Rules to Follow with Private Money Lending

Private money lending involves YOU as the private money lender and another person or organization as the borrower. When you are a private money lender for real estate investment deals, you are protected by the loan-to-value ratio and the fact that you will own the house if the investor walks. Even so, follow these rules to make sure you are completely protected:

  • Make sure the property has INSTANT EQUITY. Look for lots of room between value and price. To protect your investment money, avoid risking it on a property priced at or above the market value; it is not worth the risk. Choose properties that can easily be resold.
  • Have a clear contract and plan of action. Put everything involved in the deal on the loan papers. If the borrower is required to put a certain amount of the loan into repairing the property, include these requirements on the loan documents and specify the date the work is to be completed. To protect yourself in case the borrower fails to complete the work, include such ramifications as a late charge, spike in interest rate, or even calling the loan due and payable. If the borrower is not able to come up with the whole amount, you can foreclose and take the property back, citing specific performance. The point is, you must keep excellent documentation of who is supposed to do what in the transaction, and be sure it is clear and admissible in court. You want it clear enough that you can show a judge and they will understand exactly what was agreed to.
  • Don’t let your emotions get in the way. The only numbers that matter are the comparable sales, comparable listings, and the amount of money you are making on the deal. Don’t let attachments to the house or the borrowers get you into financial trouble.
  • Always use an escrow officer. We cannot stress this enough. For the couple of hundred dollars it will cost you, not only will you have a professional handling the closing of your investment, but also you will have title insurance. That way, you can be sure that the property you are buying has a clean title, does not have past liens or encumbrances, and that all the paperwork is structured exactly how you and the borrower have agreed upon.
  • Always use a neutral party to keep track of payments made. An escrow company usually has the option of having all payments made by the borrower go into an escrow account that accumulates or is released to you on a set schedule, whichever you prefer. This usually costs under $5 per month and it keeps everybody on the same page.
  • Review everything with an attorney. Make sure you review everything – even this article – with an attorney before making any financial decisions. Laws and restrictions are changing all the time, so make sure you get the latest information with a qualified local attorney.

Have other suggestions to keep yourself protected? Include them in the comments below!

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