects you and your lender from a serious misunderstanding if there are title problems or outstanding liens.

In my case, when lending to someone I know well, I use an agreement and a promissory note and if the amount is $50k or less I don't do a Deed of Trust. Some people do, but I don't. I just do the agreement and note.

I definitely agree with going through a title company which will need to provide a title preliminary report and verify all liens and encumbrances. Your lender should also require you to provide lender's title insurance. You should also open an escrow account with a licensed and reputable escrow firm in your area.

I strongly disagree with the advice of not using a deed of trust if under $50k since you and the lender are new to this. While I do have a few unrecorded deeds of trust at times, it is only because I have an impeccable track record and the experience and financial backing to perform on the promise no matter what happens. Going without a recorded deed of trust (or mortgage) is a big mistake for lenders, particularly with borrowers that lack experience.

Additionally, you need a promissory note complete with all the terms, complete with all necessary and state law required disclosures, the rate must not exceed your state's usury limits, and your lender will also need to require that they be named additionally insured on your hazard insurance policy with acceptable limits and deductibles. Your lender should draft a lender's escrow instructions outlining all their requirements to fund the loan and have the escrow officer, title officer, and you sign it.

All of this is not complicated however, attention to detail is important and your lender should be advised to seek legal counsel to draft all of these documents which protect the lender and their capital.

I have borrowed and returned well over $25M in private money capital over the last several years so I would consider my non legal advice above to be sound.

In addition to all the good comments above, I would add that a deed of trust in addition to securing the loan, good for lender, provides a certain amount of equity stripping which is good for borrower.

Getting hazard insurance is a must of course, beyond that you need the right insurance.  I can't tell you how many times my borrowers get a Homeowners policy or a Landlords policy because it's cheaper than what they should get which is a Vacant policy or a Builders Risk policy.  Guess what happens if you get a homeowners policy and there's a fire on a vacant property in the middle of rehab ... claim could be denied.  And if that happens guess who is out a bunch of money.

Another thing that gets messed up is when the insured doesn't match the property owner. Example, Flipper Frank is the insured on the fire policy and Awesome Flipper LLC is the owner ... guess what, the insured isn't the owner thus has no insurable interest. Again, why does this happen, well, because it's cheaper to insure an individual than it is to insure an LLC.

@Mike M. Is setting up and LOC with my lender a totally different process? Just want to be sure so the IRS doesnt view it as gift money

@Will Barnard Thanks for the solid advice, really appreciate it. If the lender is, lets say my father, should I still take all the outlined steps? Where would one get title lender insurance?

So I should:

1. Get the title report
2. Set up a Promissory note through an Attorney?
3. Set up a Mortgage at the title company

Straightforward, but detail is important.

@David C. Definitely will be getting Hazard insurance on the property. Thanks for that tip!!

I have an LLC, and plan on putting it on the title, so I'll be sure to also use it on the insurance policy! I would have missed that

Originally posted by @Jake Stuttgen :

@Mike M. Is setting up and LOC with my lender a totally different process? Just want to be sure so the IRS doesnt view it as gift money

@Will Barnard Thanks for the solid advice, really appreciate it. If the lender is, lets say my father, should I still take all the outlined steps? Where would one get title lender insurance?

So I should:

1. Get the title report
2. Set up a Promissory note through an Attorney?
3. Set up a Mortgage at the title company

Straightforward, but detail is important.

@David C. Definitely will be getting Hazard insurance on the property. Thanks for that tip!!

I have an LLC, and plan on putting it on the title, so I'll be sure to also use it on the insurance policy! I would have missed that

 I don't want to belabor the issues but as I said, if you know the person well and in this case it appears to be your father, the expense of $1,000 to $1,500 to have an attorney draw up a mortgage for $50,000 might be unnecessary. When I lend to my investing son, and it is a great deal of money, I transfer the money and it is a note in the bankbook. No promissory note, no Deed of Trust or Mortgage and no written agreement. I raised him the right way. A handshake agreement is golden and works for us. He has always paid me back because I taught him that is the honorable and proper thing to do. 

Your insurance agent should ask you how you are taking title when you order insurance. If they don't ask, get a different insurance agent. Tell them what you are doing and they will direct you to the proper insurance.

A promissory note is sufficient for the IRS and you should have a closing statement from escrow to support the numbers.

The biggest challenges are to stay under budget and to sell quickly. Time is not your friend when doing flips. You must fix and sell as fast as reasonably possible to make any good kind of profit. By the way, Fix & Flips are the highest taxed in the real estate investment world. You should consider doing Cash Flow investing with depreciation of assets and appreciation of property while selling to Tenant Buyers if you really want to become wealthy. Both you and your dad can be independent in about two years. That's what I taught my son to do and he isn't even 30 yet. It's also the least taxed of the real estate investment options. It's long term cash flow every month and no rehab worries or chasing the market to sell a property.

@Mike M. My father and I have a very similar relationship, and have a lot of trust in one another. 

So I can draft up a short promissory note for IRS purposes, so they don't view it as a gift, and how would my dad set it up as a note in the bankbook?

100% agree on buy and hold. That is our intended strategy. I am closing on a duplex soon that will be buy and hold.

The one I plan on fixing, I believe I am going to fix it up, rent it out, and refinance in a year or two years. My dad is agreeing to a 1-2 year interest only loan on it, then when I refinance, we can then go seek out another property, rinse and repeat.

Since I am in the starting stages still, his investment helps me get going quicker and allows him to have a consistent % income.

He will be retiring soon and will be investing in buy & hold soon

Originally posted by @Jake Stuttgen :

@Mike M. My father and I have a very similar relationship, and have a lot of trust in one another. 

So I can draft up a short promissory note for IRS purposes, so they don't view it as a gift, and how would my dad set it up as a note in the bankbook?

100% agree on buy and hold. That is our intended strategy. I am closing on a duplex soon that will be buy and hold.

The one I plan on fixing, I believe I am going to fix it up, rent it out, and refinance in a year or two years. My dad is agreeing to a 1-2 year interest only loan on it, then when I refinance, we can then go seek out another property, rinse and repeat.

Since I am in the starting stages still, his investment helps me get going quicker and allows him to have a consistent % income.

He will be retiring soon and will be investing in buy & hold soon

 The new tax laws change how some people invest. I think the numbers are $157,500 income per year filing single or $315,000 per year filing joint. If he is under those numbers it is pretty straight forward. If he is above those numbers he needs to talk to a CPA first. But basic accounting needs to be done either way. You have to track each expense and he has to track the amount lent to you you, the date, and any payments you make along with any interest accrual. The simplest way to put it is that every time money gets involved (buying lumber, hiring a gardener, etc) you have to put it on the spread sheet. You track date, amount, to whom, why. Your dad has a spreadsheet with a line item for every time he funds the loan or gets a payment or accrues interest. Basic accounting. Keep your receipts. I sort my receipts by type. Advertising, materials, contractors, etc. and put them in an accordion file per property. I also scan everything and put then into a folder on my laptop and back the folder up to a USB which I store offsite.

So he can lend me up to $315k then? He earns more than that, but he is also retiring this year.

Yeah I'll be tracking expenses and he will as well, we are pretty good with organization

I keep my receipts by taking photos of them and organizing them into Google Drive, by month for now, since I do not have a ton to organize yet

Originally posted by @Mike M. :
Originally posted by @Jake Stuttgen:

@Mike M. Is setting up and LOC with my lender a totally different process? Just want to be sure so the IRS doesnt view it as gift money

@Will Barnard Thanks for the solid advice, really appreciate it. If the lender is, lets say my father, should I still take all the outlined steps? Where would one get title lender insurance?

So I should:

1. Get the title report
2. Set up a Promissory note through an Attorney?
3. Set up a Mortgage at the title company

Straightforward, but detail is important.

@David C. Definitely will be getting Hazard insurance on the property. Thanks for that tip!!

I have an LLC, and plan on putting it on the title, so I'll be sure to also use it on the insurance policy! I would have missed that

 I don't want to belabor the issues but as I said, if you know the person well and in this case it appears to be your father, the expense of $1,000 to $1,500 to have an attorney draw up a mortgage for $50,000 might be unnecessary. When I lend to my investing son, and it is a great deal of money, I transfer the money and it is a note in the bankbook. No promissory note, no Deed of Trust or Mortgage and no written agreement. I raised him the right way. A handshake agreement is golden and works for us. He has always paid me back because I taught him that is the honorable and proper thing to do. 

Your insurance agent should ask you how you are taking title when you order insurance. If they don't ask, get a different insurance agent. Tell them what you are doing and they will direct you to the proper insurance.

A promissory note is sufficient for the IRS and you should have a closing statement from escrow to support the numbers.

The biggest challenges are to stay under budget and to sell quickly. Time is not your friend when doing flips. You must fix and sell as fast as reasonably possible to make any good kind of profit. By the way, Fix & Flips are the highest taxed in the real estate investment world. You should consider doing Cash Flow investing with depreciation of assets and appreciation of property while selling to Tenant Buyers if you really want to become wealthy. Both you and your dad can be independent in about two years. That's what I taught my son to do and he isn't even 30 yet. It's also the least taxed of the real estate investment options. It's long term cash flow every month and no rehab worries or chasing the market to sell a property.

 Totally agree. Since you have elaborated that the lender is your father, and the relationship is on solid ground, then you may not need to spend the extra money on the recorded deed of trust, professional note, lenders title insurance, etc. My parents are one of a handful that I have open unrecorded loans with as my father knows I will always pay it back.

Have an attorney draft Mortgage, Promissory Note, and guarantee agreement (If your LLC is the borrower and you will be the guarantor). The mortgage will be recorded as the private lender as the 1st lien holder. Good luck.

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