All Forum Posts by: Jeff S.

“When in the process do you start to get your funding in place?”

Last week is best but today is ok too, @Peyton LaBarbera. You don’t want to find a great deal, perhaps requiring a short timeframe to close, and have to scramble to find money. Plus, how will you evaluate a property if you don’t know your lender’s loan criteria? All lenders will be different.

Some lenders won’t talk to you unless you have a deal in contract. Skip those. Most should be able to give you an idea about what they will look for in you and a potential deal.

You should look for money as hard as you look for properties.

Insurance companies often obtain the floor area from the tax assessor and base their coverage on that, @Ryan Fox.  They don’t always know that the borrower might be tearing down part of the premises or building an addition. Insurers can also assume unrealistic building costs.  Most borrowers never check.  They accept the first quote and move on.  You must protect yourself and confirm you are covered.

Improved floor area is a bad term.  It’s just the total floor area of the finished house.  That’s what you’d rebuild if you had to.

It’s common courtesy for a borrower to inform their senior lender that they will be taking out a second-position loan. Similarly, all subordinate lenders would be wise to contact the senior lender(s) and agree to keep each other informed of any adverse loan status. But unless this is a commercial loan (e.g. 5 units or more), anything requiring permission to obtain a second is unenforceable. That’s not to say that many residential loan docs don’t contain this language anyway. Ours do.

Similarly, and despite what most loan docs say, a senior lender cannot call a default because their residential (1-4 unit) borrower takes out a 2nd or any other junior/subordinate loan. Nor does the borrower have to ask for permission. Of course, the lender doesn’t have to make the loan if they know the borrower’s intent. Once made, however, these loan terms are unenforceable unless this is a commercial property. It doesn’t matter that it might be a business-purpose loan.

All of our loans are for 1-4 residential flips. Our loan documents, from Lightning Docs, also say the borrower must get our approval in writing to obtain a 2nd position loan. It's a generic and common clause, applicable if the loan is for a commercial property. It will also dissuade most 1-4 residential borrowers and unknowledgeable lenders, who seem to be the majority. If you're lending in second-position on SFR flips, @Alex Sinunu, which is dangerous and not recommended, the first-position lender cannot enforce this clause.

This has been around since Garn-St Germain was signed by Ronald Reagan in 1982. It’s easy enough to look up, but you should please confirm with a lending attorney, as I have done, and not take your advice here. Lastly from me.

Don’t feel bad if you’re confused, @Ryan Fox.  In my view, insurance is easily the most confusing area of lending. I find insurance agents have a language all their own and the policies and terms are terribly inconsistent. If you’re getting your loan docs from a lending attorney, and I hope you are, both the lender’s instructions and deed of trust, mortgage, or loan agreement should specify your insurance requirements and could serve as a reference for you. Obviously, you must find an insurance agent who communicates well and can explain terms and policies in plain English.

You weren’t specific with your question but there are two types of insurance you need, Title Insurance and Property Insurance.

For Title Insurance we require a lender's title insurance policy for 125% of the loan amount, a 2006 ALTA policy or 2021 if available, and various endorsements. Endorsements are state-specific and best specified by your lending attorney. Don’t skimp on this or think it can’t happen to you. We had a $600k+ title claim after lending on a stolen house due to a forged grant deed. Fortunately, our claim was successful.

For property insurance, your borrower should have a minimum $1M liability coverage. If someone gets hurt on the property, it won’t matter what it’s worth or the loan amount. The policy must cover Replacement Value, not Actual Cash value. It must be a vacant remodel policy or equivalent and must cover builder’s risk. You must be specified as the Mortgagee. Loss Payee is also acceptable. Named insured, additional insured, additional interest, and the like, have totally different meanings and coverages and are unacceptable.

One issue is how to determine the value. To keep policy costs and risks low, both borrowers and insurance companies want this as low as possible. Accordingly, all borrowers will claim they can rebuild a property for next to nothing. If you had to take over the property, you can’t. We require a value of at $250/psf times the improved floor area. In CA, this cannot exceed the loan amount. Don’t forget that you don’t insure the land, so in high-value areas like LA, property insurance will be a lot less than the amount loaned -- thankfully.

You might optionally require specialized earthquake, flood, wind/hail, or specific endorsements for other regional risks.

If you can, be careful accepting an insurance binder in favor of the actual policy. Though they are safe and will cover you, binders are temporary and do not guarantee that your borrower will be approved for the final policy. We’re not firm on this and I’d say we get binders maybe 25% of the time. It means we have to be a bit more vigilant and remember to obtain the policy before the binder expires.

Similarly, make sure you understand whether the insurance company is “admitted” or not. Non-admitted companies are not covered by the funds most states use to pay you if an insurer becomes insolvent. For example, when the entire town of Paradise, CA burned down a few years ago, many non-admitted insurers became insolvent leaving their policy holders high and dry. This might or might not be important to you. Non-admitted insurers are often a lot cheaper than their counterparts and are a way for your borrower to save money at the risk of nonpayment to you.

Last, because we always seem to get the evidence of insurance at the last minute, insurance seems to be the number one cause of loan delays. Accordingly, we now have a one-page document we email to our borrowers as soon as we approve the loan. This explains our insurance requirements in bullet form that they can send to their insurance reps. If not, the reps tend to provide what they think we will accept based only on their conversations with our borrowers. This document gets ahead of that.

This is a pretty common scam, @Derek Tuohy. There is no such thing as an insurance policy that guarantees a private loan. Don’t I wish.

LPI is just a made-up term for a fake product. The unfortunately named Private Mortgage Insurance (PMI) is real but only available for conventional loans (Fannie, Freddy, etc.), not private loans. The only insurance any legitimate private lender will ask you to buy is a lender's title policy and fire/hazard insurance (or landlord ins., or homeowner ins., etc., as appropriate). These would be purchased when you close your deal. The title insurance would be paid out of the proceeds you wire to title or to your closing attorney. The fire & hazard insurance would be paid by you directly to the insurance company.

There’s never a reason to send money for insurance to a lender. There’s never a reason to pay any other upfront fee.

@Andrew Postell wrote:

“@Account Closed what "Business credit card service" is teaching you to go into credit card debt for a downpayment? I'd like to know what business is teaching that out there.”

Unfortunately, we see the buy real estate at any cost and at any risk mentality on this board all the time. The common responses when someone asks where they can get money to begin buying real estate is to put your family's home at risk with a HELOC or to use zero-interest credit cards. It's the height of financial irresponsibility.

@Caroline Gerardo wrote:

“0% start rate for say 12 months then the rate jumps to 24% or $1601 a month plus your hard money loan, taxes and insurance.”

It’s worse, Caroline. If you do not begin making payments when due, some credit card companies will backdate the interest owed to the beginning of the debt, not to when the first payment is due. These are a great way to become financially eviscerated.

At best (worst?) zero interest credit cards should be used for true emergencies such as for medicine, urgent care, plumbing leaks, etc. These cards are for those living hand-to-mouth and are not for investment.

Something seems off here, @Katrina O'Bannon. One month is an unusually long time and your lender should know that. Your contractors will want to be paid without delay. A day or two one way or another shouldn’t be a big deal. A one-month turnaround, assuming you’ve given your lender everything they need, is unworkable.

Too late now, but this should be one of your due diligence items when you select a lender. Questions for them that you might consider include:

• What do I need from me to submit a complete draw request?
• What do you charge per request?
• From my first call or email to you, how long do you typically take to fund a request?
• Are your draw inspections performed in-house or by an outside inspection company?
• Who do you use and how fast from your call to them will they come out?
• Will you prorate payment if the work isn’t 100% complete?
• Do you send payment to me or to my contractor?
• Do you require a lien release for work performed?
  I agree that it doesn’t matter whether this is in writing or not. If you didn't do it this time, next time ask for references.
  

Unless this refers to a commercial property (5 or more units), this is incorrect, @Alex Brashears. A lender cannot call a default if their residential (1-4 unit) borrower takes out a 2nd, 3rd, 4th, or any other junior/subordinate loan. That’s not to say that many residential loan docs don’t contain this language. And, the lender doesn’t have to make the loan if they know this is the borrower’s intent. Once made, however, these loan terms are unenforceable unless this is a commercial property. It doesn’t matter that it might be a business-purpose loan.

A Promissory Note, DOT, Personal Guarantee, and JV agreement are hardly overkill, @Jarrod Ochsenbein. But what’s the JV doing in there? Are you a lender or a partner? We get our complete loan doc package from a lending attorney, and you should too. If the state you are lending in requires a license, you should find someone with the appropriate credentials to originate the loan for you professionally. Don’t make things up on your own and, for heaven’s sake, don’t make your loan contestable. With due respect, since loan docs are state-specific, be careful asking here which documents you should use. Your lending attorney will know.

Last, even though you seem to have enough to make a relatively safe 1st position loan, if you insist on making a 2nd (???), the 1st position lender is now your best friend. Make sure you introduce yourself to them. (It amazes me how few 2nd position lenders actually do this with us even though we welcome the calls.) Ask about their background. What’s their loan mod/forbearance policy? Do they foreclose quickly? Do they have a construction arm and also flip houses? Will they call you first if there is an issue with their loan? Take heed of the answers. They could control the future of your loan.

I agree with your premise, but I completely disagree with your examples, @Chris Seveney.

Lately, there’s been an epidemic on this board of potential California lenders with amounts in the $100k ballpark who want to get into lending locally. Mind you, the median price of a home sold in Los Angeles lately is about $950k. I universally recommend they look at first-position fractional loans, which are legal here, but I know that no one listens. I guess these are not as sexy as owning an entire second-position loan on your own. And what could be more exciting than when it’s all the money you have?

The first rule of gambling is that no single loss can wipe you out. Yet lending all your money in second position is like buying a ticking time bomb without knowing when it will go off.

Where I disagree with you is that adding “3-5% higher (min)” to a 13% second position loan somehow mitigates the risk (and I know your numbers were made up for illustration). It only does this if you are doing many loans and can stand getting wiped out on occasion. Here, the extra percentages make up for the occasional loss, time value, legal, headaches, etc.

If you’ve done enough loans, you know your default rate and should be able to calculate the required percent increase. If you are going for broke with an unsophisticated second, you could arbitrarily charge an additional 5%, 50%, or 500%. But if the loan goes bad and you get wiped out, the additional interest rate was irrelevant. Thus, adding any amount of interest on a second is irrelevant if you lose everything.

We know a few who specialize in seconds and consistently lend behind us. They have the thick skin and wherewithal to put up with this. No one has any business lending all their money at any interest rate if the loan could wipe them out.

“Also, if you know somebody who selected option number three and lost 100% of their money, would you feel bad for them?”

Coincidently, yesterday we got a call from a first-position borrower informing us he’s fallen on some hard times and will have to walk away from the house. Not a problem financially because there’s decent equity left in the deal and we’ll be ok. We even have a buyer.

This was a first for us and honestly, because we get to know our borrowers well, we got choked up over his personal mess. Then, just earlier today, we had a conversation with his very unsophisticated second position lender, who we don’t know, and who made a $110k second to him behind us. We had to tell him we could only give him $30k or we could foreclose (though we were much more delicate about it). We learned during the conversation that this was his entire life savings.  No, it wasn’t BS.

If it were Kiavi, we couldn’t have cared less. But even talking to a stranger about not being able to help him recover his life savings was among the worst conversations in our lives. So yes, we felt bad. Very bad.

Don’t let the naysayers get you down or dissuade you, @Alex Sinunu. Some people here just don’t like private/hard money lenders. And don’t overcomplicate or get into anything you can’t understand or explain simply. Lending, like everything else, is easy after you’ve educated yourself and done a few loans. As you intend, we loan our own hard-earned money in Los Angeles and have been doing it successfully for years now.

First-position purchase money and only in Los Angeles and North Orange County. Yes, boxing yourself in reduces your opportunities but, with the amount of money you have, how many deals do you really need? Lending locally allows you to see the property and meet the borrower eyeball to eyeball –- our two main criteria.

As you know, you don’t have enough to make a first-position loan, and second-position loans are easily wiped out and way too dangerous. One option is to participate in fractionalized lending (or fictionalized as @Jay Hinrichs suggests 🤣). In this case, you can invest in one loan with up to ten others and have direct first-position recourse to a local property. These must be originated by a licensed CA broker, but the benefit is you’ll also get professional guidance and vetted paperwork by a fiduciary. Many brokers make and arrange these and will do most of the work.

One drawback is you don’t have 100% control since it’s usually majority rules or decisions are deferred to the broker. Plus, since there are more hands in the cookie jar, your returns will be lower than on the whole notes you’ll eventually want to own on your own, as a goal.

Don’t do this blindly. You’ll still want to learn to evaluate a property and the borrower as well as how to check out the broker. Plus, you should spend an hour with a local lending attorney to understand the basic law (licensing, usury, business purpose/consumer purpose, etc.).

Fractionalized lending is a good way to diversify small amounts of money into relatively safe, first-position loans, on local properties.  Plus, the time you spend on these loans will be minimal. It’s a good way to make a nice return on real estate without the headaches of property ownership.