How to Protect Myself when acting as a Private Lender

Question

I am looking to potentially invest money with a developer, and I wanted to know how private lenders/hard money lenders protect their investment as much as possible? By "protect" I mean, not just give money to someone who is just going to run away and you'll never see/hear from again, or the deal "failing" and you not getting ANY money at all back.

Can I as a private lender protect myself the same way a hard money lender could? Also, what happens if there are a mix of multiple private lenders and hard money lenders investing in the same deal, does this affect how I can/should protect myself?

Thank you for your help!!!

Jeff S. · Answer

You wrote, “potentially invest” but then referred to lenders, @Chris Laino. I assume you really meant, “potentially loan?”

“Can I as a private lender protect myself the same way a hard money lender could?“

Not only can you, you must. Don’t fall into the oft repeated myth here that there is any difference between private money and hard money. These are interchangeable marketing terms that represent non-conventional loans. There are no legal differences between the way these loans are originated or the way they would be enforced. You must protect yourself exactly the same way that any large HML would protect themselves.

If you are referring to flips, there would normally be one loan used to purchase the property and this would be in first position. Any construction or rehab money would be a second position loan, if allowed by the first position lender. I assume you understand the dangers of second position loans and that you’re Ok with the possibility of getting wiped out?

I don’t know New Jersey, but there are many restrictions on brokered construction loans in CA which makes them different than purchase money loans. Make sure you understand these in your state. In fact, though many will suggest you speak to an attorney, I would add that you should also talk to an experienced local hard money lender and have them originate the loan for you.

HML’s are used to private loans as these. They will be able to evaluate the deal for you as well as the borrower. If required, they will also know how to check you out to see if this loan is suitable. Attorney's normally don't do this.  In fact, take heed if an experienced HML tells you to walk from a deal.

A experienced HML will have a legally vetted loan package (not just a note and mortgage) and understand how to read a title prelim, specify title and hazard insurance requirements, and provide lender instructions. In addition to the note and mortgage, there will likely be a 1003, personal guarantee, use of money statement, appraisal, maybe a credit report, and various other docs and disclosures. Some might be state specific.  There should be no difference between how any HML originates a loan for you than how they originate one for themselves.

I’ll add that you don’t normally want to give your borrower a pile of money. You’ll need a company to do inspections so your borrower can make construction draws. An experienced HML should be able to help and guide you with this.

Many HML’s will do this as part of their normal business, hoping to generate additional loans to your borrower, so ask around.

Good Luck, Chris.

Andrew Syrios · Answer

For one, make sure you get a trust deed/mortgage and a personally guaranteed note (and of course, make sure to close at a title company so you don't go into second position). I would also vet the developer and make sure they have a good track record, solid financials and integrity. And analyze the deal as well to make sure it appears strong (and maybe ask for advise from a neutral third party with experience).