Mortgage lendingReal Estate Law

Private Lending Basics

Private lending, or “hard money” lending, is a great way to deploy funds in a self-directed IRA. With interest rates approaching 15-20% in some cases and fixed payments coming in every month backed by real estate, it’s a passive investment that’s hard to beat. In this article, I’ve summarized a few key due diligence items that should be mandatory to any real estate lending deal.

Get a credit report.

Get as much personal information about the borrower as possible. A credit report is a great starting point for this, and will tell you a lot about their ability to repay and credit history. Additionally, gather as much information as you can about the borrower’s assets, in case you need to foreclose.

Make sure you use a title company.

If you’re going to be a bank, act like a bank. If you’ve ever taken a mortgage from a bank, the process is complicated, but necessary to protect the lender. Your process should be no different. The costs of title services vary based on the amount of the loan, but expect them to amount to around $2,000 for refinances and $3,000 for purchases for a typical $100,000 loan. These fees would be passed on to the borrower and paid from the proceeds of the loan.

Make sure your document package is right.

At minimum, a separate promissory note and a mortgage should be used. The promissory note represents the actual debt and can be endorsed to others, like a personal check. The mortgage secures the debt to the property and allows you to foreclose.

Keep the original promissory note safe. Under commercial law, a promissory note is a ‘negotiable instrument,’ similar to a personal check. Anyone who possesses the original promissory note is entitled to enforce it. The “produce the note” demand is a very popular foreclosure defense tactic–if the foreclosing lender can’t show the original promissory note (not a copy), then they will have problems proving that they’re entitled to enforce the debt.

One more note on negotiability — in order for a promissory note to qualify as a negotiable instrument, it must contain an unconditional promise to pay the lender an exact amount. Any variation from this will destroy negotiability and give the borrower an opportunity to make all sorts of legal arguments about the enforceability of the promise to pay. It’s best to use a form promissory note with as few modifications as possible for this reason.

How will the borrower use the money?

It’s important to understand what the borrower’s intentions are. A borrower might need the funds to rehab the house, or needs to pay off a maturing debt on the house. Construction projects yield the highest interest rates because banks typically won’t touch them. Likewise, foreclosure sale bidders may have a need to raise cash for a purchase that they can’t make with a conventional mortgage. A borrower using hard money to refinance another lender or cashing out the equity on a stabilized property might raise a red flag. The most dangerous situations for private lenders are ones where the borrower is using your money to pay off a defaulted debt or finish the rehab on another property. It may be fine to go into this deal with open eyes, but be aware of the consequences if it comes time to foreclose.

What about foreclosure?

The foreclosure process in Ohio is not an easy one — expect the process to take a year or longer before the property goes to foreclosure sale, at a minimum cost of $2,500. It is possible to recover the costs of the foreclosure, but if your borrower never pays up, it may not benefit you. If the property goes to sale, you will be able to bid up to the amount you are owed without coming out of pocket. Any unpaid taxes would become your responsibility if you are the winning bidder. A well-timed lawsuit may bring the borrower to the negotiating table and give you the opportunity to strike a deal with the borrower to take the property back without waiting.

I made a deal with a borrower. How do I get started?

If you need help, contact us. We will handle your private loan end-to-end for a reasonable flat fee. We’ll deal with the title company, draft the documents, and coordinate the closing. All you have to do is send the money when we give you the green light. Even a well-seasoned hard money lender will typically use an attorney to handle the deal for them, so they can get back to work on making great deals. We do this every day, and we’re happy to help.

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