Making Your First Hard Money Loan--Marketing for Borrowers
In 2021 I wrote a series of Twitter threads on making your first hard money loan. Markets have changed, so it’s time to update the series. This will be of interest to those of you who passively invest in deeds of trust because it will help you understand how the “sausage is made.” It will also be of interest to those who would like to occasionally originate a hard money loan.
Hard Money Lenders make high-interest-rate (10-15%) loans secured by real estate. It’s easiest to start lending where you live. Before you even consider making a loan, get to know the state laws where you want to lend
Its usury rates
Usury rate exemptions
Licensing requirements
What constitutes an investment loan
A creditor attorney will know the answers to these questions. Ask her about your state’s foreclosure process & typical timeline/costs
I’d ask her, “if I foreclosed on 10 properties what’s the average cost (start to finish) of a full foreclosure?” Typically lawyers hate to talk in probabilities and want to say “it depends” but it’s worthwhile to keep pushing for an answer. It will be less expensive to foreclose in deed-of-trust states than in mortgage states, but the timeframe and the average cost are also important.
You’ll want to ask follow-up questions, can all of your legal fees be capitalized on the outstanding loan balance? Do your legal fees also accrue interest?
The answers to these questions will inform whether or not you even want to lend where you live. But they will also influence the minimum size loan you are comfortable with and the minimum amount of equity (in nominal terms) that you want your borrowers to have in each deal. When a loan goes nonperforming, you want to be sure that legal costs and interest accrual don’t quickly winnow away at the deal’s equity.
Assuming you want to move forward, your next job is to originate a loan. Let's break Loan Origination down into 8 steps:
1. Marketing for Borrowers
2. Comping Loan Collateral
3. Loan Structuring & Commitment
4. Collateral File Assembly
5. Title Review
6. Drawing Loan Docs
7. Drawing Lender’s Escrow Instructions
8. Funding & Closing
Marketing is the first step towards origination
Make business cards (yes I know this seems archaic)
Go to your local Real Estate Investors Association meeting
Tell people you’re a Private Money Lender
Trust me, you'll meet plenty of people. Save their cards or contact information. Open an account with Mailchimp and begin building a list of borrowers and other people in their ecosystem, such as realtors who work with investors. We will discuss database follow-up another time.
I would start by making a single-family fix & flip loan. It’s a bread-and-butter non-owner-occupied investment loan and your exit is clear. Unlike a bridge loan, where your borrower intends to refinance you later, you know that your borrower will be selling this property and you won’t have to worry about the state of the debt markets for non-owner occupied properties.
Unless you have a lot of renovation experience, you want borrowers with some experience. For typical fix and flips, it takes borrowers three deals to climb the steep portion of the learning curve. Focus on these borrowers. You can ask to see examples of previous deals they’ve done. This way you at least see their before and after photos, you see their purchase and sale prices and you see their timelines. Notice I didn’t say you see their rehab costs as it’s hard to get a definitive answer.
Bottom line, lending is like Moneyball for real estate investors. The best predictor of how your borrower will perform is how he has previously performed.
If looking at previous deals photos and closing statements is too much of an abstraction, there’s another approach. I once borrowed hard money from a smaller private lender who told me, “Every time a borrower approaches me with our first deal together, I take a pass on it. Then I follow the deal over time. I drive by the house to see if they start renovating quickly. I see what the property is listed for once it’s renovated. Does the price make sense? Does the work look good? How long does it take to sell and what does it take to sell it?” Sure enough, when I came to him with our first deal together he passed on it.
In our next Hard Money Monday installment, I’ll discuss comping loan collateral.