There are people who have retirement accounts, yet many haven’t heard about private money lending and are not aware of how it can benefit them. Lending can be ways to earn a higher return on investment while helping real estate investors find money to purchase and renovate single family homes and commercial properties.
Ok, who are private money lenders? In short, a private money lender is an individual who loans money from their investment capital or a self-directed IRA account. In many ways, they act in the same capacity as a bank. When the private lender loans money, they don’t own the property that secures the note but are protected the same way a bank would be. Taking it a step further, those who have a self-directed IRA can lend money from their account and receive tax-free or tax deferred income. As a potential private money lender, you may have questions, such as, “How am I protected?” and “How do I earn high rates of return safely and securely?”
Here Are Some Best Practices for Protecting Private Lenders:
1. The private lender receives a deed of trust or mortgage. This protects their investment. They also receive a promissory note. No loans should be agreed upon by a verbal agreement, no matter how close the relationship is between the real estate investor and the private lender.
2. The value of the property is verified by providing a Comparative Market Analysis (CMA) provided by a local realtor or an appraisal.
3. The private lender is named on the insurance policy as the mortgagee. If the property is damaged, the lender is protected.
4. The private lender is named on the title policy as an additional insured.
5. A real estate attorney prepares all the paperwork and documentation to be recorded on public record.
6. Closings take place at the office of the closing agent which can be a real estate attorney or a title company.
7. No funds are delivered directly to the real estate investor from the private lender. Funds are sent to the closing agent’s trust account. Money is not dispersed until after the documentation is recorded on public record.
8. The private lender does not incur any costs or pay any fees by making the loan. The real estate investor is responsible for closing costs and associated fees. Therefore, the private lender knows exactly the return on investment to expect the loan.
9. Private lender loans are conservative. The maximum loan to value should be 75 percent of the after repair value. For example, if a property is worth $100,000, the maximum loan amount should not exceed $75,000.
10. Frequency of payments is up to the discretion of the private lender. They can choose to receive their payments monthly, quarterly, semi-annual, or a lump sum payment at the end of the note or project. We prefer to offer lenders quarterly or lump sump payments at the end of the note or at the sale of each house, especially when dealing with retirement accounts.
11. For most loans we recommend interest-only payments. First, if the principal amount is not being paid down along with interest payments, the full amount of the principal stays at work for the lender until the house sells or the note expires.
By implementing these Best Practices, private lenders will may receive higher rates of return and lower their risk while real estate investors build relationships that strengthen their business. It truly is a win-win for the private lender and the real estate investor.