Private money lending and CA usury law

24 posts by 7 users

Medium 1399491314 avatar graymack Mike Grayford
Rehabber / Flipper from Simi Valley, CA
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Mike Grayford

Rehabber / Flipper from Simi Valley, California

Dec 04 '10, 07:31 AM


As a rehabber, I'm willing to borrow money at more than the usury-limited rate of 10% (I live in California). I have seen posts in the past indicating that private money can be loaned at higher interest rates if the borrower is a company (we have an LLC). However, I have done a bit of searching online and I have been unable to find applicable California law that would corroborate this, other than if the company already has $2million in assets and has a previous working relationship with the lender.

Does anyone know if it is true in California that a loan can have more than 10% interest as long as it is a company (LLC) borrowing the money, regardless of the company's asset value or previous relationship with the lender? If so, can you please point me to the corresponding law explaining it?

Thanks for any assistance!



Medium 1399404583 avatar planeguy67 Mitch Kronowit
SFR Investor from Orange County, CA
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Mike Grayford

Rehabber / Flipper from Simi Valley, California

Dec 04 '10, 01:44 PM


Thanks for the reply, Mitch. This is great!

I looked over all the laws, and I did find an exclusion that might be the exemption I have seen others refer to. It only applies if a person makes a commercial loan no more than once in a 12 month period, though. This would rule out using an individual investor's funds on more than one property per year, which seems limiting.

Other than that one, I didn't see anything that would be a general exemption from the usury law that I could use. We're not real estate brokers, or pawn shops, or any of the other things that would automatically exempt us. I guess there was one other thing, which was the "shared appreciation loan", but that would mean sharing profit, which I'd rather not have to do in every case.

I guess maybe we can just limit the interest rate to 10% and not worry about the usury law, but then I'm not sure if that would be competitive with other Flippers.

I feel like I'm missing something. Or maybe everyone else is just ignoring the law because really, the Flipper is the borrower and as such, they're not going to report the person they're getting money from.



Medium 1448324704 avatar barnardinc Will Barnard
Developer from Santa Clarita, CA
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Will Barnard Verified Moderator Donor

Developer from Santa Clarita, California

Dec 04 '10, 03:26 PM
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Originally posted by Mike G.:
I feel like I'm missing something. Or maybe everyone else is just ignoring the law because really, the Flipper is the borrower and as such, they're not going to report the person they're getting money from.
From the flipper's side, you are right. If you are willing to pay more than 10%, you are risking nothing, only the lender and why would you complain unless you never wanted them to lend to you again.
That said, it is the responsibility of the lender and the risk of the lender to charge more for loans here in CA unless it is made using a DRE license.

I often pay higher than 10%, but often it is from a private investor whom I have borrowed from in the past and have a working relationship with.



Medium be logoWill Barnard, Barnard Enterprises, Inc.
Website: http://www.barnardenterprises.com


Mike Grayford

Rehabber / Flipper from Simi Valley, California

Dec 05 '10, 12:33 AM


Okay, so it seems like I kind of came to the right conclusion/understanding.

Thanks for the response, Will!



Medium 1399035998 avatar eric3 Eric Michaels
Real Estate Lender from Chicago, IL
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Eric Michaels

Real Estate Lender from Chicago, Illinois

Dec 05 '10, 11:32 PM


This is not legal advice. I am not a lawyer but this is what my lawyer says to do.
Any state's laws can typically be "imported" on a per deal basis. Contracts have a clause that says "This contract shall be under the laws of X state"

Find an out of state lender and draw up the note and mortgage under his state laws if they have commercial exemptions like most do.

All that said, you really just need to find a lender to trust you. Usury laws are virtually never enforced except on a complaint from a borrower. You are the borrower. So if the lender understands that under no circumstances would you complain or cooperate with an investigation, he is really under no risk violating the law, as a practical sense.
You can also structure deals as low interest with a percentage of profits kicker with a cap.



Mike Grayford

Rehabber / Flipper from Simi Valley, California

Dec 06 '10, 12:37 AM


Hi, Eric.

Thanks for the ideas. I was actually thinking of one of those (percentage of profits with a cap) after reading about the shared appreciation exception in the legal code. Good ideas, and I think you and Will are right - it would mostly boil down to trust between the lender and us anyway.



Will Barnard Verified Moderator Donor

Developer from Santa Clarita, California

Dec 06 '10, 01:15 AM
1 vote


One of the easiest ways to give yoru lender a "warm and fuzzy" is to include in your note the following: Borrower understands that this note is in excess of the state usury laws and hereby agrees to perform to the specific notes of this agreement. Furthermore, this loan is not primarily for personal, family or household purposes, but for business purposes only.

Disclaimer: This is NOT legal advice and the wording was not written by an attorney. It is for infomational purposes only.



Medium be logoWill Barnard, Barnard Enterprises, Inc.
Website: http://www.barnardenterprises.com


Medium 1448386327 avatar financexaminer Bill Gulley
Investor, Entrepreneur, Educator from Springfield, MO
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Bill Gulley

Investor, Entrepreneur, Educator from Springfield, Missouri

Dec 24 '10, 04:17 AM


Well, Happy Holidays! IMO, the best way would be to build in lending opportunities into your LLC for a private lender to become a member and lend the money through the capital account. If properly drawn, there is no doubt that it is a commercial loan and the collateral is held by the LLC and assigned to that lender.

Drafting any clause that is contrary to state law may well be worthless as many rights, especially consumer rights or protections provided by law can not be relinguished by the consumer or individual even if by agreement. And, the fact that a borrower agrees to pay an amount over the usury rate is a violation of the lender, not the borrower.
An example of this is when a corporation, say a small cell phone company, incorporates penalties in their contracts that require additional fees for collections of a late payment. Usually under state law, late fees will have some cap and making additional charges in connection with such a payment will be viewed as part of the late fee. The consumer can not waive such rights.
Even by paying the fees.

I have also seen where usuary laws were violated that the lender ended up owing a fine to the state, but never had to remit overages to the borrower, especially when the loan had been paid off and the borrower was long gone.

Will is absolutely right that in a private lending arrangement, where no compliance audit is performed by the state that if a borrower never complains, it may go undetected. But borrowers die, they become incapacitated and others may end up standing in their place to wind up business, so from the lending side, it would not be wise, IMO, to simply have a usurus note.

State law should be investigated with peripheral laws as well, references to usury within any state may include tax law, commerce and other secured lending requirements where they may become applicable. So I suggest you see your attorney.

Any lender that does business in another state must abide by that state law, where the collateral resides, the home office is irrelevant. Think about it, Bank of America may have its national or international headquarters in one state, but the loans they make elsewhere are written to conform to the state law where the loan is made, and with real estate loans, that means where the collateral is located.

As to a shared appreciation arrangement, I'd suggest going back to the LLC suggested. If you have a formal partnership, that may also work out for you. To do any shared appreciation agreement in connection with a loan or subject to a loan being made, you will still be in viloation as the Truth In Lending Act requires all loan expenses or other charges made in connection with the loan be computed for the APR, and it will be generally be the APR that any usury rate will be applied to. Ahh, but this is a private lender and the TIL may not apply, ahhh, but, if the private lender is in the business of lending money, it may very well apply.

Without a doubt, IMO, the best way is for the lender to be in the LLC as a very limited member, make a contribution to capital and receive the applicable profits, a small rate of interest and his principal back. Good luck, Bill



Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy
Website: https://generalrealestateacademy.com


Mike Grayford

Rehabber / Flipper from Simi Valley, California

Dec 24 '10, 04:48 AM


The suggestion to have a private money lender be a partner in the LLC does not seem feasible to me, unless you create a different LLC for each property. Maybe creating a new LLC each time is a reasonable solution in another state, but it doesn't seem realistic here in California. Forgetting the potential legal fees, just creating an LLC costs $800 here.

And then there is the timing issue. I wonder if it would even be possible to arrange everything quickly enough. From the time the offer was accepted, you'd have to present the opportunity to the lender, get them on-board, file the LLC, get the EIN and documentation from the state, setup a bank account, deposit the funds, and then wire the money before close of escrow. As a flipper, we need to close fast, so our offers generally specify a closing time of two weeks. Maybe it would be possible to move this quickly somewhere else, but I don't think this is even remotely possible in California. If I'm wrong, I'd love to hear from others how this could work.

As for the shared appreciation mortgage, the law in California seems to be quite clear that any of the money that comes from the appreciation of the property is not counted as part of the interest rate. Mind you, I'm not a lawyer, but the Civil Code specifically refers to this in a number of places.

As for Will's comment about the broker involvement, he is correct in that if the broker arranges the deal, it will be exempt from the usury law. However, I have read that it can't just be a broker signing off on it, because that likely wouldn't hold up in court; it would have to be the broker actually negotiating the terms of the loan. So I've read, but I've obviously never tested this and can't point to a specific case.



Bill Gulley

Investor, Entrepreneur, Educator from Springfield, Missouri

Dec 24 '10, 05:22 AM


Hi, yes, but I didn't mean form seperate LLCs or even one to lend out of, not at all. Your existing LLC that owns the property to be purchased (I assume) would admit a member, that member would provide the capital. If you're using an individual lender, that's an option, if it's an organized HML type, that might be harder.

A member can be admitted that has no voting rights, no management rights and can be limited in any respect that you desire. They can be passive and make contributions, receive any per cenatge of profit even up to a dollar limit, interest and principal. Sorry I didn't break that down.

I didn't read the CA statutes. I understand what you're saying about the two, but I was saying that if the shared amount was ONLY on the condition of making a loan, the finance department might look at it as a LOAN CONDITION, and not just a shared appreciation....I don't know if CA specifically is saying a loan with shared appreciation is not interest, it obviously is a benefit and consideration to make a loan, a cost of borrowing the money, almost the definition of interest.

Again, the individual lender would be admitted to the existing LLC, don't need to make new ones, and after the loan is paid off, take them out of the LLC, or they could remain dormant until the next loan. You could have a dozen such members. You would also need to make them feel warm and fuzzy, like providing them with a hold harless and indemnification covenant and limiting their liabilty....I'm talking about individuals here.

I have not read CA statutes again, but the SAFE Act really means that the Originator/broker will do the entire loan, and there is also the CFPA requirements too. As a seller, you may not dictate any terms or interest, that's on the way I believe. This being applicable to loans secured by residential property, so the commercial loan excuse may not fly. This is why making the individual lender a member makes it clearly a commercial loan to the company. The company owns the property and there is no deed of trust to the lender, the security agree,ment is in the Operating Agreement, among owners. That's really why I suggested you see an attorney, this is not a do it yourself thing to construct. By any means, Good Luck....



Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy
Website: https://generalrealestateacademy.com


Mike Grayford

Rehabber / Flipper from Simi Valley, California

Dec 24 '10, 08:47 AM


Bill, sorry I misunderstood your original suggestion, probably because the idea of having additional members in my company causes a knee-jerk fear reaction. :)

Okay, getting over that reaction, are you saying that the private money lender, as a member of the LLC, would make a capital contribution to the company rather than a loan? And then upon the sale of the property, that member takes a distribution of the entire amount of their initial contribution, plus whatever additional percentage we agreed to? I wonder what happens if we break even on the property or even lose money. In that case we still want to pay the lender their interest, but now if we do that I wonder if it would be considered a loan at that point and not a capital contribution.

A couple other concerns I'd have with that approach: because their money is now technically the company's money (as a result of it being a capital contribution), it is exposed in the event of a lawsuit; also, like you said, it is not secured against the property with a deed of trust. I would think this method would be less desirable to a potential lender. Or am I incorrect in this analysis? I hope I'm not coming across as a contrarian here, I'm just trying to consider the possibilities. And I really appreciate the ideas you and others are putting out.

As for the California laws regarding the shared appreciation... From my interpretation it says that any additional funds made beyond the fixed interest rate (which must still be less than the 10% usury limit) that are tied to the appreciation (or profit) from the sale of the property are not counted as additional interest for the purpose of the usury law. There are some restrictions to qualify for this exemption, such as the borrower not being an owner-occupant, and specifying on the Trust Deed that it is securing a shared appreciation loan.



Bill Gulley

Investor, Entrepreneur, Educator from Springfield, Missouri

Dec 24 '10, 09:06 AM


Yes I think you have it! The security agreement can be filed to the capital acount of the member. The loan is made to the company...but I think you have the idea.

If I loan money to the company, it has no bearing on any profit of loss, I still am owed the P&I. Shared profits would come from the profit.

Your operating agreement covers the issues of participation, security for dbets owed to memberds, escrows, death, incapacitation, etc. In fact, as a lender/member, they could be better secured than with a standard deed of trust and having to foreclose in the event of default. The property can be assigned within the company to any capital account...bang...done! It's a UCC filing and you can file a lien on the property...that's why I suggested you contact your attorney. Good luck...and Merry Christmas!



Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy
Website: https://generalrealestateacademy.com


Medium 1448396670 avatar moneyking David Oldenburg
Granite Bay, CA
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David Oldenburg Verified

from Granite Bay, California

Sep 10 '15, 02:48 PM
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@Mike Grayford In California, most of the private money loans I see are in violation of Usury laws.  The rule of 10% includes all points and other finance charges, so it is very easy to go over 10% if it is a 12-month or short-term loan.  Even an 8% loan with 2 points would violate Usury, if the loan was for a term less than 12 months.  

The best way to protect a higher interest rate or higher fee loan is to have a CA RE Broker negotiate and / or arrange your loan for a fee.  Another way is to do a loan at 10% interest with no points and do an agreement that also gives you a right to a portion of profit.  If there is not any profit, you still have a 10% mortgage against the property.  My rule... always be in 1st trust deed position, with an ALTA title policy to protect your position as a lender. Good luck :-)



Telephone: 916-532-9398
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No avatar medium David C.
Los Angeles, CA
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David C.

from Los Angeles, California

Sep 10 '15, 03:32 PM


I saw it suggested on this website that for example if usury is 10% you could write the loan for say 8% + 4pts for two years and not violate usury.  The 4 pts is spread over 2 years giving 10%/yr, not a usury violation.  If rehabber pays off in 12 months the roi is 14% but because the loan was written for 2 yrs it's 10%/yr from a usury perspective.  Most rehabbers pay off in less than one year thus giving an even higher roi.  This is not legal advice.



Mike Grayford

Rehabber / Flipper from Simi Valley, California

Sep 10 '15, 05:30 PM


@David C. I do not believe that is sound advice.  I haven't looked into it in a while, but I recall the usury being based on the total amount paid within the year.  It didn't matter what was written, it mattered what was paid, unless the loan was a shared appreciation mortgage as mentioned by @David Oldenburg above.



David Oldenburg Verified

from Granite Bay, California

Sep 10 '15, 06:44 PM


@Mike Grayford @David C.  I think David C. may be correct regarding the extended loan term, but that could create more problems.  Under the newer ATM and QM rules, a loan over 12 months might not be exempt, because it is not a temporary or bridge loan.  QM and ATR also give an exemption for a "business purpose" loan.  I would be careful. I would always do private money loans under 12 months and then do an extension later if needed.  The whole Usury thing is really stupid :-)... Of course, in my opinion!  Here's why.  It doesn't take into consideration the type of loan, LTV, or risk factors.  I might loan at 10% to an inexperienced flipper, who puts down 50%.  But, I would not do 10% if they put down 5%.  Totally different risk levels, and there needs to be additional yield for that risk.



Telephone: 916-532-9398
Website: http://RosevilleMeetup.com
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David C.

from Los Angeles, California

Sep 10 '15, 08:33 PM


@Mike Grayford I don't know what the truth is.  Interesting idea though.  Being licensed myself I don't worry or even think about usury issues.

@David Oldenburg I don't know what ATM, QM or ATR are but I've been operating under notion that RESPA, TILA, SAFE, DF, CFPB don't apply if you can fit the loan in a "business purpose" box, carefully of course.



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