Confessions of a Private Lender Part 3
To Whom Do I Lend?
The investors I lend to are a diverse group. Most are experienced but I have funded the purchase of one investor’s very first rental home and another’s first rehab project. (Both of these investors had significant personal funds in the deal. The rehabber owned a construction trade company and though this was his first personal project he had been involved in construction for 30 years.) I usually have an existing relationship with the investors I fund. Sometimes I have known them for years, sometimes for only a few months. I have met almost all of the people I have funded at a real estate event, either a REIA meeting or a workshop. I have frequent contact with many through social media. This is the URL to my facebook: www.facebook.com/damntherecession.
I consider most of the people I have funded to be friends. These are positive people who actively seek to better their situations. They have setbacks, as we all do, but they tend not to dwell on them, preferring to forge ahead toward their next success rather than complaining about how tough life is. They are fun to be around. The nights I spend at bars and restaurants with my partners are among my most enjoyable.
Before I continue I’d like to clarify some terms.
This term may have different meanings in different contexts. The way I will use it in the next few articles, it is simply real money. Historically, that meant gold or silver. Cash on the barrel head. Now, due to a form of mass hysteria, we accept peachbacks (Federal Reserve Notes, fiat money) or their electronic equivalent as money. This money has often been saved by the lender, i.e. they are lending their own funds. This is in contrast to banks that usually lend funds that they have also borrowed.
Hard Money Lender
This does not refer to a lender that lends at high rates or with difficult terms, though there are certainly some hard money lenders that do both of these. A hard money lender, for our purposes, is one that will make a loan based more on the equity in a deal than on the borrower’s creditworthiness. I will use this term to refer to a corporate private lender, not a bank (a public lender) or an individual private lender. They will usually have formal application procedures and will charge application fees to consider the loan and other fees (origination fees, underwriting fees, etc.) if the loan is funded.
Many hard money lenders like to call themselves private money lenders because it sounds friendlier. While, hard money lenders are, indeed, private lenders (and private lenders are hard money lenders) there are often differences in the way they operate. Think of this as more of a continuum than two separate groups. Many lenders incorporate aspects of both into their processes. The main difference is that hard money lenders are in the business of lending money. They must lend in order to stay in business. A private lender does not have to lend money. They may like to, they may want to, but they will be just fine if they never lend again.
Points are percentage points. One point is one per cent of the loan amount. Loan origination fees are often stated as points.
Private Money Lender
I will use this term to refer to an individual private money lender. Your friends and sphere of influence may contain many potential private money lenders. Most of these are inexperienced private lenders or potential lenders who have never loaned money before. I, and many, private lenders you meet at REIAs are experienced private lenders. We understand your real estate activities because we may have completed similar projects ourselves. We have read much of the same material as you have (or you should have). Experienced private lenders have done this before but they do not have to do it again. They may want to deploy their funds again but they do not have to deploy them with you.
How do I evaluate a potential loan?
A bank or corporate hard money lender will have very strict guidelines and tests that must be met before they will issue a loan. I don’t, but I still must evaluate whether I will fund a deal and if so, on what terms? My decision is based on three factors: the borrower, the deal, and my plans.
Again, I am an experienced private lender. I am not your Grandma or your Aunt Sue who may lend to you, long term, at a couple points more than their money market account pays because you were a cute kid or you have had a rough time and just need a break (and a hug). Your family probably doesn’t know how to evaluate your real estate project or your loan and doesn’t really care to know how. I know how.
Neither am I a loan officer for a hard money lender. A hard money lender has very specific criteria that a borrower must meet to get a loan. These criteria are usually much more lenient than those at a bank but, still, if you don’t qualify, you don’t get the loan. Hard money lenders may have shareholders, a board of directors or partners that will object strenuously if they do not adhere to their stated criteria. They may have licensed mortgage professionals who must follow strict guidelines. They know how to evaluate loans but are usually willing to weigh the equity in the deal, the collateral, more heavily than the borrower’s credit in their loan decisions.
Be very leery about borrowing from a hard money lender that is only concerned about collateral. These may be predatory, “loan to own” lenders that are primarily interested in taking the underlying real estate and will not hesitate to do so. In fact, they may be hoping you give them the opportunity to foreclose. Many of these types of lenders fared very badly during the last real estate contraction and many had business failures (I don’t feel too bad about that either). The onerous provisions of the Dodd-Frank Act convinced most of the predatory hard money lenders to close up shop. It had the same effect on most of the reasonable hard money lenders. Know who you are dealing with.
I was pleased to be invited to contribute to this redesigned site. This is the third entry in
what I hope will be a long series of posts. Some of my posts may be familiar to some of
you as they were previously posted elsewhere. They have been updated, and/or rewritten
before they appeared here. There will be new posts, but it seems appropriate to retell
some of my stories to introduce myself to new visitors and reintroduce myself to some
old friends. If I touch on a subject that interests you and that you would like me to expand
on, or if you would like to suggest other topics, please leave a comment and let me know.
That may become the theme for a future blog or podcast. If you think I have missed the
mark completely, go ahead and tell me that also. You won’t make me cry and it may turn
into an interesting discussion. Please join the email list and/or follow on facebook.