The Beginner’s Guide to Private Lending: 5 Important Steps
Private lenders are usually higher income individuals with available cash that are looking for opportunities to increase their capital by receiving a good return on investment through collecting interest on loans secured by real estate assets. Nowadays, banks cannot offer a good interest rate on savings accounts thus it is recommended that the excess of cash is invested properly so it can generate further income and increase wealth. If you are considering entering the private lending industry you can follow the below steps to assure smooth process is in place.
Establish Capital Fund. Firstly, you need to determine how much you can invest/risk through lending. Once you know what your beginning capital is you can open a bank account to be used strictly for lending purposes. It is very important that the cash to be lent is available and the deal can be funded/ closed in a timely manner or delays might result in a cancelled loan. Refer the deal to a fellow investor if you are not 100% positive you can wire the funds as soon as all the required paperwork is signed by the Borrower and in compliance.
Set Lending Criterion of what properties/areas are qualifying so you can consider lending. The profit shall cover the risks, taxes and the time incorporated thus it is not a bad idea to set up a minimum loan amount ($75,000 is usually the minimum loan amount set by private investors). Generally, 65 % – 70% loan to value (LTV) ratio is considered reasonable risk. You should always appraise additional expenses that may occur if the Borrower defaults on payments. It is better to start with small, local deals. Once you specify your lending criterion, filtered offers will be submitted to you through a loan proposal package that includes: completed 1003 form, preliminary title report, recent property appraisal (if applicable) or pictures of the property. If interested, you will need to specify the amount of the loan approved, term, interest rate of the borrowing, prepayment penalty (if applicable), others.
Meet with an attorney who will advise you on possible legal pitfalls and develop a loan documents package on your behalf. The loan documents package will include multiple forms and disclosures as: business purpose form, etc. Also, stop by your tax accountant office and discuss how potential interest income will affect your tax return.
Network with the right loan broker. Ask local real estate agents, appraisal professionals, fix and flip entrepreneurs, others for a reliable loan broker who will bring some business in. Also, you can connect with people by attending local real estate fairs and exhibitions; make yourself visible online, etc. A loan broker will not just find the right deal for you but also handle all complexities of the underwriting process. If any judgment, liens, tax default show on the property’s title, the loan broker’s processing team will work together with title officer to ensure property title is cleared so the deal can happen and loan documents are ordered in time.
Stay Active. For tax purposes interest rate received is considered passive income, yet you will need to somehow actively participate in the process. A loan broker will anticipate a quick response from you as private money loans are generally first come/ first serve basis so a timely funding can be achieved. Therefore, establishing an efficient communication (via phone or email) with your partners can assure no opportunities are missed. Additionally, once interest payments are to start beginning, you will need to set up an account with a company that will service the loan payments for you.