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.
So, 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 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?”
The answers are found in our 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, a title company or an escrow agent.
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 (ROI) to expect on every loan.
9. Private lender loans are conservative. The maximum loan to value is 65 percent. For example, if a property is worth $100,000, the maximum loan amount should not exceed $65,000.
10. Private lenders can receive their principal back in the event of unforeseen circumstances prior to the promissory note expiring. Lenders receive a “90-Day Call Option” in the promissory note. The lender gives a 90-day notice to call the note due. There is no penalty to the lender, and the 90 days gives the real estate investor time to assign the note to another lender and pay off the current private lender.
11. Frequency of payments is up to the discretion of the private lender. They can choose to receive their payments monthly, quarterly, semi-annual, or annual basis. I recommend quarterly payments when funds are being loaned from a self-directed IRA. This gives the real estate investor enough time to rehab the property and get the property cash flowing before beginning to make payments to the private lender.
12. Our Best Practices does not involve “pooling private money.” Every deal stands on its own. Every lender receives a deed of trust secured by a property. There is not anything wrong with pooling money from multiple lenders, however; these funds require Security Exchange Commission, (SEC) registration.
13. For most loans I 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. Second, interest only payments help the real estate investor’s cash flow.
14. In the event the property sells in less than six months, the lender receives a full six months of interest.
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.
Jay Conner has been a full-time real estate entrepreneur and investor for over 10 years. He is a national best-selling author with his book: “The Masters of Real Estate: Getting Deals Done in the New Economy,” and mentors real estate investing students across the U.S. and Canada. Jay pours his talents and energies into numerous activities. He is currently president of Conner Properties and EZ Mortgages, plus the former CEO of Leader Homes and past President of Business Networking International. In 1997 Jay formed Encore Music, a private record label, where he records original piano compositions. Jay and his wife, Carol Joy, reside in Newport, NC.
*Jay Conner is not affiliated with Equity Trust Company or its affiliates. The information provided in this article is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with legal, tax, and financial professionals.