There are a few important factors you need to know before you become a hard money lender. If you can master these, then you can win.
Obtain Title Insurance
Make sure you obtain title insurance which insures your lien position as a lender and offers fraud protection against forgery. Unlike homeowners insurance, where if you suffer a loss with your homeowner’s policy you submit the claim and get a quick reimbursement, Title insurance is an indemnity policy. Therefore, you could be reimbursed only for a proven loss and not the potential for a loss.
Review a Borrower’s Credit
Carefully reviewing the borrower’s capacity to make monthly payments is a very important key to a successful loan investment. private money lenders in Washington DC often base loans on the asset or collateral. However, the best loans also give equal weight to the borrower’s past credit track record and capacity to repay the loan when a balloon payment is due, or when the loan matures.
Create the Right Documentation
Documenting the loan, by creating the appropriate security documents and disclosures to the borrower, is complicated and time consuming. There are a many state and federal regulations to be followed. Violation of these regulations could invalidate the loan and result in lost interest and/or fees. Make sure that you engage the appropriate counsel to guide you through the process!
Validate Property Insurance
Make sure the property owner has the appropriate fire and liability insurance in the amounts you desire as a private lender. The insurance company must also be notified to include you as an additional insured on the policy. In the event of loss, you want the check sent to you first! There are insurance companies that specialize in writing policies for real estate investment property. For example, National Real Estate Investment Group.
Consider Liquidity
If you think you’ll need the money before the maturity date of the loan, then do not consider becoming a hard money lender. Even though most loans payoff, there is a chance that it may not pay off as expected.
In the event that you do need your invested capital returned prior to the maturity date, you can try to sell your loan using an online loan exchange such as LoanMLS, or offer it to another private investor for sale through a hard money loan broker. However, performing and non-performing private money loans typically sell at a discount. So, prepare yourself to take a haircut on the amount of capital returned to you.
Use Several Sources for Collateral Valuation
This is where you mitigate risk! The underlying collateral for a hard money loan is very important to your overall security and participation in the transaction. Carefully evaluate the value of the collateral and use several sources to make your valuation.
A common mantra among private lenders is to “drive the comps yourself.” That means do not just look at photos on an appraisal and assume you have an accurate value. Take the appraisal, get in your vehicle, and drive to the subject property as well as each comparable to make the determination of value for yourself. What you find might surprise you.
Also, use multiple sources to confirm valuation. In addition to an appraisal and driving the neighborhood and comparables, consider using an Automated Valuation Model or a Broker Price Opinion.
Remember Advances
Some loan investments require that lenders advance additional funds for a variety of reasons. Borrowers sometimes require advances to cure delinquent property taxes, cure a senior lien position, hire an attorney, pay to defend bankruptcy claims, or even renovate and re-model a property if a foreclosure occurs.
The lesson here is do not invest in hard money loans without leaving yourself a cash cushion. Take a conservative approach and leave plenty of liquidity in your personal finances to handle unexpected circumstances.
Click here to Learn Exactly How To Become A Private Lender
How to Service Your Loan?
Once a private loan is originated, payments need to be collected from the borrower, along with various tax, regulatory and informational statements sent regularly to the borrower. There are many loan servicing options to choose from. A quick Google search will help you identify a few options.
What Happens If a Borrower Doesn’t Pay?
If a borrower does not pay the private loan, investors must be prepared to go through a foreclose process to claim the collateral. This will be an involved process which requires a significant amount of expertise and expense. Again, ensure that you engage the appropriate counsel to guide you through the process!
Other Ways to Invest in Loans
When you work with hard money loans, you should be aware of the various methods you can invest in loans and the pros and cons associated with each method.
New Loans
The new loan can be for either the purchase or construction of a new property, or for the renovation/rehab or refinance of existing debt on a property.
Pro: In this scenario you are lending specifically to one party and have control over origination, documentation requirements, terms, servicing, etc. You will not have potential liability for a previous originator or servicer’s mistakes. If this is a new loan made to a previous client you have the previous performance history readily available.
Con: If this is a new client, there will be little to no prior payment history on which to base a lending decision. You will have to rely upon other credit performance or on the accuracy of conversations or reports from previous lenders.
Buy Notes
Hard money lenders sometimes purchase loans that have already been originated. In this case, lenders purchase loans at face value, at a discount, or if it’s a great loan, at a premium.
Fortunately, you can analyze and evaluate the note’s performance history. For non-performing loans, solid valuations for collateral plus deep discounts at purchase can provide excellent yields for an investor who is willing to go through the foreclosure process. And some notes, while currently non-performing, payoff to avoid foreclosure. Others transform into perform notes through “rehabbing” and restructuring.
Unfortunately, you can buy an existing liability if the note was not originated or serviced properly. Non-performing private loans may force you to foreclose to recoup your investment that this can be a lengthy and costly process. In addition, your due diligence process will always be at the mercy of the records available from the current lender.