(This is part 2 of a 3 part series on “Becoming Your Own Bank”)
It’s Just Like Football
Decide how much “skin in the game” you want from the borrower – how much do they have to put down? Several hard money lenders I know require on 10-20%, but if your borrower has good credit, and since you will have strong equity in the property, this is a personal decision. We often match make 100% financing loans, even in today’s market, if the house purchases low enough compared to the valuation, there is not much risk to the lender, who can always sell at a profit in the unlikely case they need to take the house back.
Structuring the Loan
You, a title company, and/or an attorney can set the loan up fairly easily, and the rules are… you make the rules. Check out last week’s column first, to make sure you have answered all your basic questions first. Then you can decide how the loan should be structured, and what payment schedule will suit you and your borrower best.
Use your title company or attorney to guide you on what is standard in the state you are in, and then decide whether you want to make it easier on the buyer than the banks would, like offering to fund at a slightly lower credit score, or making interest-only payments on the loan to keep the borrower’s payments more reasonable.
There are myriad choices as to what kind of loans you will make, and you can choose not to bother with rehab at all, but it’s a great way to have a regular source of customers, since rehab is something the banks are even more scared of than other types of real estate loans these days.
If you do have rehab involved with the property, always get an inspector to look at the property and determine that there are no “gotchas” like vital repairs being needed that no one told you about. The objective is to limit your borrower’s chances of walking away from the loan, and make sure you are getting what they tell you.
But if the property includes rehab, you will want several inspections (these costs can be passed on to the borrower as part of the loan). Get a baseline inspection up front, and have your inspector compare it to the contractor’s bid. Then only pay the contractor on approved “draws.” This means they have to submit a definite request for payment – like, “Kitchen complete, $10,000”, not, “Kitchen 50% complete, $5000” - after all, 50% is subjective, but done is done. This will ensure a smooth process on the rehab, and allow you to keep tabs on it even if you are across the country.
Once your loan is in place, consider using a loan servicing company to fulfill the payment monthly. They will only charge a small percentage of the loan fee each month (you can build this cost in, too, if you like) and will calculate the interest due and bill the borrower monthly. One thing to remember, banks typically use 360 days, not 365 days, as a basis for interest calculation, and you may want to do the same just to be fair.