The anatomy of a private money loan process

10 Replies

I am new here and I am looking for a short brief description about how a private/hard money loan works from start to closing (typical process)...this might be helpful for both private parties that are interested in lending funds and also for borrowers looking to flip properties (what to expect)...I have outlined some questions below:

-What type of documents are usually needed for private money loans closing (they might differ from state to state)...sample docs links might be helpful (e.g. promissory note, deed of trust etc).? 

-What certified parties are required on the process (e.g. attorneys, brokers, title company etc) and what the lender can do himself in order to save money?

-How the private lender is protected in the case of default, late payments etc....in other words how to reassure a potential private money lender (friend, family member) that their funds are safe (mimic the professional and experienced private/hard money lenders steps)

-What are the common terms of the loan (rate, interest only payments, length, penalties, collateral on other property equity, early/late reimbursements, etc.)

@Catalin B. The private lending process can be daunting. I had all the same questions when I first started looking to utilize private money. The best way to get them answered for your specific market is to find out what attorney most wholesalers in your market are closing with. That attorney will be highly experienced with private mortgages. Offer to pay him for 30 minutes of his time. That’ll be more than enough for him to make the process clear. Or you could just line up a deal, send it to him, tell him the terms of the loan, and tell him to do it the way he normally does it for other investors. Including whatever protections he feels are customary.

I do not have knowledge of how it works with private individual. But here are some basics with hard money

They will check your credit, need a bank statement with your funds, probably want proof you have owned property of flipped before. If you have mortgages on credit report that may suffice. Probably want an llc. 

They will need signed contract of property needing funding, information for insurance you are getting, what title company is closing and any assignment contracts. If you are borrowing rehab funds you will need to provide a plan of what you are doing. An appraisal will probably need to be ordered. A HML probably has its own process set up for 3rd party attorneys, docs prep etc and you will not get to find a short cut or cheaper option.

When you close a lien will be placed on property by HML.

As you do rehab money will likely be in an escrow account and  some sort of disbursement or draw process is set up. they will give you funds as you complete certain items. 

Good suggestions here already. Two things I would add .. one is that you asked what the lender can do themselves to save money. I am a private money lender and in my experience lenders expect that the borrower will pay ALL costs. At a minimum that would be the attorney fees to draw up the note and deed of trust (that's what we use in Virginia). In my deals I do have to pay the wire transfer fee to my bank but some lenders will charge a fee to the borrower to cover this too.  If there are fees associated with follow-on transactions such as providing draws, etc then those fees would likely be covered by the borrower if the agreement is written up that way.

The other point is about the "common" terms of a loan. There's a progression in the lender/borrower relationship from one deal to the next so the terms will often change from the first deal to third or fourth deal. So a better question might be what to expect for the terms on the first deal you do with someone. As with all real estate "everything is negotiable". When you are working with a private money lender remember that this is usually another person just like a wholeseller, contractor, etc. There's not a major company with rules and policies and fixed DTI numbers for example. However, at the start you don't have a lot of leverage so it's easy to assume you have to just accept whatever they say. But as with any negotiation you should find out what's most important to them ... is it the amount of "skin in the game" that you bring to the deal, the property itself, your experience, the turn-around time, etc etc? Sometimes I have been more lenient in the lending terms just because the amount of money that the person wanted to borrow for a particular deal was a good fit for a chunk of money I wanted to fully deploy.

@Shera Gregory thanks for sharing. It makes perfect sense that there be some negotiables and non-negotiables once we get to the table, but let's take two steps back: 

1. how would you expect a NEW investor to solicit you for funding in the first place? Introduction from mutual contact? Cold-email with summary deal details? Other?

2. Assuming you do make contact, what are you expecting to see in the first call/meeting? An experienced investor would have a portfolio, but a new investor (like me) wouldn't have anything except the potential of the current prospective deal. Would that be enough? What else should I be prepared to present?

@David Whitaker -- good questions! 

1. So far everyone that I have loaned money to has been through connections I made in person at a local REIA or other real estate type meeting. In some cases I have done follow-up one-on-one meetings at a coffee shop, etc, but not always. Often someone who does private money lending will mention that during the introductions if the meeting organizer does a round of introductions at the beginning of the meetup. I have had people approach me after I mentioned in the larger group setting that I do lending. The first thing to understand is that people who have money to lend WANT to lend money. We just want to be certain that it's secure. And different lenders have different levels of risk tolerance. For some folks the fact that you haven't done a deal yet would be a no-go. If that's common in your area then you might need to use a hard money lender to get your first deal done. There are some advantages for a newer investor in working with a LOCAL hard money lender. If they don't want to lend on a deal then it's not a deal. Use their experience in the local market to keep yourself from getting into a bad deal.

If you are able to identify some private money lenders in your local area I think it's a very good idea to talk with a few of them before you have a deal just to get a feel for what they want to see. Without a deal in place you may not get them to do a one-on-one meeting outside of a regular real estate REIA but that's OK. So, to directly answer your question # 1 I would be fine if a new investor came up to me during the networking part of a REIA meeting and said "I am working on getting my first deal and I would like to be able to use private money. I plan to cover at least X% with my own money. Are you are open to working with a newer investor like me?" The "X%" could be money you get from family, credit cards, etc. The higher X is the better.

2. You said a" new investor (like me) wouldn't have anything except the potential of the current prospective deal". Actually, there is a lot that you can line up ahead of time. I would suggest making a list of the people you will use to help you with your deal. Do you have an attorney or title company?  Is there anyone in your area who does inspections to help determine the scope of the work required (not a retail home inspector but a contractor/former contractor who can go over the property with you)? Do you have a real estate agent who is helping to determine the sale price (if this is for a flip)? If it's for a buy and hold and you need short term financing from the PML then how are you determining the market rent? Basically ... what does your team look like? The more support you have from others who ARE experienced then the more confidence the lender will have that you won't get into trouble.

Best of luck!!

@Catalin B. You may want to reach out to the American Association of Private Lenders to see if they have some documents to share that could help you. Standard stuff you'll usually deal with on a loan with a private lender or a HML:

1. Lien Position (almost always 1st) Requirement

2. Deed of Trust

3. Promissory Note that clearly spells out the terms of the deal

4. Borrower lists Lender as mortgagee on insurance policy

5. Borrower pays for Lender title insurance

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Items on PN:

1. Points

2. Interest

3. Length of Loan

4. Explanation of when points and interest are paid, and when/how draws are paid

5. Extension clause

6. Default language

Recommendations when working with private lender:

1. High level of communication both when applying for the loan and throughout the loan

2. The more detail of the project, the better. Who are you working with, scope of work, comps, photos, exit strategy.

I wanted to echo Shera's point about the benefit of local private lender relationships. Most local lenders feel that a good deal should never be passed up, especially in this market, and that doing a deal locally helps the whole local investor ecosystem.

The national commodity lenders will fund a deal if it fits their box but because their institutional private money requires they diversify their portfolio by geography, rate, term, product you may not fit their box next time you knock on their door.