Private loans are not without risk.
In 2009, Lloyd Charton opened his door to a friendly neighbor. Dan J. Harkey knew all about
him. He congratulated him on his retirement, asked him about an upcoming vacation and
incidentally mentioned that his hard money lending company, Point Center Financial Inc., raised
money from private investors and doled it to real-estate developers.
This was Charton’s introduction to the ‘shadow world’ of hard money and over the next five years Charton invested more than $1.2 million in it profiting for a time.
The market flipped and Charton lost his property as well as millions of dollars and sued Harkey.
The same can happen to you. Or not. Depending on your precautions.
The shadow world of shadow dealers
Not for naught did former Pimco economist Paul McCulley call private money lenders and their cousins (anyone who fell into the private, non-tariff lending category) ‘shadow bankers’ back in the economically harsh year of 2007 when nontraditional lenders twisted themselves into pretzels to get clients. Hard money lending – otherwise called bridge or private money lending – started with the Great Depression when private individuals doled their funds to people who were rejected by the banks. Their selling point was that they would consider property as opposed to work history or FICO score. Unfortunately, too many of these lenders succeeded in sucking in misinformed people who found themselves at the end of a string of infinite debt and who lost their homes as a result of default. Today, we have government and consumer protection laws that restrict this but here and again incidents such as those of Charton make the news.
Question: How to protect you. Or put another way how to minimize the risk in obtaining private loans?
There are various options.
Firstly, investigate all precedents of the hard money lender. Considerations include: What is his website like? Do his online conditions repeat his verbal ones or do they differ in one or more aspects? Are his guidelines consistent or do they contradict? Do you see gaps – any hidden conditions? What’s his social media like? Of course, the lender doesn’t need a striking Twitter, or Facebook page and these may even – and with good sense – be deemed superficial and unnecessary but what about his LinkedIn image? Is this professional and resonant with his career? How about his references? What do his clients say?
And talking about clients, it can help you to ask him whether he has offered similar loans to
others. Likely, he won’t give you names but you can at least evaluate his experience. Other things to look for are his qualifications. Decent hard money lenders in California should show you their state licensures. Many are also licensed through the National Mortgage Licensing System (NMLS). Borrowers should verify the lenders license through the NMLS in order to prevent problems at closing, as many states require the lender’s license number to be listed on the loan documents.
Research on the internet or at the county court house to see how many properties that lender or investor has foreclosed upon. Avoid lenders with a large number of foreclosures. High foreclosure rates could signal unscrupulous lending practices or at least a very low threshold of patience for delinquent payments.
The consumer bureau may run more on him.
This is your money that you’re talking about. You may want to dip him under the most thorough review that you can. After all, he’ll do the same to you.
Finally, don’t get a private hard money loan if you can’t afford it. This seems commonsensical but you may be surprised at the amount of people who fall into this pit! Too many borrowers believe that the future is better than the present and will right itself for them. Only: for many it doesn’t.
Some hard money lenders do trap people into thinking that ‘things will work out’. Maybe. Maybe not. How is your income at the moment? Are you making enough to afford repayment? And do you have a safe pocket for emergencies? What if the market turns – will you be able to grope your way out? Are you convinced that the property is worth the risk? Have you had it evaluated by an expert?
Unfortunately, only those with clinking pockets can usually afford the high costs of hard money loans. Rarely those with no money, poor FICO and lamentable or nil experience in real estate. Wish it were otherwise and hope you fall into that category. You may want to take a drug-free hard look at that account of yours before you find yourself tipping from skewer into flame.
Borrowers are also less apt to be sucked in by dishonest traders and more apt to succeed when they approach their lender with wrapped-up data about their property. This includes but is not limited to: an executed contract with the seller of the property, a budget and preferably a bid for the repairs needed, comparables showing the After Repair Value (ARV) of the property, a survey (land only), and an appraisal. All too often I have seen hard money lenders advise clients to approach this as a business deal or interview. This may sound intimidating but it is not far from wrong. After all, this may be your once-in-a-years chance to persuade a prospective lender that you have an investment that he would delight in. You are selling him something. Your property is profitable and once repaired could bring him millions in cash. Invert it that way and you may feel more confident. You are less the beggar than the giver.
In short, hard money loans are not without risk. You can minimize them with a little diligence. Hopefully, you’ll profit from your pains.