- 1 Why Invest In Hard Money Notes?
- 2 Lending to homeowners and homebuyers of primary residences
- 3 Watch out for value fraud or appraised value fraud
- 4 What Are Hard Money Loans?
- 5 What makes funding notes (lending) a unique and worthwhile investment?
- 6 Types of properties to lend on
- 7 Residential Non Owner Occupied Rental Properties
- 8 Owner Occupied Primary Homes
- 9 Rehab Loans For Real Estate Investors
- 10 Types of borrowers to lend to
- 11 What to teach borrowers before closing a loan
- 12 How Much To Lend LTV
- 13 How I got started brokering discounted notes
- 14 Working out a default
Why Invest In Hard Money Notes?
Today I just spoke to a friend and old business associate whom with a few partners managed a small but well organized Hard Money Lending business. We originated several loans they funded for us over the years prior to 2008. For many years before the recession they never had any foreclosures or major defaults. In the great recession they were swamped with foreclosures. They shut down new lending and my friend became a par-time asset manager. They had more than 6 million in their portfolio during the recession. He once told me they funded over 20 million in a single year.
Fast forward to today, July 15, 2014, we were on the phone discussing purchasing one of their notes on a property we like. I asked him now that the dust has settled “How did you guys make out with all of those defaults and foreclosures?” He said “Not considering all the interest we collected, just looking at the principal invested in each note we funded.” On all the loans we ever did we only lost money on four properties we sold. Not a lot just a few thousand dollars.” He went on to say “Our lending formula worked when the worst case scenario actually happened. Our formula is to go look at each property and only lend 60% sometimes 65% of what we think the property is worth” They did not order appraisals by the way. He said “We were lending at 11.99% to 14% Interest with 10 year balloons. Just on the principal we are coming out ahead on the foreclosures because of that lending formula. And we made all of that great interest and continue to do so today.” His partners are retired and are cashing out as the loans are paid off. He went on to say “I think the stock market may not be the way to go right now unless you are looking to gamble just a small amount of money. If my son were asking me what to invest in I would advise him to consider funding hard money notes and avoid the stock market right now.”
Solid Secured Returns
Recently the Dodd-Frank Act regulations have put a scare into many small private mortgage investors who are pulling back on residential loans right now. I believe this will create an even better, more lucrative business, for those that are willing to look past the rumors and learn how to fund loans that meet the government requirements. You can get even better quality loans to invest in with a lower risk of default.
Update: September 7, 2015
Both companies with fund owner occupied loans with their underwriting focus on loan-to-value and the borrower’s ability to repay.
Citadel is a new player that jumped in to fill a need, to fund borrowers banks would not. First National Bank of America has been funding non-prime borrowers for over 50 years. They only had to upgrade their disclosure and document preparation software to comply with the Dodd-Frank Act. FNBA is also the only bank lender I am aware of they will fund section 32 High Cost Mortgages.
Investors that invest wisely in private mortgage notes and reinvest their interest payments watch their principal double about every 8 years or so. New to hard money investors can’t roll over their 401K’s into self-directed IRA’s or turn their stock assets into lend-able cash quick enough when they find out their investment is backed by real estate with about 40% equity remaining behind a first mortgage note they could fund.
Today many retired individuals, real estate investors, hedge funds, and small businesses are thriving on Hard Money Lending.
Some individuals are looking to create tax-free future wealth by funding private mortgages with a self-directed Roth IRA.
Create Dependable Income
Retired and early retired folks are looking to create a dependable stream of income from their savings. They live on the interest and preserve the principal by lending it out over and over again when payoffs are received. Imagine having just a $500,000 retirement savings it’s possible to earn $50,000 or more in annual income.
I recently spoke to a private lender in the business since 1990. He started out with one million from the sale of a family business. He was a real estate investor who decided to use private lending as a way to earn income and build wealth simultaneously. He used leverage with his million he got credit lines which increased his loan portfolio in the first 15 years. In 2005 he was able to stop using the credit lines and only lend his own money. Today his lending portfolio is in the 40 million dollar range.
For us it has mostly been the brokerage and lending side of the business. The real estate market crash (correction) in 2008 increased demand from borrowers for loans since the banks were lending to fewer borrowers with greater restrictions. We have worked harder than ever before to meet local and statewide private mortgage investors that want to deploy money in Florida to fund requests from borrowers throughout the state. Chuck’s brokerage firm is located in sunny Tampa, Florida. More information can be found on the web at http://c-mortgage.com/investors.
At the end of the book I’ll include a link to a special lending resource page along with some links to national hard money rehab and small commercial lenders. You’ll also find some case study examples from loans that have been put together and closed. This information will be invaluable to you if you decide to use it. I am willing to bet this is the reason you purchased this book.
Many of you reading this book are either considering Lending, borrowing or even brokering private mortgage money. Smart borrowers will surely check this guide out so they will be able to get better loans for themselves. From a borrowers stand point there is not too much that could go wrong. You need to understand the fees associated with a private mortgage loan. You may want to meet the investor funding the loan just to make sure they are someone you would like to deal with while you have the loan outstanding. Recently we had an investor ask a borrower if he could use their vacation property that he was funding the loan on.
Lending to homeowners and homebuyers of primary residences
Note: Most hard money loans on principal residences are considered “high cost loans” or Section 32 loans. Under HOEPA laws owner occupied loans need to be treated differently than non-owner occupied real estate loans. Effective January 10, 2014 balloons and prepayment fees will no longer be allowed on high cost mortgages secured by principal residences. Purchase money mortgages will no longer be exempt and will be considered covered under the new rules. By the way HOEPA stands for Home Ownership and Equity Protection Act. I’ll provide links to much more detailed info on the rules for making private mortgage loans in a special resource section later in this book. To confuse you a little more Higher Priced Mortgage Loans or HPML fall between conventional Qualified Mortgages (QM) and high cost mortgage loans. That’s three different categories, each with their own rules, of first mortgages on principal residences. The good news in all of this is cash-out and high cost loans are not being eliminated they just have to be disclosed to the borrower properly. It’s always been my experience dealing with local regulators that if you are following the rules then you have nothing to worry about other than where to find the next loan to fund.
I have seen prepayment penalties that last the life of the loan except for the last payment on seller financed private mortgages and on many institutional commercial loans among other things. We also see some savvy mortgage note investors that require a share of the equity or profits in addition to their interest payments. I have to recommend just staying away from this type of deal altogether unless you are really partnering with real estate investors. The key to long term success with hard money lending is to be firm and fair.
I regularly hear borrowers’ stories about how they got taken on a private note deal – mostly sellers holding paper or a contract back on owner financed properties or worse fraudulent investors taking advantage in masses selling many homes each month with wrap around notes. Eventually the deals start to unravel due to payments not being made on the wrapped underlying bank notes. We don’t hear of problems with hard money loans.
There are actually a lot of newer laws that may eventually drive most regular hard money folks to get licensed or work with mortgage brokers. Most of the laws still allow a few seller-financed deals a year by unlicensed investors, but if your operation looks more like a business than personal investments you may be breaking some new laws being passed nationwide. If you don’t have a license you should never formally advertise you are a lender or broker especially for residential properties.
My personal opinion is to not worry when you are working with good mortgage brokers as an individual note investor. We live in a huge marketplace but the hard money lending circles are really very small. It should not take long to figure out who the “good guys” are.
Hedge funds and others regulated by the SEC are / have been usually exempt from state mortgage licensing when they are not originating or servicing residential notes. Currently many large investment funds are are investing directly in deeply discounted defaulted mortgage note portfolios or actual REO portfolios of foreclosed unsold homes. Recently I have seen hedge funds making commercial loan offers to real estate investors with large portfolios in order to allow them to purchase more rental units.
Here is how we explain the loans, prepayment penalties and balloons to borrowers
Most private mortgages made prior to January 10, 2014 have prepayment penalties and balloons so there is no reason not to accept a loan with them as long as the Prepayment fee falls off after a short period of time and you do not plan to pay off the entire loan within the prepayment penalty time frame.
For example let’s say you are approved for a loan with 12% interest only payments, a three year balloon and one year prepayment fee. If you are planning to fix and sell within the first year then you do not want to accept these terms. It’s in your best interest to go back and ask for a penalty that expires within two or three months. This way you can pay off the loan after the prepayment penalty expires. The balloons work the same way. If you are offered a loan with a two year balloon and you plan to rent the home out for two years prior to selling then you’ll have to come up with the lump sum of cash to pay the loan off prior to selling. In this case you’ll want to go back and ask for a three year balloon or a full term loan (fully amortizing) without a balloon if you can find it and if you can afford the higher monthly payments in the case of shorter amortizations.
Watch out for value fraud or appraised value fraud
As a lender your number one enemy is fraud and incompetence among the brokers and real estate investors that refer you loans to fund. Always look at the property either yourself or someone you hire on your own who is not affiliated with the transaction, buyer, broker or any other related party. All of the files I have seen with major problems have the same thing in common the lender did not view the property but relied solely on an affiliated appraiser or worse interested parties opinion of value.
Most Fraud is harder to detect outside of inflated value fraud. The good news is you really don’t have to worry about other types since they will likely be detected by a good title agency during their due diligence of the properties title and if not it should covered by your lenders title insurance policy (loan policy).
I have seen borrowers sign multiple loans in the same day without any of the lenders knowing about the other loans. Fortunately this liability ultimately falls on the title insurance company or attorney who provides lender’s title insurance to protect against title defects. There should be no exceptions on the title commitment except current years taxes not yet due and recorded property easements. Knowing this happens sometimes, it might be a good idea to have the title company or attorney providing the coverage and handling the closing do a last minute title update prior to the closing. Make sure they are recording your documents right away.
Busy firms have been known to sit on documents for weeks after the closing. This brings us to the second most common problem, private lenders making informal hard money loans to real estate investors or friends and family without title insurance and proper documentation.
Each loan file you fund should contain at least:
Determination of value – after all this is the reason you are willing to fund the loan
Lender’s Title insurance commitment – followed up by a title insurance loan policy issued after closing
Original Signed Note – this usually does not get recorded, you should keep the original in a safe place. Original notes are very important if you need to enforce, transfer or sell your note.
Assignment of leases, rents and profits – this will allow you to step in and take the rents or to take over a business if making a commercial loan in the event you have a default.
Hazard insurance, flood insurance too, if in a flood zone. Don’t forget to check for flood zone prior to funding. Call an insurance agent or have your broker run one through his credit report provider
HUD-1 closing statement signed by all parties
Flood elevation certificate if property is in a flood zone
Borrower signed loan disclosures if making homeowner loans
Your life will be much easier if you also have a complete copy of the broker’s file to include: 1003 Loan application, all loan and fee disclosures signed by the borrower, photo id’s and copies of borrower social security cards, cell phone and nearest relative phone numbers and addresses. I’ll share new processing and document procedures in the HOEPA resources or rules section for loans secured by principal residences.
Contrary to popular belief lending out hard money is very easy and will take very little time and effort on your part. You don’t need millions to make a nice livable cash flow lending out money either. I talked with an investor today who is bringing in $4000 a month on $400,000 lent out.
I’ll let you know about a servicing company that will do all the heavy lifting collecting the payments, reporting, and accounting. Most servicing companies are very expensive and want a share of your loans interest to manage. We have sourced a loan servicing firm that caters to the small note investor and only charges a small monthly fee after loan setup. They will collect payments on any kind of contracts with regular payments between parties.
In 20 years I have only met two hard money investors that make use of a “business system” to fund and service their transactions. Most private mortgage investors deal with the borrowers, collection, and accounting on all of their loans themselves. This will take some time and effort depending on the number of loans in your portfolio. I highly recommend using a payment servicing company to collect the payments and send out statements if you are funding more than a few loans at any given time.
What Are Hard Money Loans?
These types of Mortgages or trust deeds are secured in first position by real estate. The mortgage is the recorded lien (security) and the promissory note (promise to repay) contains the terms of the loan, payments, interest rate, balloon payments, etc.
OK so that last paragraph described a mortgage and note. A Hard Money mortgage is one that is _______ because there is a large amount of equity or downpayment on the real estate collateral offered as an enticement for funding the loan. These types of notes offer a high rate of return, around 12% is typical.
What makes funding notes (lending) a unique and worthwhile investment?
Why do I love private mortgage note investing and I think you will too? It’s a way to invest in real estate without having to deal with tenants and their broken toilets.
If you do it right there is a large amount of equity remaining in the subject property over and above your note investment. We recommend lending no more than 60% of a good residential or commercial property’s value or purchase price whichever is lower. You are leaving 40% free and clear equity just in case the borrower defaults and you have to foreclose or get a deed-in-lieu of foreclosure. This should also leave plenty of room if you make a mistake on the value or the market changes.
Some property types like condos which have high carrying costs you may want to avoid or be more conservative by lending less. Maybe only 50% of market value on some property types.
Many private lenders will go to 70% loan-to-value (LTV) others try and stay below 50% LTV. A rapid drop in property values, like what we experienced after (inflated) values peaked in 2006, taught many of us that 70% may not always leave you enough equity left over if you have to foreclose and quickly sell the property securing your note after a default.
Especially if you have to deal with foreclosures due to a wide spread fear after a sharp decline in values or mistakes in valuations or property investors with buyers’ remorse.
Types of properties to lend on
Residential single family loans are the most common types of loans you are likely to come across. Non owner occupied residential are the easiest to fund with few regulations to worry about. Non owner occupied and small commercial loans are also what most other individuals and small hard money lenders and brokers are going after as well.
Requests from homeowners are much more common and easier to find opportunities with low loan to values and clean properties. You’ll have to do plenty of research on the CFPB website (check the resources section for links) and get with a broker and/or attorney that knows how to properly disclose and prepare documents for these types of loans. Unfortunately most individual investors don’t seem too interested in working with homeowners or home purchasers anymore due to the regulations.
Rental property investors with lots of free and clear properties in their portfolio and small commercial loans are the next best loans to go after. Or maybe they are the best considering the restrictions on owner occupied lending. Loans on groups of rental properties below $500,000 will be a good niche to fill.
Residential Non Owner Occupied Rental Properties
The first group – straight equity loans are considered by most to be less risky. Many note investors like these best when funded on non-homestead income property because they are very simple to make, you can step in a take the rents to replace your lost payments in the case of borrower default prior to the completion of foreclosure you’ll need to request this with the court when you file the default paperwork for foreclosure. This group of loans are what most private mortgage investors focus on along with the non owner occupied purchase money notes, because they are exempt from most consumer protection laws aimed at cash out home equity loans made to homeowners.
Owner Occupied Primary Homes
There are fewer note investors that are willing to fund homeowner loans because of the consumer protection laws and keeping in compliance with them. However in my opinion these are some of the very best quality loans you can make. You’ll want to make sure you find and have an attorney to review the files for compliance and proper borrower disclosure prior to funding any loan where the borrower lives in the property (homestead filed or not) Primary home purchase loans are no longer exempt. This attorney should also be willing and able to handle the foreclosure if you ever have to file one. The reason I like these loans is that they can have a much lower loan to value ratio, meaning more equity. Most people take better care of the home they live in physically and financially.
Rehab Loans For Real Estate Investors
Next real estate investor rehab loans. In my opinion you should only do these if you have experience fixing and selling real estate. These can be more profitable because investors will pay more since they are using your money to make money for themselves. You’ll want to be cautions and make sure not to make informal loans without recorded documents and title insurance. This type of loan is usually based on what the property will appraise for when repairs are completed making it very easy to inflate the value and underestimate the cost to repair the property.
Most real estate investors are honest individuals trying to make a living. There are a few that are highly skilled and will take control of the arrangements and paperwork leaving you just to put up the money. While this sounds very appealing and convenient you always want to verify everything and view the property before making a loan. You want to make sure your attorney or title agent prepares the documents and closing or pre-closing review of the transaction and all documents so that your interests are protected and to make it impossible for the borrower to default without recourse.
Types of borrowers to lend to
There are three types of Hard Money loans with very different borrowers. The first is the standard hard equity mortgage where you are lending based almost exclusively on the value and condition of the non-homestead income property. These can be residential or commercial.
The second classification is the homeowner loan, equity out on a homestead property.
The third group is the real estate investor rehab loan – you should only do these if you have experience fixing and selling real estate.
There is a fourth, the purchase loan for a homestead property, but because these are no longer exempt they can be treated the same as standard equity type of homeowner loan with the borrower putting down 30-40% at closing from their own funds.
What to teach borrowers before closing a loan
A good borrower will learn and understand the terms and what is expected of them prior to closing specifically balloon payments and prepayment penalties need to be explained to them. Balloons are a great way to make shorter term loans and increase the investor’s yield. However for borrowers, only concerned about getting a loan, not paying attention to the terms, an unexpected balloon payment can cause a borrower to lose property even after making all payments except for that last balloon payment on-time!
We always encourage our investor friends to work with and be fair to loyal borrowers who have always made their payments and have kept the taxes and insurance up to date. A prepayment penalty clause should also be explained. “This prepayment fee will be added on to your payoff figure and you will be required to pay it in addition to the balance owed on the loan if you pay the loan off too early”.
Recently I have talked to lots of investors or would be investors being scared off by the Dodd-Frank act rules that took effect. Some of the public are critical of hard money lenders and brokers because these loans are expensive when unfairly compared to Conventional loans that your borrowers cannot qualify for. I can tell you being a hard money lender or private mortgage investor is a good thing and you should “feel good”. You truly are helping people who really appreciate and need your loans. Many borrowers would be forced to sell their properties or to pay with all cash since they do not qualify for conventional or FHA financing. The likelihood of them coming up with 60% more cash may keep them from owning.
Note: FHA loans are extremely expensive due the high mortgage insurance premiums being charged today. On a $100,000 loan the Upfront MIP is $1750 and the monthly is an additional $112.50 every month.
Hopefully you would never make a private mortgage with just 3.5% down…I just wanted to illustrate that FHA loans are by no means inexpensive to the consumer, they are a needed option for people with credit issues and or low down payments.
Pro tip: Use FHA mortgage brokers to refinance your hard money loans on principal residences if you want to get paid off after a couple of years. Many borrowers will qualify and may not know it. The mortgage broker will gladly make contact with the borrower if you ask them to by referral.
Pricing Your Loans
Private lenders have all kinds of personal strategies which I find very interesting. Pricing can play a role on how quickly you can deploy your funds and how quickly they are paid off. Then you have to find new loans (notes) to fund.
Lending your money at 12% interest and 60% of the purchase price or appraised value (the lower of the two)offers a great return with lots of security and you can get your money out at a good pace on good properties.
Some lenders I know will lend at a 10% interest rate for 30 year terms and their money goes out faster and stays out longer.
Generally speaking loans priced between 10% and 12% are refinanced within one to three years. A self employed borrower that borrows at 10% may keep a loan out much longer since he may not want to prove a taxable income in order to qualify for a bank loan. Someone with bad credit that has a job and can prove their income is likely to refinance and pay you off as soon as they can get to where they will qualify for a bank loan at a much lower interest rate.
These are things you will learn over time on your own without this book but hopefully sharing my experiences here will help you choose which loans fit your strategy and long term goals.
Others try and get 15% with some up front points this pricing typically only works with short term rehab (construction) loans. These loans can be risky if you are not prepared to take over a rehab gone bad and get it completed and sold. They are also more work since you should be inspecting the progress of repairs and construction frequently and releasing funds that were held back for the repairs.
If you do ever have a default you will not only be able to get the pledged collateral you also can get a monetary judgment against the borrower. This is one small but very important thing I love about hard money note investing especially when compared to unsecured investments like stocks or partnerships. If you get personal guarantees you have two ways to collect your principal, expenses, interest, and fees due. You can get the property and income it generates and if that’s not enough you have the option of collecting the monies due personally from the individual(s) who signed the note by getting a judgment.
How Much To Lend LTV
Determine value looking at similar recent sales $140,000 on this example
- Deduct one years interest payments
- 10% selling costs
- 5% repair costs
- $5000 for foreclosure legal costs
- On a $100,000 loan
- 12,000 allowance for one years interest payments
- 10,000 allowance for selling costs
- 5,000 allowance for repair costs
- 5,000 allowance for legal costs
This all comes to $32,000 – which leaves 108,000. Then he likes a margin for error in case he is off on values and a profit margin for his time having to deal with a foreclosure.
Loan offer on this file that he did not like much was $75,000. It’s easier just pass on what you don’t like or stick to the simple 60% formula which would have been $81,000.
How I got started brokering discounted notes
I started buying and selling private mortgage notes in the early 90’s when I was just 19 years old. Why? Because I was brand new to the mortgage broker business and no one else wanted to make cold calls to past home sellers that held private mortgages then offer to buy so the not holder could get cash now.
The senior brokers gave me a box with a huge layer of dust on top filled with 3 x 5 index cards that someone scribbled details about a note holder from the courthouse. My job was to call and make an offer to buy the note so the note holder could get CASH NOW! Did those all caps get your attention like those commercials with a catchy song on TV to buy cash flows? So the former home seller would not have to collect the proceeds from their home sale a little each month.
Once the index cards were exhausted we purchased lists that were generated from public records data of private mortgage holders. We did direct mail followed up with phone calls to find people who would sell their notes at a discount.
This was a great learning experience for me. I made an excel spreadsheet that would calculate the amount I could pay and make a XX% spread of the note purchase price vs what we could sell the note to a bank or private investor. We were able to give a solid quote instantly while on the phone with a potential seller. Most others would have to call the prospect back and use a fill in the blank form with their HP 12C calculator. I could make a quote and start the negotiating right away on the first call without putting them on hold or hanging up.
It took hundreds of calls just to get a few deals closed. The note trading business became over populated with note buyers since it was unregulated and people started selling courses and seminars on how to find and resell or table fund existing private mortgage notes. Typically these were seller carry backs from the sale of a property with owner financing.
When I got started in the early 90’s until 2006 there was not as great of a need for private investor capital except for, investor flip property, odd properties and some commercial loans, finance companies would not accept. Borrowers could get approved with equity bank loans, and then later, sub-prime loans.
Before sub-prime loans banks and finance companies funded hard equity loans. The loans were underwritten based on credit grade and income. The lower the credit grade the lower the loan-to-value (LTV). If the borrower was self-employed with limited proof of taxable income the LTV was lowered and alternate documents, like bank statements could be used instead of tax returns. The maximum LTV’s were generally 70% or less in the beginning.
Once high-loan-to-value sub-prime lending and 125% 2nd mortgages hit the market borrowers could get whatever loans they wanted on real estate.
Many banks funded equity loans very similar to what hard money loans are today up until around 2006-2007. Prior to this time most hard money loans were commercial real estate loans on unique non bankable type properties or residential loans made to real estate rehab and flip investors.
Since then the demand for private money has grown rapidly and even become main stream recently with many borrowers unable to obtain bank financing.
The demand for privately funded hard money has been stronger than ever.
Working out a default
One of the best lessons I have learned in my 20 something years in the lending and real estate investing businesses.
Work It Out
Coming to a “work out agreement” is always better than keeping someone’s payments (rent collected) while they (the lender / hard money note investor) have to pay the foreclosure costs. In the end the hard money lender / note investor will end up with either the house (collateral) or a loan payoff. Yes right now in Florida this could take a year.
Offer up a taking deed for a little walking away money – assuming they invested additional monies in the property, if not talk them into giving up the deed and sell the property. The borrower will be doing right by their tenants and you as the lender.
As a lender the most common issue or technical default you will face are balloon payments (notes due). For this “work out” example I’ll use an example put together about 4 years ago that is just being worked out now because the balloon became due last year AND the lender wants the principal balance now paid in full OR a principal reduction of 20% to reduce the outstanding principal balance. Another good workout to extend balloons by the way always ask for a principal payment if the borrower can come up with it.
The borrower is not in a position to pay the loan in full or even come up with the principal reduction payment to extend the term for another two years. [a very good idea and offer on this private lender by the way]. The borrower has an additional $20,000 invested in repairs of the collateral. So the numbers look like this total cost investment on the borrower’s part is about 70K the lender funded 50K four years ago. The borrower paid monthly interest only payments, all on time of 12% in the first year, 11% in year 2, and 10% in years three and four.
year one interest $6000 paid $500 monthly – rents were 950 note property was vacant most of this time
year two interest $5500 paid $458.33 monthly – rents were 850 – vacant many months of year two also
year three $5000 paid $416.66 monthly rents were 750 bad rental market & mismanagement
year four $5000 paid $416.66 monthly rents were 750 finally rented & lender wants payoff or deed and walk away
In this case it was a fair deal for the lender to offer up after deed for $0, or 10K principal payment – these were the lender’s firm demands after the balloon was due.
Borrower felt they should get something back for the 20K invested and that fact that there was an A+ tenant currently in the property paying rent on-time.
After some tough negotiating they settled on five thousand dollars as a “fair” settlement for the deed to the rental property. It may be a tough pill to swallow having to pay someone a little extra for a deed but it’s much easier that to hassle with a foreclosure.
Most work-outs allow the lender to keep the asset generating a return and avoid a foreclosure instead of not receiving payments for some time during a foreclosure process.
Although in many cases the lender can enforce their assignment of leases, rents and profits. By doing this the court appoints a receiver to collect rents for the lender during the foreclosure process.
Lender gets the collateral (he would have eventually anyway) with an additional outlay of 5K to make it happen fast
lender “invests” 50K by funding a hard money loan on a property believed to be worth about 80K at the time.
Lender collects $21,500 monthly interest payments from borrower from 2008 thru 10/2012 – $50,416.16 balloon payment due 11/2012 lender refuses to extend wants payoff or deed.
Lender pays additional 5K for deed 11/2012 – this reduces his “profit” / interest by $5,000, he saves up to a year of time and all of the foreclosure costs about 2K. –– Always check for past due real estate taxes and do a title search for borrower judgments that could attach. If there are judgments that affect title use this in your favor and get the deed without paying but don’t record it. Take control of the property and foreclose or do a suit for quiet title to remove the liens. Always get the property back to work and earning income as soon as possible, foreclosures and title issues can take some time it would be a shame to let the borrower continue to collect rents now due you or worse let a property sit vacant.
Lender has house worth more than 55K now, rented for $750 to an good tenant. – Other costs and pitfalls to hard money lending and balloons… lender has to pay three years taxes about 6K and a $500 lien.
Total investment on lenders part 50K, plus 5K for deed, plus 6.5K for unpaid taxes and assessments.
Property produces $9000 per year gross. $7150 net after taxes and insurance.
A 12% yield on $61,500 is $7380 per year, so all lender has to do is increase the rent by 20 bucks a month and he maintains his best return on this deal. Even though he “lost” 11.5K taking the house back he gained $334 in cash flow (179.67 net). Enough to hire a property manager to deal with the tenants and toilets.
The borrower lost 15K in cash but did collect some rents over the years and probably learned a valuable lesson.
This is a great real life example of a default (balloon due) being resolved so the lender comes out ahead and the borrower walks away with a little something.
Had the borrower not run into trouble with the balloon payment or a cash resale of the property the lender would have received the $50,416.16 payoff and earned $18,000 net in 36 monthly payments of $500.
Not only was that a great example of a work out but it is also a good case study for your run of the mill average hard money investment and loan with the balloon default for example.
In hindsight the “investor” purchase price and/or the loan amount on this property should have been lower in the $35,000 range based on a conservative value of $55,000. Or the lender should have required a $20,000 down payment.
Now had he not spent any of the return he would have had $68,000 to fund another deal, now he would be collecting $680 in monthly interest payments for the next three to ten years, depending on the term of the new investment / loan.
He is still getting the exact same money but now holds an appreciating asset that puts $595.83 in net cash flow each month.
Either way the Smart Hard Money Lender comes out on top! What more could you ask for from your real estate note investment capital? On time payments and no balloon payoff issues is what we always shoot for.