Guide to Hard Money Lending in California: Part 4
Important Components of a Private Money Loan
Real estate investors often come to private money lenders for their financing needs, and for good reason. Going through the process of applying for a “traditional” bank loan can be long and drawn-out, and real estate investors often need to act quickly. Because of how speedy the process of taking out a private money loan can be, it often makes more logistical sense to go this route. Consider for a moment the fact that private lenders can fund a loan in anywhere from one to three weeks; this is much faster than the average bank or mortgage lender can complete the same funding, with many banks taking up to a month or even several months before funding on a deal is complete.
Because real estate investment loans are typically driven based on the value of the property being flipped itself, investors who take out private money loans also don’t necessarily have the strict credit and other financial requirements that are often in place for a traditional loan. This is another aspect of private money lending that really speeds up the process overall. Speaking of speed, these loans also tend to have shorter re-payment periods. Once the real estate property is flipped and a sale is made, the loan can usually be paid back more-or-less immediately. This is beneficial to both the borrower and the lender.
Characteristics of a Successful Private Money Lender
If you’re thinking about getting into the world of private money lending, there’s a lot to keep in mind. After all, not all investors necessarily make good private money lenders—at least not if they don’t have the right characteristics. Of course, the most important asset to have if you’re wanting to become a private money lender is capital; simply put, you need to have access to large sums of money, and it needs to be ready to transfer for funding at a moment’s notice. Otherwise, you won’t be able to pull of any deals. On the other hand, money is not the only thing you need to become a successful private money lender. You’ll also need to have experience, ideally in the real estate industry. If you’ve been involved with real estate lending in the past, you’ll likely be better able to identify good investments and avoid making mistakes as a lender. Of course, it’s also possible to learn along the way—but having experience never hurts.
Finally, keep in mind that if you want to get into the world of private money lending for real estate, it’s generally best to develop a very localized knowledge of real estate. Knowing the market, where it’s been, and where it’s heading is all important in knowing how to take on the best deals and avoid ones that may not work to your advantage.
Are You Making a Smart Deal?
Speaking of deals, how can you get a sense for whether a deal you’re being proposed is a smart one to take on? This can be especially challenging when you’re first getting into the world of private money lending. Being able to mitigate risk is important so as to avoid losing out on your hard-earned cash. By taking the time to assess the most important factors when a deal is brought to you, you’ll ultimately be able to make the right decisions.
Some of the most important factors to look at when assessing a deal include:
- due diligence – the research you’ve done on the proposed investment and their plans
- market value – the calculated value of the property
- borrower credit and borrower equity
- exit strategy – the plan you have in place if the deal were to go south
- additional collateral – anything you collect (cash, assets, etc.) from the borrower until the loan is paid off
- pricing strategy
- lien priority
Taking the time to carefully consider and assess all of these factors is key to making smart private money lending decisions. Even overlooking one of these factors could result in a terrible deal that can leave you on the hook for hundreds of thousands of dollars in losses, so it’s not something to take lightly.
What Else Do You Need to Know?
Now that you have a better idea of what it entails to become a private money lender, what else do you need to know about the process? For starters, be aware that the documentation required for private money lending is quite similar to the documentation required for a traditional loan. Not only will you want to make sure your borrower signs a promissory note and a mortgage, but other steps typical in a traditional loan may also be required. For example, you may want to order an appraisal on the property being sought for purchase by your borrower to ensure you’re not lending more than the property is worth for the project. You may also want to have an inspection done on the property to ensure there are no hidden and costly surprises that the borrower may run into. All of this, in addition to running credit checks on your borrower (if desired) is part of the documentation that is typically required of a private money loan. Of course, as the lender, you will have a little bit of flexibility on this.
No matter what, there’s a good chance you’ll end up working with a few key documents when you take on your first deal as a private money lender. Some of these documents may include:
- a mortgage note – the promissory note that is signed by both you and your borrower
- a letter of intent – an outline of your lending agreement to ensure everyone is on the same page
- personal guarantee – documentation of any collateral collected on the loan
- purchase and sale agreement – an outline of the total amount of money being borrowed/paid, including earnest money and other costs
- proof of funds – usually a bank statement or other documentation showing that the borrower has enough cash to complete their end of the deal
- preliminary title report and title insurance – documentation on the history of the property and insurance on the title
By being aware of these documents and making sure they’re a part of your deal, you’ll be in better shape moving forward.
Overall, becoming a private money lender can be a great choice for those who have the available capital and the real estate experience to back it up. By making the right decisions and deals, you can see a lot of success with these investments.
Hard Money Lenders California
620 Newport Center Drive Suite #850
Newport Beach, California 92660