Private Money Lending to real estate investors can be a very profitably strategy.
Private money lending comes from an individual that lends their own money to a real estate investor. This loan will typically be secured by a mortgage on the property.
Pretty much a Private Money Lender is the bank to an investor. You are an investors alternative to a bank loan and hard money loans. Many investors will need a short-term loan to buy and/or renovate a property. A private money lender can help by lending with favorable terms.
Private money lending is as passive of an investment as you can make in real estate.
Honestly, we think it's the ONLY true passive form of investment.
Private money lending is for people that have the extra capital. This is not a cheap option. Lending money does come with risks (which we'll address later).
Private money lending is perfect for people who can relate to any of the statements below:
Now, you don't need to be ultra rich to be able to lend money. Sometimes there are opportunities where an investor needs $20K to do a cosmetic rehab.
Private money lending is not for someone that is looking to lend the only $20,000 they have.
Like we said before, lending can be risky.
We see this a lot with people who feel like they're missing out with this rising real estate market. Because of this the lend to the WRONG investor.
Later in this guide we will cover the pitfalls with lending and how to avoid them.
Also, private money lending is not for someone that can't handle risk. If you see that it's hard to part with your money for an investment then don't do it. If you do you will put unnecessary stress on yourself as well as the investor.
You also don't want to lend if you think you will need access to that money in the next 6 months.
We want to take a minute and cover this very real fear. We see over 90% of new investors get in to the market because of FOMO.
Please be honest with yourself and determine if this is the reason why you're getting into it.
If so, don't worry not all is lost.
We understand that you may be seeing on TV or Facebook, how many people are "crushing it" by investing real estate. So you don't want to miss this amazing, once in a lifetime opportunity.
The truth is, this isn't a once in a lifetime opportunity. People have been making money off real estate since the beginning of time. They will continue to do so until the end of time. As long as you have money to invest, you too can take advantage real estate. Regardless of the point in time.
The key is having money! But if you rush in because of your FOMO then chances are you will make a bad decision.
We know investors that made money right up until, during, and after the 2008 crisis.
So please, eliminate your FOMO. Don't feel like you need to jump into a bad deal now because they're all going to vanish! As long as people live in houses there will deals to be made.
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You want to make sure you understand the market you're lending in. This will determine how much you lend and for what terms.
We recommend speaking to both Hard Money Lenders and Investors. They each have very valuable information to share with you.
Private lending is much better than Hard Money Lending to an investor. A hard money loan comes from an institution which charges investors extra fees and points for loans.
So, how this helps you is because you should interview the top hard money lenders most investors are currently using. Now figure out what are the terms and rates they charge. Once, you've done this all you have to do is beat their terms!
You also want to ask them questions about the market. Here are some questions that will help:
You want to start attending real estate groups to meet and network with investors you may possibly be willing to lend to.
NOTE: Don't start announcing that you have money to lend! The issue with this is that will not get the truth out of people now. All they will be interested in is selling you to lend to them.
You first want to find the savvy investors that are actually doing deals and borrowing money. After some time at these events those people will become clear.
Now, you start asking them the following questions:
Introducing yourself as another investor helps keep peoples guards down as far as them trying to pitch you on lending. This way they tend to open up more and tell the truth.
Now that you went to hopefully 4-5 different meetups, spoken to many different investors and HML, you start putting your research together.
By getting the answers to the questions above you should have a better picture of what the market is doing.
When a market is hot you find that investors can find money rather easy. This causes HML to also lend with much better terms and at times much higher risks.
This is useful information to know because you don't want to throw your money in when the market is too hot. At least not until you've found a great deal and investor to work with. Like we said earlier, don't be afraid of missing out.
In our market of San Antonio, TX, we have seen a big inflow of money for investments. The issue is that the majority is chasing short-term gains. So you have a lot of competitions as a lender for flips. But that means other avenues have opened up as well.
Long-term financing is going to be the next thing to pick up here. This means lending to investors that want to hold on to properties either for rental income or as an owner finance.
If the market is not as hot you will find investors having an abundance of deals but not enough money to take them down. This isn't necessarily great. This could be because it's a bad market and no one is buying. Or, it could mean that it's a growing market.
What you need to figure out is where in the cycle you are in.
Things to look up:
All of this information will be very helpful in determining whether or not to invest there or maybe look elsewhere.
As a lender you are investing in the investor not the deal!
What we mean by this is, that when you lend the money, you're doing so to a person. Even though it's protected by the house/investment you're still depending on that investor to make it work.
We have seen countless times where an investor takes a deal that was a great deal and completely killed it because they didn't know what they were doing.
You can do all of the due diligence on the property and the numbers and realize that it all looks amazing. But, if it's poorly managed then you run a real risk of maybe not getting your money back!
We know you're probably thinking, "Ok, I'll just look for someone with experience." You're right, but in today's world with social media and how quickly come in and out of this business, how do you know you're getting the right info?
Experience is very easy to fake if you're not asking the right questions. We have seen new lenders get fooled by fast talking wannabe investors. Understand that there are people out there that know A LOT about real estate investing... in theory! So, you talk to them and they can regurgitate everything they've heard, read, or saw someone else do. This makes them seem like they know their shit.
You have to dig deeper here.
You find the right investors by going to your local networking event. These people are either or people they've worked with are there.
You want to find someone that meets the following qualities:
Ah, the people we love to hate. Attorney's are a crucial part of any business dealing whether you like them or not. But, it must be the RIGHT attorney!
What we mean by the right attorney is, if you're doing a real estate transaction get a real estate attorney. Many of you maybe think, duh! But some of you are thinking, "what's the difference?" Well there's a huge difference.
A family attorney may have a broad understanding of the law but may not completely understand real estate law. We have had trouble with people that have tried using divorce attorneys because it was their friend to look over a real estate contract. The advice they gave was terrible. So bad in fact that our attorney called theirs and advice that attorney that they can go to jail if their client proceeded with this advice!
Now, you're probably thinking, "that was just one bad attorney" and the answer is, NO. Not all doctors are the same not all attorneys are the same. There's a very good reason why they specialize in a certain area. Each area of law is very extensive and is subject to change at any time. So if this isn't their main focus they may miss new changes to the laws.
That being said, attorneys are here to look at every worst scenario possible. If you listen 100% to what the attorney wants you will NEVER get a deal done. In real estate like any other investment there's always a risk. But attorneys want to protect you against every possible risk. While this sounds great to you, this usually means the risk is now passed to someone else. Now, that someone else needs to be ok with all of that risk (which they won't) in order to proceed.
Here is where you need to weigh you risk reward. As investors we take risks all of the time. What makes those risks worth it is the possible reward.
As a lender, your risks are losing the money you've lent. So how do you protect yourself?
We already covered Finding The Right Investor. This will help tremendously.
You want also verify that what you're lending makes sense. For example, if someone is asking for $100,000 make sure that house as it sits is worth more than that. The reason for this is many investors are overpaying for houses because they hope prices will be substantially higher when they sell.
By lending on a home that's potentially worth more will protect you if you have to foreclose on the borrower and sell the home.
Your loans should always be protected by a lien on the home (promissory note) and a Deed of Trust.
NEVER lend money to an individual without having any collateral. We have seen this happen too much. You should never trust someone that much. We don't care who they are and how long you've known them. Always protect yourself!
All of that being said, it's still 100% up to you how much risk you take.
You can always lend money on a first lien position or second or third or no lien position. The further back your lien position the less of a chance there is that you will be paid if things go south.
In a loan 1st lien has priority and if the investor really messed up sometimes that's all of the money that's available.
Typically what happens is, the further your lien position is, the more you get paid. So, say the 1st lien is paying 10% interest only then the 2nd lien my get 1 point and 10% and the 3rd lien might get 2 points and 11% and so on. Remember as a lender points are better than straight interest.
But, everything is up for negotiation. We meet many lenders that want too much for their money and they either never find an investor that will pay that or they find the WRONG investor.
At PRYME Homes we wouldn't pay more for 2nd or 3rd lien just because it's not necessary. We have enough credibility and get our properties low enough that everyone has equal protection.
Like we said before, there are 2 main documents that you want.
Some of these documents and laws do vary by state so make sure you consult an attorney first.
Many new lenders what to charge too much because they've never done this before. Like we said above you will either not get someone to lend to or get the wrong investor!
Here's the other problem with charging too much that happened to one of our lenders.
Lender wants to lend at 12% interest. Borrowing $100K for 6 months that'll make them $6,000.
We have lender #2 that will lend at 10% interest. Now, lender #2 on the same loan only makes $4,999 in 6 months.
But this actually leaves us with an extra $1K in our pockets. So what happens is we make sure we bring our next deal to lender #2.
Now lender #2 has had their money out for the full 12 months which has generated $10,000. But because lender #1 wants 12% they have had to wait until someone that really needed the money brings them a deal. In this case it took lender #1 four months before they found the next deal to lend.
So in a 12 month period lender #1 made $8K and lender #2 made $10K.
Now guess who will get priority moving forward?
At the end of the day we're all in it to make money. Your money sitting there because you think you can make more at some point down the road sometimes doesn't make as much as you think.
We hope that you have found value from this Becoming An Experienced Private Money Lender Guide. This isn't the answer to all of your lending questions but it should be more than enough to get you out there and doing the RIGHT research. Private money lending should not be taken lightly.
PRYME Homes is always here to help. We will be posting more articles, podcasts, and social media content in order to expand on many of the points expressed in this guide.
If you have any further questions always feel free to reach out.
We really appreciate the time you took to read this and feel free to share this with anyone.
NOTE: Nothing here should be taken as financial advice or legal advice. Always consult a real estate attorney before doing anything.