Private Lending Mistakes
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
For you "private lenders" what mistakes have you made? I'm wondering if private lenders are 1. willing to disclose mistakes and 2. what they did to correct it, if they did at all.
I just read about private lending, the lender claimed to be a private lender and not lending to non-owner occupied, leased properties, leads be to think they meant owner occupied.....then claimed to be in the business of lending. So, is there a mistake there?
Then, there was a comment about charging loan fees (or points) on a private loan, is that another mistake for a private lender?
So, what is a private lender? :)
The biggest mistake I've made is not analyzing the borrowers deal, and making sure there is enough reserves (which they resent I'm sure). I now have a spreadsheet that calculates rehabber (borrower) profit and cash they need. If borrower is not going to make a profit, I say it right up front. Saying no, by the way, was very hard for me, but I've learned. You can't imagine how many rehabbers think they have a deal but don't.
If the deal is bad for the borrower, it's a disaster for me. I know everybody thinks the lender makes a killing if borrower defaults, that's just not true. The last thing I want is to fix the borrowers mess. I want a borrower that is successful every single time so I can lend deal after deal after deal and not be involved in the rehab, at all. Unfortunately, I had to foreclose recently, I rushed around and finally found a local rehabber and sold the loan to him a few days before the scheduled trustee sale. He, I'm sure, will make a good profit, me, I'm glad to have my principal back. If I wanted to be a rehabber, I'd be a rehabber, not a lender. Driving to the rehab site every day, being sticky hot, listening to contractor bs lies, dealing with blood sucking government officials, historical societies, standing in line at HD, owner liability ... need I say more.
This is a great thread by the way, BP tends to focus on the greedy lender, but there are two sides to that story.
Another thing I've noticed: Everybody should be concerned about costs, if you aren't your not a good business person, plain and simple. On the other side of that same coin is the person that is overly concerned about fees and loan amount. When a potential borrower starts drilling down on fees and wants 100% of the purchase price and 100% of the rehab costs, and simply doesn't understand why that doesn't work for the lender, I just want to run ... that to me is a clear sign of a beginner. I have never had a successful rehabber drill down on the stuff, never.
Being on the lender side of the rei fence, the difference between a beginner and experience is as big as barn door. I smacks you up side the head in the first few minutes of the conversation.
My biggest mistakes were on the first deal I ever lent on. The borrower didn't have enough reserves and stiffed one of his contractors (agreeing to pay him upon sale) -- since I had recommended the contractor, I paid the contractor and the contractor filed a lien and ultimately reimbursed me when he got paid.
Next, the borrower didn't close the deal on time and I had to extend. He was already under contract, so I agreed to extend for 30 days without any penalty or additional payment. Well, the deal fell through and I had to extend again. This time for another 60 days and just a single extra point. That was a three month extension for just one additional point -- not enough!
Then a second contract fell through and the buyer got two new offers -- one financed and one cash. He wanted to take the financed offer because it was higher, but his time was running out on the loan extension, so I finally told him to take the cash offer, get me paid off, or I would foreclose when his time was up.
He ultimately took the cash offer, but switched closing attorneys mid-process and screwed over the attorney I had recommended to him. All said and done, my returns were average (about 14% over 15 months) andI had a pissed off contrator and closing attorney.
I learned a lot on that deal...mostly about not being too nice!
I love J Scott's post! Private Lending needs a referee, like a lawyer or CPA.
Joint Venture Agreements too.
Like an aggressive type of referee. He - she doe not communicate unless someone does not perform as agreed - contracted.
GREAT post, and thanks Bill Gulley thanks for starting it!
Used the wrong lawyer. When we first started lending, we foolishly asked our real estate friends for a good attorney and received the same recommendation. The advice we got couldn’t have been worse and I wrote about our experience mid-way down this post.
It turns out, most everyone recommended this guy because he's an excellent speaker at the local REI clubs and markets himself well. That's it. We learned that few actually used him and none used him for lending. It became clear that people confuse being an entertaining speaker with being a great lawyer representing a firm with great lawyers and we were simply naïve enough to bite.
In the end, we did the right thing and rewrote several notes, leaving somewhere around $15k on the table. We also found another attorney and became much smarter since.
Here are the few lessons I concluded that post with:
1) Select an attorney based on your specific need and his specific skills. Don't choose one because someone else was happy and recommended him, unless you know your situations are identical. Worse, make sure those who recommend anyone to you actually use him or her (duh??).
2) It's not the firm, it's the attorney. Make sure you know who you're getting as well as their specialty/capability and fit to your problem.
3) Don't choose an attorney because he's a good entertainer/speaker on stage at a real estate club or any other professional, or guru, for that matter. You'd think the RE community would learn.
4) Obtain and check relevant references from those in your shoes.
Jeff
I learned a lot on that deal...mostly about not being too nice!
One lesson we all eventually learn is to not sweat the small stuff. As someone also in the construction side of business, Jason, I know you relive this lesson daily and to an infinitely greater extent than anyone who loans money.
I suggest your mistake was not being “too nice,” but choosing the wrong borrower.
Jeff
The biggest mistake I've made is not analyzing the borrowers deal, and making sure there is enough reserves (which they resent I'm sure). I now have a spreadsheet that calculates rehabber (borrower) profit and cash they need. If borrower is not going to make a profit, I say it right up front. Saying no, by the way, was very hard for me, but I've learned. You can't imagine how many rehabbers think they have a deal but don't.
If the deal is bad for the borrower, it's a disaster for me. I know everybody thinks the lender makes a killing if borrower defaults, that's just not true. The last thing I want is to fix the borrowers mess. I want a borrower that is successful every single time so I can lend deal after deal after deal and not be involved in the rehab, at all. Unfortunately, I had to foreclose recently, I rushed around and finally found a local rehabber and sold the loan to him a few days before the scheduled trustee sale. He, I'm sure, will make a good profit, me, I'm glad to have my principal back. If I wanted to be a rehabber, I'd be a rehabber, not a lender. Driving to the rehab site every day, being sticky hot, listening to contractor bs lies, dealing with blood sucking government officials, historical societies, standing in line at HD, owner liability ... need I say more.
This is a great thread by the way, BP tends to focus on the greedy lender, but there are two sides to that story.
Another thing I've noticed: Everybody should be concerned about costs, if you aren't your not a good business person, plain and simple. On the other side of that same coin is the person that is overly concerned about fees and loan amount. When a potential borrower starts drilling down on fees and wants 100% of the purchase price and 100% of the rehab costs, and simply doesn't understand why that doesn't work for the lender, I just want to run ... that to me is a clear sign of a beginner. I have never had a successful rehabber drill down on the stuff, never.
Being on the lender side of the rei fence, the difference between a beginner and experience is as big as barn door. I smacks you up side the head in the first few minutes of the conversation.
Ahhhh, the easy life of a lender..... LoL
So far it's about underwriting the dealm usually where the mistakes are made.....
Okay, so who loaned on a deal and lost money? An installment deal or cah, what happened? :)
Regarding "You can't imagine how many rehabbers think they have a deal but don't." Indeed. And regarding "...the difference between a beginner and experience is as big as barn door. I smacks you up side the head in the first few minutes of the conversation." That means you are asking the right questions. I am a lot better at it now. Fortunately, my lending mistakes have been small and all related to underwriting. Bigger non-lending mistakes... passing on funding some flip deals (ultimately funded by HML, one in FL and one via CA) that ended up being pretty lucrative.
My biggest mistake came on one of my earlier funding deals, where I was given a fraudulent B-C contract with forged signatures. The guy gave me a contract from a buyer that turns out was his cousin, who had no idea she was party to the transaction. He had created a fake lender letterhead -- and I even spoke to this "lender" extensively about the buyer's qualifications to be able to close. Turns out he was fake too. Now I get IDs on all signers, and get independent verification online of all the players. This includes looking up company websites, Googling telephone numbers, verifying realtor's and mortgage broker's license numbers online, looking at state records of LLC docs, and putting names through a criminal background check. So far, so good, and haven't had another bad deal in the years since this happened.
Wonder what Will Barnard has for us? :)
My lending mistakes all were in transactional funding deals that were 30 plus days. As it turns out, 2 of the 3 were for sure fraudulent, the third likely fraudulent but could never prove it. Lost money on 2 f the 3, basically broke even minus opportunity ousts on the other.
Be careful of borrower fraud!! They used fake ID and filed a QC deed on a vacant house to a fake identity - we require Pass Port for ID- too hard to fake!!
I've made two small loans (20K, 50K) in the past to two individuals I know well. In both instances a mortgage was registered in first position on the properties in question.
Both instances turned out "Ok" - one was slow paying and needed a 6-mth extension (at a slight increase in interest rate). However since discovering BP and spending more waking hours reading @Bill Gulley and @Dion DePaoli's contributions then they did writing them, I've concluded that the paperwork for these loans was insufficient and I was simply lucky nothing really went wrong. On top of that, not enough of the costs associated with the loans were apportioned to the borrower.
I've recently been approached to provide another loan and am mining the content and minds on BP to ensure I do things correctly this time (if I choose to proceed with the loan).
@Roy N. what was the duration on the loan?
The original two loans had terms of 6 and 18 months. The 6 became 12.
The possible loan about which I was recently approached would have a 3-yr term.
Roy, I'll pick up suggestions in your other thread.
Shari, other than ID and the buyer's copy of a sale contract I usually don't take documents from a proposed borrower.
That said, I have, I have been pretty good at sizing people up quickly, how they carry themselves, how they speak, can they convey an idea easily, level of comprehension on the matter, even body language is observed and written materials are important aspects to me. I may ask other questions to probe ethical opinions when appropriate.
Depending on where they fall on my personal assessment I begin explaining the deal they have and their responsibilities and ask how they will meet them.
To documents, I'll accept their tax returns and check them and their bank statements. I may take other docs, like LLC docs. I also tell them that they will be signing authorizations for loan processing (usually the already did the application and signed them) but in processing all the information submitted will be verified.
If they get skiddish, I stop and ask questions, if they are cool with the minor intimidation of stuff being found we move on.
I always used an advisory approach, I'm on you side, here to help, but I'm also here to keep you out of trouble in getting into something you shouldn't be doing. That could be getting a bad deal, getting the wrong type of loan, help with a strategy to achieve the goal. It also is in pointing out how they can get in trouble (not paying on time, missing a balloon payment, not keeping property insured or in missing tax payments for example) Regardless of how many loans some borrower had gotten in the past I'd try to inform on areas they were not familiar with and teach or inform them.
That sets the stage for the relationship. I'm not a small guy either, I have various eyebrow raising techniques and investigative techniques, might tell a story about what happened with the last guy that ran out on some deal (no leg breaking, just ruined lives, loss of property, judgments, garnished wages, loss of job, run out of town, etc) These little tactics are only for the nearly qualified, highly leveraged, or newbies, young kids. It's not to intimidate them out of taking the loan but to stress the serious manner of what they are getting into, as a fatherly approach. I'd always say too, we don't want this property we must have the money back as agreed!
Another comment I'd use was "the money for the loan is from investors, we have to pay them back regardless of what you do and I'm not buying your house, so...." regardless if it was mine or not. Yes, I'd pass the buck later on if I had a problem, "look, the investor isn't going to put up with this and we need to do this", kept me out of being in a personal situation in curing any problem, it's just business. After telling one guy something like that he just asked "can you play hard ball?" My answer was yes and I usually pitch no hitters too!
I really believed this really washed out the cons, borrowers that were trying to pull one over or over sell me on a bad deal, you really get that in small commercial deals, seed money for some business selling some invention or some such. (LOL)
I believe in taking command immediately, we are going by the golden rule here, he who has the gold makes the rules.
In lending you really need to be careful as J. Scott pointed out, taking command doesn't mean driving the bus, I may suggest three people they can check with for some deal but I never suggest they use anyone. You can find trouble if you make some deal as you are in charge, you're driving the bus, you suggested this guy be used, then it will be you said, you said, you said and that will come back on you and you can lose your money. Stay at arm's length.
In transactional type deals where your deal is based on performance of the next transaction, that next transaction is viewed just as their might be, so you're right to verify other parties. You can make those contracts a requirement for your lending.
Knock on wood, while I had a few attempt to load me up with smelly stuff, no one succeeded. With your verifications use dual control, don't allow any borrower or one entity, party, Realtor or others to influence of have control over or report any original information with a verification of that information or take information without it being verified. For example, you don't give an employment verification to a borrower to have the boss fill it out and bring it back or return it. They could fill it out, give you the right business phone number, but the guy you ask for may not be the boss!
I had points of contact at all the major employers in the area, when calling them start from the top and have them give you the right person to verify something, not the name given on the application. It sometimes turns out to be a different person.
Usually verifications that are filled out are neat and professionally prepared by lenders, creditors, employers and property managers, if they look sloppy I'd call the person to verify they filed it out.....also was an opportunity to chat, gain some human intelligence as I call it.
Well, no more rant time......
As to a mistake......I loaned funds out on a construction project, some of my first ones, the contractor was buying materials, billing my project and taking it to another project. It took awhile to catch him and see where the materials went, he cleaned it up with the threat of fraud, paid off the obligation, late I'll add, but it was paid. I was doing drive bys to see that materials were going into the build, which is how I caught the gaming. I then turned all the construction loans over to the title company and made the borrower pay for the construction management and approve future disbursements. Never had a problem thereafter. :)
Shari, other than ID and the buyer's copy of a sale contract I usually don't take documents from a proposed borrower.
While I agree with this totally, there are some exceptions. Case in point, many, many lenders have used my loan docs for their private loan investments with me, however, these docs were drafted by my attorney, edited by my broker and have been used over and over again. However, I would add that I always inform lenders to have their counsel review the docs and make any changes they deem necessary. This allows new lenders and even those who have been lenders but do not have their own docs, the ability to invest without spending the money to have the docs created, rather, a small fee to have my existing docs reviewed.
I have made lots of mistakes that created lots of hassle for me but never lost me money in the end.
Not requiring rehabber to get permits and I ended up with a FC'd house with unpermitted work that caused a hassle when I sold.
Not being in touch with the borrower to know he cut a side deal with the contractor to be a partner. Contracter didn't get paid and recorded a document on the property which wasn't a lien but clouded it enough that it eliminated the possibility of an easy DIL.
A borrower's "story" of his plan for a quick flip convinced me to lower my interest rate more than normal. Then he changed his plan and I was in the loan for 2 years at the bargain rate.
But those are only small nuisance issues if you have enough equity.
My concerns at this point are much more about fraud issues. In the past 2 years I have seen a lot of bogus documents and deals. I almost wired money to a fake title company. Saw a properties that had been sold 3 times by the same guy in a week. Transactional deals with fake B-C contracts. Etc, etc. I don't have the resources to keep up with the latest fraud techniques so it feels like only a matter of time before I get tripped up. Has made me pull back tremendously.
I'm not a small guy either, I have various eyebrow raising techniques and investigative techniques, might tell a story about what happened with the last guy that ran out on some deal (no leg breaking, just ruined lives, loss of property, judgments, garnished wages, loss of job, run out of town, etc) These little tactics are only for the nearly qualified, highly leveraged, or newbies, young kids.
Bill, I like the leg breaking approach, must be the Italian side of me! While I personally respect and weigh heavily on credit worthiness, morals, and ethics, others don't always seem to have the same respect for it and the threat of a hole in the desert may be better served as the warning not to mess with you!
:)~
I have seen the same and was burned by such instances of fraud. Fake B-C docs, fake escrow companies, etc. are all risks in the transactional funding world. Don't these people realize that there are so many ways to make money legally! Obviously they don't or are just to lazy to do so.
Were any of these lending issues with members of Bigger Pockets? You don't have to name names, just wondering if when someone has lent money to a Bigger Pockets member, that the transaction has gone smoothly whereas a non-Bigger Pockets member it hasn't?
My first two loans occurred prior to my discovering BP. I am still a little leery about lending money over the 49th, but you can't find 40K SFH or 90K quadraplexes in this county ... so it may happen one of these days.
@Ted Akers
Rest assured, I would return your phone calls ... and sell a property if needed to make my lender whole.
@Roy N. I didn't quite understand what you meant at first by "over the 49th" until I caught that you're in Canada.
@Ted Akers - There appears to be 5 users on the site with that name; perhaps best to clear the names of the innocent here . . . where was the person you're referring to located (city/state)?
Furthermore, I know that you've done business with many other BP members, so this one bad experience certainly isn't the norm for you with folks here, correct?
"What are the lessons of a lifetime?"
"Exactly that"
I think one of the most important lessons to take away is that in this business of loans, Details Matter. I walk around with many catch phrases to express my points nowadays one of my favorite ones is inspect what you expect.
We had a deal where we funded the construction of a sub-division. The borrower was a builder and the property owner. We used a local title company and had our counsel review all documents and was in charge of draw payments. The assumption to some degree was there was a level of attention to detail that we didn't need to pay attention to because of the vendor services we had put in place as control points (title and attorney).
Long story short. We did a loan on parcel that was to be sub-divided and then released two lots to build models on with separate mortgages. We checked on perfection of the instrument but failed to read the legal description for the three liens (master parcel and two lots) and cross reference the survey in detail to ensure correct property. One loan attached to the wrong parcel for the lot and the description of the master parcel was incorrect leaving out a main value feature in the land, which was a lake. The lots for the models became intertwined in land that was not a part of our deal as everyone making instruments and reviewing them was using the incorrect legal description. One parcel was transferred amongst family members related to the property owner three times during all of this. The title company didn't catch it. Our attorney didn't catch it and it cost us some dollars. In the end, the buck stopped with us, we didn't catch it. It was a mess to unwind. We had to correct the title issues before any of the properties could be conveyed with clear title. Making it worse, other parcels were sold to builders who then sold to owners which also ended up being affected in regards to our partial releases which we couldn't issue due to all of the title issues. It took many months to fix all of this. Of course as all of this came to light, the borrowers didn't want to help cure any corrections and it became a fight over what the intend collateral was.
The local RE attorney firm we hired to help said it was one of the worst messes they had ever seen. (not a proud moment) I read through the master metes and bounds survey so many times it almost became memorized. It was eventually cured and made right. It was a bit of a tiring and bloody fight. I don't recommend trying it.
We have been stuck a few times with back taxes for a couple we took back DIL but fortunately resold them for more $ & have done well regardless.
The one that hurt was for a good friends son.
It was for $12,000 @ 12% & I trusted this friend of ours but unfortunately he died suddenly two years into the 10 yr payback & just as quickly the son stopped paying. The kid then abandoned the totally trashed property. We assumed the father left him enough cash to party then abscond.
He finally gave me the DIL after his credit report took a big hit (I sent it to collections.) He had a CDL so it was easy for collections to skip trace him.
We eventually made our money back reselling the property & holding another note, but it took some time to recover.
5 years later he sends me an email asking if we had any properties available 'rent to own'. Apparently he is now divorced, broke & renting a run down single-wide with 2 other 'low-lifes'.