Private money, also referred to as “hard money”, are loan transactions that are funded by non-institutional lending sources. For many reasons’ property owners may be unable to secure a loan from bank or institutional lender. These lenders have a significantly higher threshold when it comes to being approved for a loan.
Private money loans are funded using the capital of private party investors as individuals, and capital raised in investment loan pools created for the purpose of funding such loans. Generally, the lender or mortgage broker who arranges the loan transaction will become the loan servicer, collecting the monthly payments from the borrower, and distributing the payments to the private party investors.
Real estate loans are considered a security, because they are an evidence of indebtedness. Various securities exemptions are used to comply with federal and state securities laws. Federal exemptions usually are Reg D, Reg, A, and Rule 147. In California the Corporations Commissioners rules allow for multiple exemptions that may be applicable. They include the private offering exemption 25102, including 25102(e)(f)(n), 25113, and 25102.5. 25102.5 is the most commonly referred to as the fractional note exemption. A maximum of 10 private investors can invest into a single trust deed as tenants in common. Rules are defined in 10237-10238, and 10232.5 of the business and professions code. There are also specific regulations affecting private money transactions, including licensing, trust accounting, and required borrower and investor disclosures. The reason for pointing this out is that for those who do not understand private funding of real estate loans, that all aspects are highly regulated.
Why do borrowers use private money financing?
1) Bank rejections, for any reason, including:
a) Credit problems.
b) Debt coverage ratios.
c) Cash out.
d) Property in a poor condition, questionable condition and/or partially completed?
e) Borrowing entity is a family trust, corporation, or limited liability company, or some other form of entity as opposed to an individual(s).
f) Cash flow from borrower’s business may be difficult to analyze.
g) Fix and Flips.
h) Avoiding the long hassle of bank processing.
2) Borrower financial circumstances:
a) Tax liens, judgments.
b) Arrearage in payments, foreclosures, bankruptcy.
c) Probate sale.
d) Complex circumstances.
3) Purchase and sale of promissory notes and note hypothecations, usually at a discount.
Each loan transaction is fully analyzed for pricing and acceptable risk. The process may be less cumbersome than an institutional lender.
The process includes the following:
1) Identify a potential transaction, with discussion about the requested amount and collateral backing the loan.
2) Obtain a loan application, 1003 residential, or commercial loan application for non SFR.
3) Obtain a property profile online and download pictures from the web.
4) Financial statement, real estate schedule, 2 years of tax returns, or as alternative 3 recent bank statements. Some lenders may not need income verification when the protective equity is high.
5) If the proposed loan transaction is a second lien two things need to be proved up. One is to obtain a recent payment invoice to show balance and the fact that the first lien is current. The other is to review the first lien trust deed to decide if a second lien is allowed without first lien lender’s approval.
6) Authorization to obtain credit report.
7) Obtain info about borrower’s property insurance coverage.
8) Various other miscellaneous disclosures depending on the purpose of the loan, including borrowing entity, property type, and state of origination.
The following information will be obtained as part of the pre-assessment.
1) Purpose of loan proceeds written by the borrower. The primary distinction is the difference between consumer and commercial business purpose. Consumer purpose falls under federal consumer laws which show dramatically different underwriting requirements and licensing. Most private money companies only engage in business purpose lending. The purpose of loan proceeds may be partially for consumer and partially for business. A discussion of the difference can be found on www.danharkey.com in the private money lending section. The article is entitled Loan Purpose-Consumer vs Business.
2) Property type, description, and condition.
3) Property income stream, if any? Analyzing the quality of the income stream is an important part for the purpose of generating enough income to make the loan payments.
4) Identifiable protective equity that serves as the security.
5) Borrower financials, strength and ability to pay.
6) Credit report and possible background search. Credit requirements of private money lenders are less stringent.
7) Exit strategy. Does the borrower have a realistic exit strategy to refinance, sell, or other method of paying of the private money loan at maturity?
8) Some lenders rely more on the protective equity based upon the appraisal, less recorded debt. Some lenders rely on the income generated from the property and the financial strength of the borrower. Some lenders also need personal guarantee’s when the borrower is a single purpose entity such as a limited liability company or a closely held corporation.
What types of real estate are appropriate for private money borrowing? Most are appropriate however some properties like rural land, dirt roads, and environmentally challenged are much more difficult.
Acceptable property types include:
1) Single family owner occupied, and non-owner occupied.
2) Apartments, office, retail, industrial, mini-storage.
3) Special purpose, such as restaurants and automotive related.
4) Land loans.
It is imperative that you work with a private money-lender who has advanced experience, a direct source of funds and a support staff to complete your loan transaction with professionalism and efficiency.
Dan Harkey
Business and Private Money Finance Consultant
Bus. 949 521 7115
Cell 949 533 8315
dan@danharkey.com
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