Lend Money to Investor?

Question

A friend of ours owns and operates a successful construction company and he also flips. He wants to borrow $30K from us and he would pay us back within 30 days once his other flip closes. He would use the money to start another flip he's working on. I don't know (yet) if the money is to help him purchase or fix it.

I trust him but I don't trust circumstances. Is this too risky? Of course, I'd want to have him sign a promissory note but if something falls through what recourse do I really have without getting into a legal battle? Typically lenders like to ensure they have first lien position but what is my position or collateral if something goes haywire? I'm not sure I'm even asking the right questions. I also wonder why he doesn't get hard money - we'd likely offer similar terms otherwise, what's the point? Thanks in advance for any insight you may have.

Andrew Syrios · Answer

If it's not something your comfortable with than you should definitely walk away unless you can get a first position loan.

Pari Thiagasundaram · Answer

Lending 30K for 30 days is not worth the efforts/time/paperwork and return (not sure what return you are looking for). You've got to wear your business hat and think if this deal is really worth it.

Can you buy a note for 30K and get a 10% annualized return - sure. If this makes sense, go buy notes elsewhere.

I only speak from my experience. When it comes to business, leave your friends and family away from the deals as much as you can.

Nicole S. · Answer

thank you @Andrew Syrios  I'm not comfortable being in the subordinate position and @Jeff S.  you make a good point, this is a one time deal, I'm not in the business of loaning money so the risk you describe is great and we would stand to lose a bundle if something goes wrong. Thanks for your time, I appreciate it.

Jeff S. · Answer

I respectfully disagree.  This strategy works when you are doing many deals, where getting wiped out on one doesn't hurt you.  For example, non-performing note investors might buy many loans at one time, make a huge profit on 1/3, a nominal profit on another third, and get wiped out on the remainder.  Here they can spread their risk and make a nice return in the aggregate.

If you asked for an exorbitant interest rate on your one loan, say 30%, and got foreclosed out, what would be your net profit? Even if your borrower made most of his payments, you would still lose a bundle if the senior lender foreclosed.

Same argument for higher points, which reduces your up-font cash outlay (and increases your APR), but doesn't prevent getting wiped out on the remainder.

Of course, I know several lenders who prefer loaning on many deals in second position (so-called gap funders) for the extra return and also a profit share.  If Nicole's question was about one of many deals she is doing, which it does not appear, than this is a different story and perhaps she could withstand the blow.  If not, I'd still avoid this one.

Andrew Syrios · Answer

I think you need to ask him a few more questions about what he plans to use the money for. I would definitely ask for a first position trust deed (or mortgage depending on the state) which would offer you a lot of protection. He may already have a loan though, in which case you'd have to go into subordinate position. That's a lot more risky and I would ask for a higher interest rate in that case, assuming you're comfortable with that at all.

Pari Thiagasundaram · Answer

@Nicole Sorensen Hull, you might want to goto  @Bob Malecki 's  meetup

http://www.meetup.com/Seattle-Note-Investing/event...

He is a great "local" resource that you can talk to.

Nicole S. · Answer

@Ian MacIntyre - yes, this is in Washington (state)...

@Jeff S. you are correct, this is probably a loan to fix the house and not to purchase, you can't even by a trailer in Washington state for $30K! You have scared me and I'm very appreciative, lenders don't settle for second position for good reason and I don't want to either.

@Mike Hartzog  thank you, I had not considered scrutinizing his deal before investing and to make sure that there's equity left. I am very much out of my league here.

@Pari Thiagasundaram , so true, you sold me on that point, this is far too much work for a short term loan! Too much work for very little return.

@Nghi Le  thank you for the great advice, it would not be worth it if I didn't charge him a point or two and thank you for informing me on the documents needed.

Thanks again everyone for your expert insight, I really appreciate you taking the time!

Nghi Le · Answer

@Pari Thiagasundaram Although I understand where you're coming from, I disagree with your stance on not involving business with friends and family, unless you don't know what you're doing or you don't have their best interests at heart.  We got into this business to create win-win-win scenarios.  We teach our friends about the value of money and investing, and we help them make better use of their money and plan for a better retirement.  We give them better, safer opportunities that wouldn't have been possible without our business.

Nghi Le · Answer

If you're going to loan only on interest, it may not be worth it.  You should probably charge him a point or two as well.

The two documents you'll need are:

1.  Promissory Note2.  Deed of Trust (will need to be notarized)

Easiest way to get this done is to go to the Recorder's Office (after all documents are signed) and have them record and put the lien on title.  This ensures that when the property is sold, you'll get your money back.

That's the easy part.  The harder part is the due diligence, both on the borrower and the property.  You need to make sure you can trust him and his ability to repay you if anything goes wrong.  As a lender, you make the rules, so you can ask him anything you want (income, tax returns, credit report, etc.)  You need to make sure there's enough equity and that the total CLTV (cumulative loan-to-value) isn't any higher than... 65%-75% (whatever you decide).  Note:  Most hard money lenders lend up to 65%-70% of the ARV.

As mentioned above, make sure you review the title report and get lender's title insurance policy.  Not sure how this is done outside of escrow though.  And it's also a lot of work for a 30-day loan.  Also make sure you're added as an additional insured on his hazard insurance policy too.

Jeff S. · Answer

$30k is not enough to purchase a house in Washington State, @Nicole Sorensen Hull, so unless he owns these properties free and clear, I assume you would be in second position, or lower, behind a hard money lender who provided the purchase money.  This is very dangerous.  Unless you will be in first position, I strongly suggest you avoid making a loan like this.

Understand too that a note alone is nothing more than an unsecured IOU.  You'll also want him to sign a deed of trust that puts a lien against the property when recorded, enabling you to foreclose if he doesn't pay you back.  Make sure you check your borrower out, as well as the property you loan on, ensuring it's properly insured and that you review a preliminary title report and receive a lenders title policy.

If this doesn't scare you, my strong advice is to attend a few real estate clubs and find an experienced hard money lender to originate the loan for you. Hard money lenders are used to dealing with private loans like this. He or she should be appropriately licensed and be able to provided professional, legally vetted paperwork, including all the required disclosures, and also be able to explain the process to you in clear terms.  Good luck Nicole.

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