Before getting into the thick of things, I want to make it very clear that I am NOT an attorney, accountant, or professional advisor of any kind, and when seeking such advice you should really speak to the proper adviser. While the information I’m writing here is based on many years of experience flipping 100’s of houses at House Flipping HQ, this doesn’t really constitute professional advice (since everyone’s experiences and situations are different), so be sure to get professional legal and financial advice from those who can help you every step of the way.
What is Private Money Lending?
A private money lender is just another way of referring to an individual who provides a loan to help fund your real estate investment purchase. Virtually anyone — from family members or friends, to a family physician, or colleague — could be a private money lender.
Working with Private Money lenders is probably my favorite way to get my house flipping deals funded. There usually aren’t any qualifications or hoops to jump through, it’s less expensive than working with “hard money” lenders, and in many cases you can get the entire cost of your deal funded!
Why would someone be a Private Money Lender?
The reasons someone might be a private money lender are clearer when you see some of the alternatives:
When someone invests in the stock market, they don’t know what their return will be. They may win, break even or even lose (as we often see in today’s economy.) If they are investing in a company that goes under, they lose their investment. They cannot take possession of the company buildings, or office equipment and there is no collateral for their investment.
When someone keeps their money in a bank, mattress or low yielding investment such as CD’s or bonds they usually don’t even earn enough interest to offset inflation.
On the other hand, with private money lending, you can earn both a high and consistent return on your investment, and your investment is “collateralized” with the house which you are lending against. This adds a lot of additional security to the investment!
What do you need to do when working with a Private Money Lender?
When working with a Private Money Lender you should provide them with the following:
1. Promissory Note: This is the document which outlines the terms you agreed to. It’s kind of like your “contract”.
2. Deed of Trust (Trust Deed): This is the instrument (or document) which secures their investment to the property. This is the same thing banks use to secure their investment when they lend money. It is the document which allows them to legally foreclose on you if you don’t make your payments on the property.
3. Hazard Insurance naming them as additional insured: You should really have insurance on all of your house flipping properties, and this gives your private money lender an added layer of security. If anything were to happen to the house they can still get their investment back as long as it is covered under the policy.
Protecting their interests
Be sure to keep your investors protected by never letting them loan more than 70 – 75% of the value of the house. If you get good at buying (learn about evaluating property values here) this still means they can fund the entire purchase. The main idea is to try to keep their Loan to Value (“LTV”) ratio below a certain amount.
There isn’t any “hard and fast” rule here, and it is completely up to you and your private money lender to work out the details. However if your private money lender knows you are looking out for their investment they are more likely to feel comfortable with you and continue to lend you money on future investment deals. Some private money lenders may want a lower LTV, but once again it is up to you and your private money lender to fine-tune your arrangement.
Paying back Private Money Lenders
With a private money lender you can either pay their interest on a monthly basis or you can pay them “accrued interest” which means their interest will accrue and they get paid all their interest in a lump sum along with their principal investment at closing when you sell the house.
For example if you borrowed $100,000 on a house and you are paying your private money lender 12% on the capital, and you owned the house for 4 months, then they would be paid $4,000 out of the proceeds of the house when you close. (1% of $100,000 per month for 4 months) If you are short on capital this is a great way to structure your house flipping deal with your private money lender!
Where to find private money lenders
Private Money Lenders are all around you! You would be surprised at who would probably be interested if they understood how the process worked, or knew you were looking for a private money lender. I mean, what other investment can you get paid a 8 – 12% return on your capital, and have it secured with a hard asset?
Many people don’t know this, but retirement accounts can also be used for private money lending!
You would need to set up what is called a “self directed retirement account”, which will allow you to control the direction of your investment without having to rely on a “middle man” to decide what is best for you (or for them to assure themselves a nice commission). This allows you to grow your money at incredible returns in a tax free environment. Talk about exponential growth on your capital!
I will cover this entire process in more detail in the future, but in the meantime if you would like more info on how you can go about exploring these options feel free to ask questions in the comments section below and I will do my best to answer them for you.
When working with a private money lender it will be up to the two of you to come up with the terms for the agreement or note you write up. You will need to determine the interest rate and how they will be paid, as well as how long the “note” for the loan will be. If you are anticipating it taking you 4 months to “flip” your property then you should do the note for around 7-8 months just to give you some extra time in the event that it ends up taking longer than anticipated. Since the paperwork may change from state to state speak to your escrow, or title company or attorney to get the paperwork for your Promissory Note and Deed of Trust.
Following the rules
The SEC (Securities and Exchange Commission) and your local officials have rules and regulations when it comes to “raising” capital, and it is important to be mindful of those rules. Some SEC attorneys I have spoken to have said that any kind of raising capital falls under these regulations, while others have said Deed of Trust investing does not.
Overall, private money lending is a great way to get your house flipping or other real estate deals funded! It is one of my favorite ways to finance properties for flipping houses and I hope, after you have done your research and gotten the right professional advice, you are able to explore this method of raising capital.
Again, if you have any questions just post them in the comments area below!
P.S. If you enjoyed this article then you may also like our fan favorites: “20 Top Real Estate Pros Tips for Success” and “4 Steps for Evaluating House Flipping Deals to Ensure a Killer Profit”
One Last Disclaimer
This post is only meant for informational purposes related to some of the benefits of private money lending and how it works within our business. My only goal is that you might become more aware of what private money lending is. I am not an attorney. This is not a public offering, and should not be interpreted as legal advice. Before advertising for or borrowing private money one should consult with an attorney or other professional to make sure they are following guidelines regulated by the SEC.