Making Your First Hard Money Loan--Collateral File Assembly
Hard Money Lenders make high-interest-rate (10-14%) loans secured by real estate. 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
Previously on Hard Money Monday, I discussed Loan Structuring & Commitment. Today, I’ll discuss Collateral File Assembly.
In my previous two Hard Money Monday’s, I walked through a loan quote. But even when a borrower and I have a meeting of the minds about a loan quote, it’s subject to review of a number of documents that we will assemble into a collateral file. Just as a property owner assembles a file on their property, Lenders assemble a collateral file on the borrower and on the property that is the collateral for their loan.
These docs are assembled prior to, during the life of and at payback for the loan. Today I’ll highlight nine critical documents to fund/close a loan:
Insurance
Credit/Criminal
Appraisal/BPO
Bank Statements
Construction Budget
Corporate Documents
Preliminary Title Report
Purchase & Sale Agreement
Loan Collateral Photos and Video
Clearly, there are other docs needed prior to funding and closing. While important, many tend to be more black or white admin tasks.
INSURANCE
Property Owners need General Liability and Property Insurance. As a Lender, I’m added as a loss payee to this policy & have my borrower’s insurance agent send me proof. If there's a covered claim (ie property burns down) we receive a check from the carrier before our borrower receives anything.
CREDIT/CRIMINAL BACKGROUND
Some borrowers choose hard money because their credit prevents them from getting bank loans, think historical credit delinquency or an absence of credit history. These are viable clients. I avoid borrowers that are currently over their skis: currently behind on debt service or with an unsustainable amount of debt service. I RUN from borrowers with any history of fraud.
APPRAISAL/BPO
I'm not into appraisals for residential investment loans. They’re backward-looking & take too long, weakening the value I bring to a deal. 95% of the time, I’m lending not only in cities that I know well, but also in neighborhoods within those cities that I know well.
Occasionally I’ll make a more rural loan outside a major city where I have less experience. In this case, rather than get an appraisal, I’ll speak with a number of realtors until I find one that understands investing. I will have him or her walk the property and assemble a no frills one page BPO with their favorite 3-4 comps. This is a good common sense approach because, given our smaller loan sizes and the importance of speed in our value proposition, an appraisal tends to be just a little too expensive and a little slower than I like.
No matter what a BPO says, I’m lending an amount I’m comfortable with. A BPO is just a tool, it isn’t the bible.
BANK STATEMENTS
Your borrower will need cash to close on your loan, to service your loan and will need working capital to reposition the property in between construction draws. I gather and review a few months of bank statements to make sure there's sufficient liquidity. Looking at a few sequential bank statements is useful because you get a feel for the fluctuations in your borrower’s cash balances.
CONSTRUCTION BUDGET
Construction costs vary by region, state and city. The more loans you make in the same city the faster you’ll come to recognize when something is “off”
Is there a contingency?
Do the numbers make sense?
Is the budget drawn up by a licensed contractor?
CORPORATE DOCUMENTS
Our borrower will send us articles of incorporation (or organization), an operating (or partnership) agreement, valid state issued IDs and either a W-9 or a form SS-4. The IRS issues SS-4s when they issue an Employer Identification Number.
I want to be sure that the entity in which name they intend to take title is in good standing with the secretary of state’s office where the property is located. I want to be sure that my borrower has signing authority. If there are multiple members of the entity, I will likely require a corporate resolution or action by written consent where the partners agree to purchase the property and borrower from us. When it comes to corporate docs, there’s a lot of overlap between what I require and what title requires, so I put as much of it as possible on title’s shoulders.
PRELIMINARY TITLE REPORT
This document is SO critical it will be the subject of its own future Hard Money Monday. It needs to be in your file early in a deal so you don’t waste time on a deal that’s going nowhere. When a property is bought both the new owner & you as the lender will get title policies
PURCHASE & SALE CONTRACT
I review the purchase and sale and all its amendments/addendums to proactively flush out potential problems.
Is the buyer my borrower?
Does escrow confirm the same?
Does the seller’s name match the preliminary title report
LOAN COLLATERAL PHOTOS AND VIDEOS
Early in the process we walk the property with a borrower. During this walk through, I’ll take photos and video of the loan collateral. When our loan includes a construction draw, I set up several “walk through” folders with updated photos of the loan collateral prior to each loan draw.
In my next edition of Hard Money Monday, I’ll discuss Title Review.