Am I qualified to become a Hard Money Lender?

8 Replies

I have about 2.5mm in liquid assets I can loan out, might be closer to 3.5 or 4 in the next couple years. I want to work alone (not run a consortium/partnership). My background is in banking, finance, analytics, and consulting. I know my way around an Excel spreadsheet. My wife is a lawyer, which is a plus.

Where do I get started? Obviously setting up an LLC and networking/putting my name out there in local real estate groups. But other than that, are there any resources for getting started? What are the biggest risks? It would appear to me that with a "free" lawyer by my side and first liens on the properties I finance, the only major risk is locked up capital during a foreclosure process. Am I thinking about this right?

First, be careful of all the solicitations you will receive now that you disclosed how much money you have to lend, @Vik C.   And, unless your wife is a lending lawyer, “free” could cost you a lot of money. This is a very specialized area of the law.

You’re looking to do what we’ve been doing for some time now in California. You might read my post in this thread: Becoming a Private Lender, where I detailed our process in a reasonably actionable form. It’s still quite accurate for us and we are still quite active mining our little niche out here

Having money tied up in a foreclosure is certainly a risk. Your first line of defense of course is avoiding foreclosure altogether. In our view, this is accomplished by loaning locally to experienced, full-time house flippers, with whom you’ve developed a relationship -- and we put the relationship far, far, far above everything else. If you don’t know, like, and trust your borrower (the ultimate real estate cliché), don’t make the loan. As you’ll read, this is the common thread in our process.

A greater risk in our experience is fraud. We have had issues with identity theft of our company as well as fake grant deeds (we loaned on a stolen house). For the latter, both owner and lender's title insurance with the appropriate endorsements is crucial. Our borrowers have also had some hair-raising issues with wire fraud, though unrelated to deals we’ve done with them. These are the real minefields in my view.

Though scary at first, once you surround yourself with bright, experienced borrowers, and get a repeatable process down, this is a remarkably easy and rewarding business.

Good luck, Vik.

Thanks Jeff, super helpful. One question I had is - why doesn't everyone just go to the most reputable, longest-tenured HMLs in the region? How did you compete when starting out? I would imagine that a seasoned flipper would have HMLs competing for their business, not the other way around. Did you compete on price at first until you established a track record and enough relationships? Or is it just that there is a finite supply of capital in the market and a new lender will always have a choice of good investors to work with since demand outpaces supply in most markets?

Good questions, @Vik C. .

Why do some buy their clothes at Target and others only at Nordstrom?


If a flipper typically makes aggressive offers agreeing to close in 7 days and “… the most reputable, longest-tenured HMLs in the region …” needs two weeks, how do you think that will work out?

You seem to assume that the only criterion a borrower uses to select a lender is the cost of the money. Nothing could be further from the truth. We’ve never chosen to compete on cost. That’s the race to the bottom currently being played out by the big boys.

After you've gone to just a handful of real estate clubs (when they ever open), you'll realize that potential borrowers don't limit their questions to what you charge. Borrowers will want to know your LTV, how fast you can fund, loan duration, requirements for an extension, how you evaluate a flip, loan to newbies, … and on and on and on. We've observed these over the years and have a list of dozens of the most inciteful questions. This is sorted according to our risk level, the problems we're able to attack, and what the market will bear. The result is our lending criteria.

All businesses, but especially any entity in the market of renting a commodity (in our case, money), must develop a competitive advantage. Since the money in everyone’s pocket is worth exactly the same amount, why should anyone borrow from us? I have two responses:

  • NEVER UNDERESTIMATE THE VALUE OF A RELATIONSHIP. (No, my keyboard is not broken)
  • You must strike a balance in your lending criteria between the risks you are willing to take and satisfying the several most important criteria your borrowers will use to decide with whom they want to do business. If you are too conservative, no one will want to borrow from you. Too risky, and you can get wiped out.

It’s up to you to choose your competitive advantages. This is just one reason we insist on going to lunch with anyone who wants to borrow from us. Borrowers never have written criteria they use to choose a lender. We learn the borrowing issues they’ve had in the past to see if our criteria can help them. Often it does, and it’s never about the cost of our money. The other half of the meeting is used to decide if we can know, like, and trust one another.

Long answer, but to a good question. Hope this helps, Vik.

@Vik C.

I have borrowed from 3 different hard money lenders. Honestly, terms are what would do the trick. I see hard money lenders as a necessary evil when getting off the ground.

The biggest obstacle for me is building a relationship that doesn’t gouge me when I borrow. I want a long term relationship with a lender I can drink a beer with. I’m still looking for the right partnership, my previous lenders were a means to and end.

You, Vic, I think will see that as an independent lender the PML and HML lines get a little blurry. The big differentiator isn't the lending process, per se, but that most HML use other people's money and private lenders use their own. Many HML are also NMLS licensed, PML aren't. As a (mostly former) private money lender in NC, there are limited risks if you develop the right processes. I agree with Jeff S posts. He is spot on with "...loaning locally to experienced, full-time house flippers, with whom you’ve developed a relationship..." A key part of the decision making is vetting the person signing as the borrower. As Jeff says "If you don’t know, like, and trust your borrower (the ultimate real estate cliché), don’t make the loan." 

You'll need to check your state banking laws regarding your lending activities, which may influence some of your decision making... usury laws if applicable, methods of 'advertising' if applicable, etc. I have no idea of state regulations outside NC, so I am clueless here for your specific case(s).

For my deals, the other obvious points I can reference are having a seasoned real estate attorney who has done private financing and knows and has executed state foreclosure laws, to not lend as owner occupied, verify carrier for builders risk insurance, have your LLC as additional insured, have additional draw conditions (D-T vs. UCC) in writing, on and on.

I've been on both sides (borrower and lender) of private lending and seller financing. I stuck with the independent PML route. I had opportunities (with others) to try HML but it wasn't for me.

@Vik C. - There's an educator by the name of Dyches Boddiford who teaches the topic of private money lending. I've only seen him present at a REIA meeting and never taken his courses. However, people I trust and respect say great things. I think he'd be worth investigating.

For what it’s worth, legally there is no difference between an HML and a PML. Some here say these are defined by where you get your money. Others claim it depends upon who lends it (e.g., your grandma would be PML, but a professional would be an HML). These are distinctions with no difference, and it seems to be a BP thing. All the law recognizes is that you are a lender. The only reason this is important is when you think you can skimp on your docs, disclosures, or processes because of how you define yourself. You can't. A judge won't care.

I listened to Dyches Boddiford's presentation too. There was no mention of relationships and some of what he advocated would be illegal in CA. Can't speak for NY. For the roughly $1200 he charges for his online class, you could spend several hours with a good lending lawyer, lunch with a local experienced HML, and get focused, state-specific, advice.

Find a lawyer who specializes in lending, @Vik C. . This is not a real estate attorney who is knowledgeable about the topic. Most real estate lawyers focus on conventional (consumer purpose) loans. You will be making business purpose loans. Could be a long list, but here are a few recommended topics to discuss at a first meeting:

  1. Licensing
  2. Usury
  3. Consumer Purpose & Business Purpose loans (e.g. who you can & can’t loan to)
  4. Obtaining your loan docs.
  5. How to and who can originate a loan in your state.

@Vik C. When I started lending, I attend an American Association of Private Lenders conference. I found that to be helpful. A few tips to share for getting started: You'll need to decide on your "lending box". Borrowers will have a range of questions such as types of properties, your min/max amount, min/max length of time, you need to have the answers. The more specific you are, the more efficient the conversations will be. If you focus on lending just in your state, it's easier to be familiar with the laws (several responses above have referenced the importance of knowing your state regs already). You'll want to have a plan for underwriting the deal. HMLs require a 3rd party appraisal, but private lenders usually don't. In terms of risk mitigation, these are key items:

1. Max LTV with plenty of equity cushion

2. Deed of Trust (1st position lien is obviously safest)

3. Insurance

4. Title Insurance

5. Comfort with the Borrower (Borrower Experience, Skill Sets, Communication Skills)

I hope this helps.