That sounds like a very healthy return for the investor considering the projected turn around. On one hand it is their first investment with you and you want to give them a good return to get them to continue to invest. On the other hand, this will also likely set a precedent for future deals on what they will expect, so keep that in mind.
Is this truly a loan? Meaning, do you guaranty repayment of the principal plus the interest even if the deal doesn't make money? Or are they participating as an equity investor with the risk of losing their equity? This matters since one has very little risk and one has the risk of losing all their investment. Rates of return or interest rates should be based upon the level of risk being incurred by the person putting up the money.
That sounds like a very healthy return for the investor considering the projected turn around. On one hand it is their first investment with you and you want to give them a good return to get them to continue to invest. On the other hand, this will also likely set a precedent for future deals on what they will expect, so keep that in mind.
You are very generous but I get that if you want to hook your family up. I'd give my family more (maybe0 but people who invest in my projects get 8 to 10 percent. That's is close to the same for most in my networks. Another I know offers 7 percent. No matter what it thought it's more than the average on the stock market. For me they know it's a sound investment.
It is so much easier and cleaner to just do a loan from them to you or your LLC. Give them an 8%or 10% return and secure it with the property with a deed of trust or mortgage and a note. If something happens to you, like death, they can still get paid their money back and there is evidence of the money they put in. When there is no mortgage, your family could lose big time.
@Randy G. that's cool. Also, being it's your first one sometimes you have to go that route as well. It's great that it will benefit a senior. As time goes on people will see that you are a safe bet with lower risk and the track record will bring more. For someone who they are very confident in they will gladly want that 7 to 10 because it's still better than most other investments. Best of luck.
So you already have a 1st mortgage with a hard money lender?? You will get an attorney to get you the deed of trust and note and the deed of trust needs to be recorded so that the lender is protected.
2nd Liens tend to pay higher rates of return. Make sure that the lender knows that they are in second position. That is not always where people are comfortable.
@Rick Pozos. Great recommendation to have them tie into assets to ensure repayment. 10% with a legal contract is much safer than 25% without legal binding. You are providing them lower risk for the loan almost a guarantee at 10%, therefore a lower rate makes sense as you are fronting the majority of risk.
Not saying I wouldn't do it but I paid 8 to 10 percent and secured it with nothing because they knew they would get their money back. Simple promissory is all provided there was.
@Randy Galliani it sounds like you started the flip with the Hard Money Lender and now need extra funds to complete the project? If this the case, you can offer your family member similar terms as a hard money lender. Give them 2-4% points up front as well as interest on the money they lend you. I would give them at least 8%-10% but you can go as high as you want. The interest and principle can be paid in a ballon payment after the flip sells or you can make interest/principle payments monthly. If this isn't the situation that you're in, I'm sorry for misunderstanding.
Hey @Mark Cruse I have borrowed from friends that know me 100% without any kind of contract or with a simple promissory note. 5k, even 40k, BUT they know that I am not going anywhere. They have known me for 30 or 40 years. They know my character. They have been to my house. We have done deals together. They have seen the good end of a deal and the bad. They know that I will not run away when things get bad. I stay and fix the issue.
I have even lent 10k to a few people with only a promissory note. Again, I know the people for years. I have been to their house and know their situation. BUT for others who you know for a few years I would never do that. Not without something put on the property to guarantee an interest in the property.
Ask them. Good question is always “what return are your investments making now?”. Most common answers seem to be 10% & 20%. Both are usually a made up guess. Neither usually include the 2-3% skim their FP is taking. When they answer 30% an appropriate response may be “wow, what’re you doing that’s returning that?! I should be giving YOU money!”. That usually generates a response of “well,.... it’s about that,... I think..”
And whatever you do, under promise and over deliver. Always.
@Randy G. I would stick to normal lending interest rates and not complicate it. Depending on how much the loan to value is, I would stick to offering 6-14% with either interest-only payments throughout the loan or all interest deferred till the end of the loan.
If you go into offering equity like it sounds like you're considering, things can quickly get weird with laws and ownership and such. Hope this helps!
Banks are paying 0.15%. 5%-6% for a secured loan is a GREAT rate for friends and family. If you are going to pay them the same rate as you would pay a hard money lender just go to the hard money lender and avoid all of the potential drama of dealing with family/friends.
@Randy G. I think the promissory note with your family member is fine. This would indeed be considered debt and not equity. As mentioned above by @Rick Pozos, since you already have a hard money lender in 1st lien position, your family member's interest is subordinate to that lien, and likely any potential mechanics liens placed by unpaid workers given the specific timing of this transaction with work already taking place. This of course is a non-issue when deals go well and everyone gets paid, not so much when something unexpected happens.
I also want to clarify and differentiate two concepts being discussed as the same concept on this thread, that is "interest rate" and we'll call it "return." When you say you're going to pay a certain interest rate on the money, generally that means the annual return the investor will expect on their investment. Many people above reference 7% - 10%. What that means is the investor would make $7 to $10 for every $100 invested after 12 months time. However, what you have proposed to your family member, if I'm not mistaken, is a 25% cash on cash return in a matter of 30-40 days.
Let's say your hard money loan carries 10% interest, and someone taking a second lien position would want 25% interest (which I think is quite high) with 3 points:
Three points costs you: $20,000 x .03 = $600
Daily interest: 25% / 365 x $20,000 = $13.70
30 days: 30 x $13.70 = $411 + $600 = $1011
40 days: 40 x $13.70 = $548 + $600 = $1148
I hope this helps to illustrate what I referred to as a very healthy return of $5000 on the $20,000. It's about 5 times greater than a 25% interest rate over the same period. Even if the lender in second position required a minimum 3 months of interest, you would still be better off. 25% is still high for a second position lien, but I understand your desire to treat family differently than a hard money lender.
I work with a number of private lenders and a few are family as well. The family is currently getting 25%. I offer 20% to everyone else. Everything through title/escrow, the lender gets 1st lien (I never have a 2nd), I buy them a lender policy, name them on the insurance, no payments until sold, and the contract includes a personal guarantee so it's secured by both the property and myself and wife personally. It's pretty bulletproof for the lender. I've always been able to get 15% - 22% (some years more) from the market just using mutual funds, so I kinda scratch my head wondering why people accept low paybacks on real estate investment lending when they can do better in the market, which makes me feel weird offered someone less than what I know they can get elsewhere. But that's just me. You do you. I've never had a single problem until COVID-19 stopped all my projects. I'm just now getting rehabs restarted and properties listed and am late with everyone, but they all know and understand why and are calm.
@David de Luna if you are always able to get 15 to 22 percent from the market you are doing better than the average individual. I know with the bull market we had laced with quantitative easing, many did well but that won't last forever. The market is thousands down for many people now! I also invest in the market and it goes up and down for me. Cant say I ALWAYS got 22 percent or more but sometimes I did. Others chose real estate because it's another form of investment diversity. Some people will drop some of their money in CDs or bonds for the very same reason. Others have invested in my projects because they wanted to become part of the process and earn while they learn. It's astronomical to get an education on something you want and earn money while you do it. Investing in a stable project you know will return your principle with interest works well for many.
I've served as the lender a couple of times now to rehabbers I connected with here on BP. And just wanted to call out that your percentages are backward, in the sense that the more someone invests, the lower the interest rate. No one would want to work with a lender if it goes up and up the higher the amount loaned.
25% interest rate is what I charged on a small loan, 15k loan, as it's only $3,750 in interest costs. The juice has to be worth the squeeze and with lower loan amounts, the interest rate should be higher.