How do I become a private money lender?
- Decide where the funds will come from.
- Find an investment opportunity.
- Conduct your due diligence on the investment and the borrower.
- Determine the loan terms.
- Finalize the paperwork.
- Begin collecting.
Decide where the funds will come from
If you're just getting started as a private money lender, you'll first need to decide where the funds will be coming from and how much you are willing to lend. You may have cash readily available in a savings account that you can wire or write a check for when the time comes. Or you may need to convert a traditional IRA or 401k plan into a self-directed IRA plan, which allows individuals to participate in private money lending for real estate.
Once your funds are in the proper account and available for lending, determine how much you are willing to loan at any one time. Make sure that you are not lending your entire savings and that you are diversifying your funds across different investment opportunities to mitigate risk.
Find an investment property
Once you've established where the funds are coming from, and how much you are willing to lend, you will want to identify an investment opportunity to lend on. A great way to find potential investors to work with is attending local investment associations. Talk with colleagues, friends, or family members who are active in real estate and discuss that you offer private financing if and when the time feels appropriate.
It's important to note that investors looking for private money should not explicitly solicit their need for financing if they are not a personal friend or colleague unless they have a private placement memorandum (PPM) and have filed for the proper regulations. Some investors do not follow the proper guidelines and regulations relating to raising private money, so as you get started, it's ideal to start with people you know and trust or ensure you are working with individuals who have gone through the proper steps to work with you as a private lender.
Conduct your due diligence on the investment and the borrower
Knowing how to analyze and review a real estate investment is imperative, even if you are acting solely as the lender. The investor may have a decent track record, but it's your job to vet the borrower and the investment property.
Confirm the information the investor provides, and do your homework on the individual themselves. Specifically:
- Have they failed to make a payment on other debt obligations?
- Have they filed for bankruptcy in the past?
- Are they involved in any past or active litigation relating to their investing?
You can research the borrower for a fee, paying for things like a background check or credit report, or simply research them online for free.
But before lending money, be confident that the borrower and the investment are worthwhile.
Determine the loan terms
The next step is to determine the terms of the loan. You can offer the same terms for each loan you create, or you can negotiate based on the investor and investment opportunity. Some lenders require a down payment, which is a percentage of the property's purchase price, while others do not. It's up to lender and borrower to establish the following for the loan:
- Interest rate.
- Interest type (adjustable or fixed).
- Length of loan (time for repayment).
- Closing costs or fees (like points).
- Whether there is a balloon.
Finalize the paperwork
While it's not required, it is best practice to have a licensed attorney draft or review any paperwork relating to private money loans. This ensures both parties are adequately protected and the proper legal terms were included in the event of default. The lenders should always keep the original note and mortgage or security instrument in their possession, providing a copy to the borrower. Depending on the state, if the borrower defaults and foreclosure action is pursued, the original note and mortgage must be produced in court in order to foreclose.
Now the lender can start collecting! Keep good records of the payments the borrower has made, including copies of checks or bank statements or an Excel spreadsheet, to confirm the proper principal and interest was accounted for with each payment. This reduces your risk if the borrower does default while also making the loan marketable if you ever want or need to sell on the secondary market.
Private money lending in summary
Becoming a private money lender is not for everyone. It can be a good optionIf you have idle money or want to grow your portfolio while investing passively in real estate, but it must be done properly. Make sure you stay informed on real estate investing strategies, the market, and lending practices and that your risk tolerance aligns with this form of investing.