Summary:
Private lenders play a pivotal role in the real estate industry, particularly when traditional bank or institutional loans are not feasible. Their more flexible approval criteria ensure that real estate owners always have available financial options, even in the most challenging circumstances. This not only empowers them with a strong sense of control over their economic situation but also underscores the vital role of private lenders in the industry.
Private money loans, funded by private party investors, are facilitated by lenders or mortgage brokers. These key players not only arrange the loan transaction but also serve as the loan servicer. Their responsibility for collecting the monthly payments from the borrower and distributing them to the private party investors is crucial in ensuring a smooth and transparent transaction for all parties involved.
Article:
Real estate loans are considered a security because they are evidence of indebtedness. Various securities exemptions are used to comply with federal and state securities laws.
Federal exemptions typically include Reg D, Reg A, and Rule 147, under separate types of lending platforms.
In California, the Corporations Commission's rules allow for multiple securities exemptions that may be applicable. They are included in the private offering exemption 25102, 25100(p), 25102(e)(f)(n), 25113, and 25102.5. 25102.5 is commonly referred to as the fractional note exemption. A maximum of 10 private investors can invest in a single trust deed as tenants in common.
Rules governing the use of loans under Section 25105 are defined in Sections 10237-10238, 10232.3, and 10232.5 of the Business and Professions Code, as well as Civil Code Section 2941.9 (actions governed by majority rule).
Specific regulations affect private money transactions, including licensing, trust accounting, and required investor disclosures. The reason for pointing this out is that all aspects are highly regulated for those who do not understand private funding of real estate loans.
Private money financing stands out for its adaptability to various financial circumstances and property conditions. It offers a flexible solution tailored to the borrower's specific needs, providing reassurance about their financial options.
Bank rejections, for any reason, including denial of credit due to:
Credit problems.
Debt coverage ratios.
Cash out.
Condition of property. Is the property in poor condition, questionable condition, or partially completed?
A borrowing entity is a family trust, corporation, limited liability company, or another form of entity, as opposed to an individual.
If the cash flow from the borrower's business is difficult to determine.
Fix and Flips.
Is the property in need of rehabilitation?
Avoiding the lengthy hassle of bank processing.
The borrower's financial circumstances, including credit problems, derogatory marks on their credit report, tax liens and judgments, arrearages in payments, foreclosures, and bankruptcy, as well as the type of sale (probate sale), are all factors considered in the loan approval process.
Credit problems and derogatory marks on their credit report.
Tax liens and judgments.
Arrearage in payments, foreclosures, and bankruptcy.
Probate sale.
Complex circumstances.
Purchase and sell promissory notes and note hypothecations, usually at a discount.
Each private money loan transaction is thoroughly analyzed for pricing and acceptable risk. While the process may be less rigorous than that of an institutional lender, it is undoubtedly not lenient. The strictness of the process ensures that all aspects are highly regulated and that the loan is a sound investment.
Initial inquiry: The information will be placed in a digital file.
The procuring loan broker plays a pivotal role in initiating the potential loan transaction. Their primary responsibility is to facilitate the process and ensure that all necessary steps are taken to secure the loan. They bring their expertise and cooperation to the table, which are highly valued and indispensable in this process, making them integral to the transaction and crucial to the borrower's financial success.
The loan agent or broker, as the procuring loan broker, collects data from the prospective borrower. They will discuss the type of property, address value, loans, protective equity, the purpose of the loan, payment plans, and exit strategy.
Is sufficient protective equity above the lien to satisfy the lender's requirements?
Protective equity, which refers to the portion of the property's value that exceeds the loan amount, is a crucial factor in the approval process. For example, a 65% loan and 35% protective equity. This equity acts as a buffer for the lender, ensuring that they can recover their investment even if the property's value decreases.
The borrower must have adequate protective equity, as this determines their financial stability and ability to cover the loan amount in the event of default. From the lender's perspective, a financially stable borrower is less likely to default, thereby reducing the risk associated with the investment.
The preliminary value determination procedure is critical in the loan transaction. Initially, it's based on online inquiries, such as Redfin and Zillow, or comparables available to substantiate the value.
All initial value determinations remain subject to a third-party independent appraisal during the processing period.
The borrower usually pays for the independent third-party appraisal, making the payment directly to the appraiser.
Phase I Environmental Site Assessment - If the transaction involves a commercial property, the borrower must also pay for an environmental professional to conduct the research and prepare the report.
Limited Phase I- A few lenders will not require an appraisal, and will do their internal valuation
Early discussions about paying for the appraisal and, if required, the Phase 1 environmental site assessment are crucial.
The upfront borrower's payment obligations to third-party vendors are disclosed in full, preventing any surprises for the borrower and ensuring they are fully prepared and informed about the process.
Will the net proceeds of the new loan pay off the debt, thereby reducing their outgoing expenses and increasing their cash flow?
The procuring broker should actively calculate improved cash flow as part of a submission, with the assistance of the real estate agent and the borrower. It is essential to consider whether the new loan enhances the borrower's financial situation or serves as an interim measure to address issues and regain economic stability. Early in the conversation, the borrower understands they must pay for an appraisal upfront.
Organizing the loan application process is crucial. One way to do this is to set up a lead file using the property's address and the agent's name for reference.
This file serves as a centralized depository for all relevant information, making it easier to track the progress of the loan application.
Could you email all required exhibits for the loan transaction? This will allow you to place them in the designated digital file efficiently, eliminating the need for cumbersome paper files and ensuring a streamlined process.
Go to Outlook, Google, or another search engine, look up the property, and set up an email to yourself. Include 2 or 3 references, such as Zillow, Redfin, Realtor, etc., and send the email to yourself to place in your lead file. This will provide you with an idea of the property's condition, an estimate of its value, and a detailed physical description.
Could you obtain a property profile from your chosen title company? This will enable you to identify any liens and encumbrances recorded against the property, providing crucial information for the loan transaction.
If the borrower is an entity, look them up on Google and the Secretary of State's business search. This research shows that their entity is registered to do business in California.
If the borrower is an individual, you can search for them on Google and LinkedIn.
Could you place the data in the digital lead file?
If the property is located in another state, could you research the distinction between judicial and non-judicial foreclosure proceedings? Many lenders only make loans in non-judicial states. A few exceptions exist, like Florida and Texas, if the borrower is an entity. Some states provide for both methods.
Foreclosure laws change frequently, so could you please review the latest reference regarding the type and procedure?
The bare minimum documentation for underwriting a loan transaction is a completed application, a recent home loan payment statement, three months' bank statements, a credit report, and a background check.
If the loan is a second trust deed, please take a look at the first trust deed and loan agreement (if applicable) to determine if placing a second lien on the property is prohibited by contract.
For single units to four units, you can place a second lien as a matter of law.
An exception may apply if the first trust deed is in the name of a prior owner, rather than the current owner. In that case, you may want to have it passed by your attorney.
On units of five or greater and all commercial, industrial, and land, you must review the documents. The prohibition for placing a junior lien on the property will be in the deed of trust or the loan agreement. The deed of trust is a recorded instrument, but the loan agreement is not. Sometimes, the prohibition only appears on the loan agreement, so a copy is not readily available as a recorded instrument. You'll need to ask for it from the borrower.
If the borrower is an individual with a business, could you obtain three months' worth of bank statements for both the borrower's account and the company's account?
The key to having a business and personal account is to figure out the trail of cash flow. Sometimes, a written explanation from the borrower is necessary.
All commercial property inquiries should lead to a visit to the geo-tracker to determine if the property or properties in the vicinity may be contaminated. Could you download the summary and place it in your digital loan file?
https://geotracker.waterboards.ca.gov/map/
The loan process includes the following:
Could you identify a potential transaction, discussing the requested amount and collateral backing the loan?
Obtain a commercial loan application for non-SFR or use a 1003 residential form.
Financial statement, real estate schedule, two years' tax returns, or, as an alternative, three recent bank statements. Some lenders may not require income verification when the borrower has high protective equity. Lenders are looking for cash flow to pay the loan payments.
If the proposed loan transaction is a second lien, two things must be proved. One is to obtain a recent payment statement to show the balance and that the loan is current. The other option is to review the first lien trust deed to determine whether a second lien is permitted without the first lien lender's approval. On all properties, except those used for residential purposes of one to four units, there may be a "due-on-sale" or "due-on-encumbrance" provision, typically found in the trust deed or loan agreement.
Authorization to obtain a credit report. Credit is less of an issue.
Could you obtain information about the borrower's property insurance coverage? The lender must be named on the policy as a "lender loss payee."
If an association exists, the lender will verify that the association dues are up to date.
Are the property taxes current, or must they be paid out of the proceeds of the new loan?
Are the homeowners' dues up to date?
Various other miscellaneous disclosures may be required, depending on the purpose of the loan, the borrowing entity, the type of property, and the state of origination.
Loan purpose is paramount: Business vs Consumer:
Purpose of loan proceeds written by the borrower. The primary distinction is the difference between consumer and commercial business purposes. Consumer purposes fall under Federal consumer laws, such as the Truth-in-Lending Act (TILA), which reflect different underwriting and licensing requirements.
Business purpose loans are made for 1 to 4 residential units, where the loan proceeds are used primarily for business purposes. "Primarily used for business" is essential. This means that a portion of the loan proceeds, exceeding 50%, must be used for business purposes. A percentage of the loan proceeds (less than 50%) may be for consumer purposes.
A consumer-purpose loan is one where "loan proceeds are used primarily for personal, family, and household purposes," accounting for more than 50%.
A borrower may obtain a loan where the loan proceeds are primarily used for business purposes, but use a smaller portion of the proceeds for consumer purposes and still comply with the Truth in Lending Act (TILA).
Setting up a professional summary to be sent to a prospective lender:
The role of the procuring broker is to address all questions and concerns about the proposed transaction and present all material facts known in a written format, commonly referred to as an "executive loan summary."
Name of the procuring broker and the desired fee.
The description of the property, condition, income, and value.
The exhibit flow should include pictures, a location map, and a property description.
Could you express the positive attributes of the loan transaction?
Secondly, could you describe any weaknesses?
If there are more than 5 or 6 exhibits, then send two or three emails with the exhibits. In most cases, there is insufficient computer memory to transfer large amounts of data unless you use a program like LockBox.
Could you email the executive summary of all exhibits to the lender and follow up within two business days?
You can expect to be asked questions, and you should provide the lender with the necessary information to make an informed decision.
What real estate types are appropriate for private money borrowing?
Single-family owner-occupied and non-owner occupied.
Apartments, office, retail, industrial, mini-storage.
Special purposes, such as in restaurants and automotive-related uses.
Land loans.
Some, such as rural land, dirt roads, and environmental challenges, are much more difficult.
California Code 25206:
A broker licensed by the Real Estate Commissioner is exempt from the provisions of Section 25210 when engaged in transactions in any interest in any general or limited partnership, joint venture, unincorporated association, or similar organization (but not a corporation) owned beneficially by no more than 100 persons and formed for the sole purpose of, and engaged solely in, investment in or gain from an interest in real property, including, but not limited to, a sale, exchange, trade, or development. A spouse's interest shall be considered held by one person for this section.
A tenant in common ownership should be interpreted as a form of partnership when used for a 25206 form of 25102(f) or 25102(e).
California Business and Professions Code 10137.1
Nothing in this division shall preclude a partnership from performing acts for which a real estate broker license is required, provided every partner through whom the partnership so acts is a licensed real estate broker.
When a mortgage decides to use a 25206 for 25102 (f) or 25102(e), at least one of the investors must be the sponsoring broker as manager. As a result, the broker is required to make a minimal capital outlay to become a tenant in common or partner, such as $1,000 to $5,000, or to become an investor in the deal.
Both (e) and (f) require filing a form online with the corporate commissioner for each transaction and paying a fee.
Filing with the corporation's commissioner 25102.2
The commissioner shall require any issuer that is engaged in the business of purchasing, selling, financing, or brokering real estate, and that relies upon an exemption authorized by subdivision (e),(f),(h), or (n) of Section 25102, for an offering which involves the offer or sale of securities to any person who is not an accredited investor, as defined in Regulation D of the Securities and Exchange Commission (17 C.F.R. 230.501 et seq.), in a transaction that is not registered under the Securities Act of 1933, [FN1] to provide additional information regarding the nature of the proposed offering on a form prescribed by the commissioner. This information shall include the names of the issuer's officers and directors in the case of a corporation, managers in the case of a manager-managed limited liability company, members in the case of a member-managed limited liability company, general partner in the case of a limited partnership, or persons performing similar functions in the case of other types of issuers, the offering disclosure documents provided to prospective purchasers, a list of all state and federal licenses required to further the purposes of the investment, and the names of all licensed persons that will undertake those activities.