Logistics of private money for rehab

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Logistics of private money for rehab

Dan Hertler
Investor · Long Island, NY · Member since 2019 · 50 posts · 22 votes

Hi all, I have a SFR under contract that will be closing in the next week, and I will be doing a BRRRR once tenant moves out (next few months). I am funding the down payment myself, but I would like to obtain private money for the rehab.

My question is surrounding the exact logistics of making this possible if I do not currently have an LLC.

Qualifying question: do I explicitly need an LLC to do this type of transaction without setting off IRS red flags?

If no...

Once the promissory note and other loan documentation is in place, how exactly do I take this cash in? Does the lender wire to my checking account, then I pay the GC or tradesmen directly? And once I complete cash-our refi, I would wire loan proceeds + agreed upon interest back to the lender?

From an IRS perspective, can I receive/pay out loan proceeds from a non-business checking account? e.g. I ONLY use this checking account for real estate purposes, but it’s not considered by the bank to be a “Business” checking account.

Reading Matt Faircloth’s Raising Private Capital and while being a great book, still need some more info regarding the operational aspect of the transaction

Thanks & Happy new year!!

Dan

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Rick Pozos
Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
5y

If you get a construction loan for 50k remodel of your home they will record a loan for 50k. BUT you will not get any money at closing. They will probably hold all 50k until the contractor needs a draw. They send someone to see if they did 10k worth of work, then they release 10k. This process happens 2 or 3 or 5 times to get to the 50k. Some draws might be for 10k or 25k or whatever work contractor has done and needs a draw for.

The same would happen with your private lender. They would put a 2nd lien on your house for 50k (or whatever your rehab is), but you dont get money right then. You ask for the money as work is done. They write a check, wire or however you guys are doing it. Then you pay the contractor that money.

When I first started, I was doing most of the work so I got a draw for 15k and only had to pay out 7k or 8k and got to keep the rest for my work or sometimes I just requested less money so that my loan balance was not so high at the end of the project.

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  • Kenneth GarrettPro Member
    Investor · Florida Panhandle/Illinois · Member since 2016 · 4k+ posts · 3k+ votes
    5y

    @Dan Hertler

    Dan you don't need an LLC but you do need to keep your finances from your business separate from your personal. The private lender can loan to you personally. They will likely want to be protected somehow. In this case, it sounds like you have a first mortgage and they will be in second position as the lender. Most lenders are not crazy about this. If things go bad they might not get there money back. You'll have a note and mortgage or deed of trust (depends on your state).

    Since you are borrowing after the closing on the purchase they will need to send funds to you.  You can set up the arrangements any way you want.  It’s whatever your agreement stipulates which will be in the note.  You might want to accept payouts over the length of the rehab, much like a construction loan.  It’s a little hassle for you and your lender, but it insures money is being spent correctly and under control.  Otherwise you will take the entire lump sum, say $50K, the mortgage will be recorded at the same time.  I would use an attorney to draft the documents and to insure the loan is recoded.  This protects you and the lender.  You could use a title company, but in this case it is unnecessary.  At the end are you refinancing to pay the lender back?  How are you paying him back with Interest?  Some arrangements are you pay the interest back monthly or pay the principle and interest back during the refinance.  I typically do the latter.

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  • Dan Hertler
    OP
    Investor · Long Island, NY · Member since 2019 · 50 posts · 22 votes
    5y

    @Kenneth Garrett

    Thanks for the reply and really good info!

    I plan to refinance into a conventional mortgage after seasoning, upon which I will repay the loan along with interest.

    As for being a second position behind the primary mortgage, isn’t this a similar situation to construction loans? e.g. if I took out a construction loan to put an addition on my primary home, wouldn’t this be a second position loan?

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  • Kenneth GarrettPro Member
    Investor · Florida Panhandle/Illinois · Member since 2016 · 4k+ posts · 3k+ votes
    5y

    @Dan Hertler

    Yes, the construction will be in second position, but they are going to conduct an appraisal to make sure there is enough value.  You’ll have to roll the construction loan into a new mortgage or a second mortgage. 

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  • Rick Pozos
    Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
    5y

    If you get a construction loan for 50k remodel of your home they will record a loan for 50k. BUT you will not get any money at closing. They will probably hold all 50k until the contractor needs a draw. They send someone to see if they did 10k worth of work, then they release 10k. This process happens 2 or 3 or 5 times to get to the 50k. Some draws might be for 10k or 25k or whatever work contractor has done and needs a draw for.

    The same would happen with your private lender. They would put a 2nd lien on your house for 50k (or whatever your rehab is), but you dont get money right then. You ask for the money as work is done. They write a check, wire or however you guys are doing it. Then you pay the contractor that money.

    When I first started, I was doing most of the work so I got a draw for 15k and only had to pay out 7k or 8k and got to keep the rest for my work or sometimes I just requested less money so that my loan balance was not so high at the end of the project.

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  • Dan Hertler
    OP
    Investor · Long Island, NY · Member since 2019 · 50 posts · 22 votes
    5y

    @Kenneth Garrett thank you so much for the info!

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  • Dan Hertler
    OP
    Investor · Long Island, NY · Member since 2019 · 50 posts · 22 votes
    5y

    @Rick Pozos I see what you're saying- so you'd only pay interest to the lender based on the drawn portion of the loan, similar to a HELOC. That's very good.

    When you had a private lending agreement, did you file the deed of trust with the state/county? Or were they unsecured loans?

    Also, from an underwriting perspective- am I required to disclose this debt to mortgage underwriters (conventional) so long as the debt is still outstanding? So far all of the research I've done on these private loans has been silent from that aspect. I can envision a scenario where I want to purchase another house in the short-term with a conventional mortgage while this BRRRR/private debt is still in progress.

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  • Rick Pozos
    Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
    5y

    The loan needs to be recorded, unless your lender is a complete idiot. You could just walk away and never pay them back. They would have no recourse or proof that you even lent them the money.

    As far as disclosing...it is a matter of are you honest or not?! Do you tell the bank the truth when you apply for a loan?

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  • Dan Hertler
    OP
    Investor · Long Island, NY · Member since 2019 · 50 posts · 22 votes
    5y

    @Rick Pozos of course and that’s certainly not what I was intimating. I was purely asking about the logistics for recording these loans, and how this all works since I have not seen much info in my research regarding the recording of private loans. As I mentioned, I am admittedly a beginner in the private lending space.

    Thanks for the info, I appreciate your guidance

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  • Rick Pozos
    Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
    5y

    When you borrow money, you should close with an attorney or at a title company. I dont know which way that NY does it. In Texas most people close with a title company. So when I borrow money, the title company handles all of that. They draw up the deed of trust with the approval from the lender(depending who the lender is). Title company records in the deed records or county clerk. They pretty much can and will handle all the work for you.

    With all of that said, I have borrowed from family members and just asked an attorney to draw up the deed of trust with a note. They record or I record the deed of trust and the borrower keeps the note as this has the terms of the transaction.

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