The Tale of Two Private Loans that Never Happened (And Why I Said “No!”)

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In the private lending market, I am seeing several newbie private lenders doing some imprudent actions when making private loans.  Meaning frankly, these credit cowboys are going to lose money by extending certain credit terms.  Ask me how I know this…because I extended those loan terms once upon a time and found myself in a ringer.  Let me tell you about two loans I recently declined, but may have funded in years prior.

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Loan #1 : The Loooong Term Flip

This 3 bedroom 2 bath home needed about $12,000 in remodel costs – mainly cosmetic.  Borrower wanted another $15,000 for construction rehab for an additional outside and upstairs exterior entrance.  This was to be given back to the borrower upon his completion of the construction.  Property has new plumbing and electrical installed by the prior owner who lost the property to foreclosure.  Borrower requested 2 years term.  Loan amount of $82K.  Estimated market value of $127,000 gave the deal a loan to value of 65%.

I could not give the borrower 2 years to complete the project and pay me off because invariably, the borrower could move a tenant into the property and thereby risk destroying my collateral as tenants sometimes do.  Also, your borrower will thank you for keeping him on a ‘short leash’ regarding term because that keeps the project moving forward.

Secondly, to give the borrower’s cash back before my loan is paid back is unwise in my humble opinion as the borrower now would have NO ‘skin in the game’.  The borrower could walk into the lender’s office and through him the collateral’s keys and be gone.  Again, ask me how I know this.

Lastly, during the inspection, it is found out there are adequate comparable properties to establish a value, however, the collateral is in a small pocket of run-down homes known, in our area, as Felony Flats.  The immediate neighborhood did not support the borrower’s purchase price for a flip.  It did not matter the neighborhood is improving,  our loan would be short-term in nature.  (see my last blog with the Bering Sea analogy and leaving your money at risk too long)

Loan #2: The Small Town Spa

3 bedroom 2 bath home built in 1951 on 2 acres out in the country.  Loan amount of $60K.  Estimated value was $130K.  Borrower as going to convert the property into a relaxing spa in the country.  Needed $40K in repairs – collateral was a mess!

Glossing over the fact the borrower did not have the cash on hand for the repairs (this is not a deal breaker, but it is a red flag), the property was not near a major metropolitan city.  Meaning, the number of buyers for the take out loan to pay me off were limited.  The borrower tried to assure me there were several buyers who would be interested in the completed property.

Secondly, the borrower wanted to convert the property into a spa.  What this does is make the property a single use property way out in the middle of nowhere.  The number of buyers for this type of property are limited!  And again, ask me how I know this.  When I first started lending, I did a deal like this and I barely got out with my skin.  A man from Alaska happen to be looking for that exact type of property in that exact location and bought my borrower out.  The borrower made no money.

The Take Away

Although private lending is how I and my employees make a living and it can be very profitable, if a lender makes a loan based upon imprudent credit factors or wrong assumptions, it may take the lender a long time to recover.

To Your GOOD Wealth….

About Author

Lee is a private lender with over 15 years of personal experience in the real estate industry. He teaches the everyday investor how to stop thinking like an investor and how to start thinking like a Banker by reviewing and creating cashflow-secured promissory notes that create double-digit returns.

8 Comments

  1. John Thedford on

    Hello Lee. I am new to the private lending business. There have been quite a few surprises. Mostly, the results have been very good. The biggest surprise has been defaults on properties where the loan was less than 25% LTV. My belief was that all these loans were “guaranteed” due to the low LTV. I found out this was a poor assumption…and you know the old saying about ass-uming things. If they get 30 days late, they get a letter from my attorney (at their expense if they want to continue our relationship).

  2. Good idea John. My borrowers get a phone call from me on the 5th and a firm letter from me on the 7th or 8th, if I have not received payment. And just because a loan has a low loan to value does not mean they won’t default. If the borrower mismanages his funds or unforeseen circumstances happen, he will have no money to make your payment regardless.

    Happy Lending!!

    Lee

  3. Good article. I am more interested in long term buy and hold rather than flipping. Reading between the lines I guess private lenders would not be interested in lending to me?

    • John Thedford on

      It will depend partly on rates, terms, etc. Some hard money lenders don’t like tying their money up for long periods unless they have a clause for rate increases. I have found one lender (whom I believe it not typical) doing 5 years interest only but with a clause for yearly increases if interest rises. Start looking and you will find all kinds of different people with different wants and needs that might be willing to lend money. One avenue might be to find private money and then convert to a longer term traditional mortgage after a few years. There is a BP blog about always have cash to lend out and he emphasizes his love of very very short terms. I have done a few, and try to keep them at two years or less. Adding in points along with a faster payoff increase rate of return. Best of luck!

      • As I mentioned in another comment I’m just starting to do some lending with my SDIRA and am trying to pick up on pitfalls to avoid.
        A loan I’m finalizing right now is a rehab and hold with a 5yr term.
        13% interest only payments and after 5 years can be automatically renewed annually for 1pt each year up to 10.
        In addition I’m getting an equity stake of 48%.
        So I’ll get 48% of cash flow after my loan and other expenses are paid monthly and if he sells I get 48% after my balance is paid and he gets his small down payment back.
        I am also getting a lien on a 2nd free and clear place for additional collateral.
        It is a pre-rehabbed junker so it isn’t that valuable, but boosts LTV about 10%.
        There are also pre-payment penalties the first few years.

        Anyway I’m wondering why I should be worried about having my money tied up at those rates for a long time. Maybe less chance for upfront fees but I never have it idle either.

        Thanks for any insight!

  4. Bruce,
    I don’t like the long term buy and hold of small multi family or single family residences as it subjects the borrower and lender to several unnecessary market risks. However, there are several Private Lenders out there who just want to place there money and get a return. This is good for you, but not for them because anytime you simply place your money in an investment(be it a stock, bond, or private loan) and then leave it, the investor is looking for a problem in my opinion.

    To Your Good Wealth…
    Lee

  5. That 2nd one seems like a no brainer deny.
    Way to many issues, maybe if they knocked the zero off the end of purchase price.

    On the first one if the value estimate was right and you had a reasonable term (12 month max) would it have been a candidate?
    I see your point about not having any skin but I’d think there would be worse things then having him toss $30k in equity (after the cost of selling) at you.

    I’m just starting to do some lending from my SDIRA so I’m very interested in avoiding bad decisions.

  6. Deanna Opgenort

    My parents have done 2 notes so far (one to me ..they figured the borrower was a good risk ; )
    The second was a small home loan (too small for banks to want to deal with). We discussed in detail before & came up with following criteria for any note loan;
    a) that if they had to foreclose the property would be worth more than the loan + foreclosure costs
    b) the property is something we’d be willing to own if we had to foreclose
    c) the person borrowing had to have “skin in the game” (in this case @ 40% equity)
    d) the person borrowing had have an excellent history/reputation and sufficient means of repaying the loan (no felonies, no drug convictions, no recent DUIs, good credit history).
    Their other borrower has done well, paying promptly every month, even paying down the principle of the loan well ahead of schedule. Last year she was hospitalized with sudden life-or-death illness, at which point my parents worked with her/family to get loan payment/taxes & insurance taken care of by rolling them into the note & extending the term of the loan. Small towns are different.

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