Private Money Lending

[Abe]

Back in February I started this thread about private money lending. Now that I have some experience, I thought I'd report back for anyone who's looking for fixed income outside of the bond market.

I've made two loans and about to do a third. Here are the basics:

1. First borrower had credit issues from a short sale of a vacation property. He bought a newer home in my area, put down about 40% cash down payment and borrowed the rest from me at 8.5%. Our letter of intent stated he needed to make automated payments via a processor. Thus far, every single payment has arrived a few days before the first of the month. So far so good.

2. Second borrower also bought a newer home with about 40% down payment. Interest rate to me is 9.5%. Same deal as the first borrower (all payments received) except they pay on the 4th instead of the 1st.

3. Third deal is about to close. The home is older, but still is valued at more than the buyer is paying, and they're putting down 33%. They'll pay 10% interest and 3/4 of a point at closing.

In all cases, the broker and I checked their credit, their employment, their taxes and met with them personally. We also checked the homes, got inspections, etc. In each case, the borrowers were "near bankable" meaning they all had good credit but had done a strategic short sale at some point when their homes went deeply underwater.

Overall, I'm quite happy with this new found investment class. Each home has plenty of equity so should I ever need to foreclose I should be able to get my money back. All the payments have arrived like clock work, and I get the chance to meet each borrower, look them in the eye, and let them know that late payments will lead to them losing their home. Unless home values tumble tremendously from here, then I've definitely become a fan of hard money lending for my fixed income portfolio.

RenoJay: I'm glad this is working out for you. I would still recommend that you get the book "Invest In Debt", by Jimmy Napier and the calculator that I mentioned in an earlier post on this thread. I believe that if you got the book and calculator and learned how to use it from the book, it would make you a lot more money than they cost. It did for me. Good luck.

[RenoJay]

Thanks for reminding me. Yes, I'll pick up the book and the calculator.

[ryuns]

Thanks for following up. It's always great to see updates about things like this.

I had a couple thoughts.
First, wow these people must really like home ownership to pay those kind of interest rates. Everything about the loan makes total sense--there are probably a lot of people who made strategic defaults on loans in non-recourse states, but were otherwise current on payments, who now can't get traditional finance. That means a good deal for you, but it doesn't sound like a good deal for them!

Second, do you have any experience with or opinion on other types of "private money lending"? Specifically, I'm thinking of P2P lending, e.g., Lending Club. It doesn't offer anything in the way of collateral, but it does offer much more diversification.

[Abe]

Thanks for following up. It's always great to see updates about things like this.

I had a couple thoughts.
First, wow these people must really like home ownership to pay those kind of interest rates. Everything about the loan makes total sense--there are probably a lot of people who made strategic defaults on loans in non-recourse states, but were otherwise current on payments, who now can't get traditional finance. That means a good deal for you, but it doesn't sound like a good deal for them!

Second, do you have any experience with or opinion on other types of "private money lending"? Specifically, I'm thinking of P2P lending, e.g., Lending Club. It doesn't offer anything in the way of collateral, but it does offer much more diversification.

What RenoJay is doing is originating loans. That is okay, but he could be buying already originated owner financed mortgages at discount and get much higher yields and at the same time have lower loan to value ratio. It takes a little studying to learn how to do this but is well worth the effort. At least it was for me.

[RenoJay]

Thanks for following up. It's always great to see updates about things like this.

I had a couple thoughts.
First, wow these people must really like home ownership to pay those kind of interest rates. Everything about the loan makes total sense--there are probably a lot of people who made strategic defaults on loans in non-recourse states, but were otherwise current on payments, who now can't get traditional finance. That means a good deal for you, but it doesn't sound like a good deal for them!

Second, do you have any experience with or opinion on other types of "private money lending"? Specifically, I'm thinking of P2P lending, e.g., Lending Club. It doesn't offer anything in the way of collateral, but it does offer much more diversification.

Good questions. In each situation I did, it was people coming to reality. Usually they had been living the high life before and are now moving down to a house that's actually in line with where they should have been all along. The rates are definitely high for them, but part of the deal is that my broker discusses with them how to "get out" of our loans by fixing their credit, etc. over the next year or two so they don't see it as a long term thing. Whether or not they actually do fix their credit remains to be seen.

I do lending with LendingClub and Prosper as well. It's pretty hands off, and the returns have been roughly as advertised. The reason I'm leaning toward this lately is because there's plenty of collateral so I feel comfortable putting $200k into one loan as opposed to $50 in an uncollateralized loan with LendingClub. With the P2P stuff, I've noticed the borrowers pay off the loans pretty quickly which is good if you need the money or bad if you want it to compound. (All you need to do is re-invest it, so it's really not "bad".)

[RenoJay]

What RenoJay is doing is originating loans. That is okay, but he could be buying already originated owner financed mortgages at discount and get much higher yields and at the same time have lower loan to value ratio. It takes a little studying to learn how to do this but is well worth the effort. At least it was for me.[/quote]

Abe, I've heard of this. Can you explain more how it works, how to find good deals, what the risks are, what the realistic yields are, etc.? I saw some book by a guy who claimed he was once homeless and became a billionaire doing this.

[HomerJ]

How much does the broker cost?

Does he do these loans with his own money as well?

[HomerJ]

Thanks for following up. It's always great to see updates about things like this.

I had a couple thoughts.
First, wow these people must really like home ownership to pay those kind of interest rates. Everything about the loan makes total sense--there are probably a lot of people who made strategic defaults on loans in non-recourse states, but were otherwise current on payments, who now can't get traditional finance. That means a good deal for you, but it doesn't sound like a good deal for them!

Second, do you have any experience with or opinion on other types of "private money lending"? Specifically, I'm thinking of P2P lending, e.g., Lending Club. It doesn't offer anything in the way of collateral, but it does offer much more diversification.

Good questions. In each situation I did, it was people coming to reality. Usually they had been living the high life before and are now moving down to a house that's actually in line with where they should have been all along. The rates are definitely high for them, but part of the deal is that my broker discusses with them how to "get out" of our loans by fixing their credit, etc. over the next year or two so they don't see it as a long term thing. Whether or not they actually do fix their credit remains to be seen.

It would be interesting if you could report back to us in a year or two if they actually fixed their credit, and refinanced with a real bank to pay you off...

I'm amazed they aren't just renting... I can't believe they are willingly paying 9.5% interest with such a huge downpayment.

[justus]

There are a lot of gotchas including ensuring that not only that first liens are filed, but that in whatever legal contracts are drawn up, that it is actually your money that is being secured by the first lien. Several of my friends/family members lost significant investments in something very similar to what you're describing. What happened to them is described here

http://www.fbi.gov/sanfrancisco/press-r ... ment-fraud

As it turned out, the property values dropped quickly and there was insufficient equity to pay off the investors. To add insult to injury, the broker had fraudulently misrepresented the investments and they weren't not even actually secured by the first lien.

Good luck to you. Personally, I wouldn't consider it at this point in my life, and if I ever did, I wouldn't invest more than 5% of my portfolio.

[Call_Me_Op]

There is a pretty well-defined relationship between risk and return. If you don't mind the risk that ALWAYS goes along with a high return, go ahead.

[jimbojones]

I saw an episode of American Greed that somewhat resembles this arrangement. A broker in Hawaii was arranging similar loans until he ran out of eligible borrowers. Instead of telling his investors that there were no more loans to fund, he lied and kept taking investors' money. Instead of funding loans, he now funded his lavish lifestyle. And like any Ponzi scheme, he required new contributions to pay the interest/principal on older investments. Eventually, of course, the scheme derailed and he ended up killing himself. Many investors lost significant sums of money. Here's a link to a related article:

http://www.cnbc.com/id/46796860

Prosecutors say Lull, based in Hawaii, offered investors the opportunity to help distressed homeowners by funding high interest bridge loans. He claimed it would help people pay off debt to boost their credit scores, so they could qualify for an affordable mortgage and provide investors with a high rate of return. However, Lull’s loans became too popular among his investors.

The high risk, high return mantra applies here. Of course, not every broker is a fraudster like Lull was. But there is no free lunch.

[Abe]

What RenoJay is doing is originating loans. That is okay, but he could be buying already originated owner financed mortgages at discount and get much higher yields and at the same time have lower loan to value ratio. It takes a little studying to learn how to do this but is well worth the effort. At least it was for me.

Abe, I've heard of this. Can you explain more how it works, how to find good deals, what the risks are, what the realistic yields are, etc.? I saw some book by a guy who claimed he was once homeless and became a billionaire doing this.[/quote]

RenoJay: I'll try to answer your questions. This may be lengthy. People occasionally owner finance the sale of their homes (mobile homes, etc.) for various reasons. Not as much now as when interest rates were high. A lot of these sellers will sell these mortgages for a lump sum of cash now rather than wait for a series of payments. You run an ad in the paper or put little signs up on bulletin boards in stores, etc. saying, "I pay cash for mortgages, land contracts, name and phone number". When these people call, you get the information you need and make them an offer. So, if their 10% mortgage has a balance of say $20,000. you may offer them $12,000. Can you see where your yield will be more than 10%? If they accept, they assign the mortgage to you and then you collect the payments. As far as risk, I'll have to say that I have never lost any money doing this, but a lot of risk can be avoided if you know what you are doing. In order to know what you are doing, you need to put in some time studying. The book I told you about earlier, "Invest in Debt" by Jimmy Napier explains how to do this and how to use the calculator to compute yields, etc. He recommends the Texas Instrument BA ll calculator that you can buy at Walmart for less than $30.00. You can order the book here http://www.jimmynapier.com/productlist.php for $24.00. Later, I went to Pensacola, Florida and took Napiers basic paper course. You can order the Basic Paper Course also. It used to be on tape, but I guess it is on CD now. You may not be too impressed with Napier at first because he comes off as sort of a country bumpkin, but he is very knowledgeabe. The book is self published and not necessarly well written but the information is right on. I would not do these through a broker or anyone else. You need to do your own due dilligence. As far as yields, whan I first started, back when interest rates were real high, my average yield was 24%. That sounds unbelievable now, but that is what it was. I would think you should be able to get 12% to 15% yields now. As far as the homeless guy becoming a billionaire in discounted paper, I don't believe that; nevertheless, it is lucrative. Let me say one more time, this has risk. You need to know what you are doing. A lot of the risk can be mitigated, if you know what you are doing.
In the last few years, I have been originating loans at 14% through a government program called "The Officer Next Door Program". This is a little simpler than discounting paper. If you want information on that, let me know. All of these things are riskier than Boglehead type investments. I would recommend setting a limit on how much you put into these investments, just a percentage of your investable assets. Sorry this is so long.

[cldrunner]

The high risk, high return mantra applies here. Of course, not every broker is a fraudster like Lull was. But there is no free lunch.

jimbojones

It is all about how you see risk. If these deals were done at 100% LTV then the risk would be very high. Since the loans are done at LTV of under 70% of LTV then the risk is much lower. I would even consider the risk to be lower than owning a bond fund at this time. I see greater risk in any stock or bond fund. Even in a foreclosure situation the investor might make more than in a non foreclosure. The higher return is due to the lack of liquidity in these types of loans. To me this investor is making great loans as long as he has title insurance and a first lien on the property. The loans can still be sold in the open market but not as quickly as a stock or bond. I have done several of these types of investments for short periods of time (1-5 years).

The lack of liquidity is not a big deal if the money is coming out of an IRA or 401K. Many will say you can not use IRA for loans. Simply do a google search for self-directed IRA. I have even bought single family rental home inside the IRA's. No, I can not move my parents, kids, or brothers/sisters into these properties. I do not fix toilets, and I have never spoken to a renter. All that work is done by the management company. Many of these transactions and investments do not even require a mortgage broker. All of my loans have been direct with no broker. Saves both sides some money.

Many think that their Vanguard IRA's are self directed (sorry your wrong). Even with a slightly higher cost of the custodian, my overall cost is way lower than any index fund. Investors need to consider how large and small companies are wasting your indexed dollars. Not a free lunch. Just not a lot of Vanguard lemmings chasing these types of investments. Wall-street is not involved (and I like that).

[Abe]

The high risk, high return mantra applies here. Of course, not every broker is a fraudster like Lull was. But there is no free lunch.

jimbojones

It is all about how you see risk. If these deals were done at 100% LTV then the risk would be very high. Since the loans are done at LTV of under 70% of LTV then the risk is much lower. I would even consider the risk to be lower than owning a bond fund at this time. I see greater risk in any stock or bond fund. Even in a foreclosure situation the investor might make more than in a non foreclosure. The higher return is due to the lack of liquidity in these types of loans. To me this investor is making great loans as long as he has title insurance and a first lien on the property. The loans can still be sold in the open market but not as quickly as a stock or bond. I have done several of these types of investments for short periods of time (1-5 years).

The lack of liquidity is not a big deal if the money is coming out of an IRA or 401K. Many will say you can not use IRA for loans. Simply do a google search for self-directed IRA. I have even bought single family rental home inside the IRA's. No, I can not move my parents, kids, or brothers/sisters into these properties. I do not fix toilets, and I have never spoken to a renter. All that work is done by the management company. Many of these transactions and investments do not even require a mortgage broker. All of my loans have been direct with no broker. Saves both sides some money.

Many think that their Vanguard IRA's are self directed (sorry your wrong). Even with a slightly higher cost of the custodian, my overall cost is way lower than any index fund. Investors need to consider how large and small companies are wasting your indexed dollars. Not a free lunch. Just not a lot of Vanguard lemmings chasing these types of investments. Wall-street is not involved (and I like that).

I agree with what cldrunner is saying. It's all about how you see risk. Someone who is not knowledgeable in this sort of investment will see more risk than someone who is knowledgeable. One should not take anyones word for anything, but should do the research themselves. Get a title search and be sure you are in first position. Get the value of the property and be sure the loan to value ratio is low enough. Read the paperwork, etc. I have foreclosed on some properties, and as cldrunner said, I made more money by foreclosing. However; I had rather not foreclose. As far as liquidity, a mortgage that one buys at discount can also be sold. There are always people looking for a good investments. And yes, these can be done inside a self directed IRA. I had a friend who invested in discounted mortgages for years. He did this inside a self directed IRA. I might add that I would rather have a few good mortgages right now than invest in a intermediate or long term bond fund. Most of the fraud you hear about is when an agent is involved like a broker or lawyer. I would not do this through a broker. This needs to be hands on, and once again I'll say that you need to know what you are doing.

[cldrunner]

I agree with what cldrunner is saying. It's all about how you see risk. Someone who is not knowledgeable in this sort of investment will see more risk than someone who is knowledgeable. One should not take someones word for anything, but should do the research themselves. Get a title search and be sure you are in first position. Get the value of the property and be sure the loan to value ratio is low enough. Read the paperwork, etc.

You hit the nail on the head. I thought several years ago that these type of investments were high risk. I was not knowledgeable at the time. I read every book I could find on "trust deeds", read every article I could find using self-directed IRA's, and searched every custodians website for educational material. I talked to builders, real estate brokers, and IRA custodians asking these questions. What I found was not many "professionals" know how to use self-directed IRA money to lend to individuals at 8%-12%. CPA's that did not have a clue what UBIT taxes were and bankers who had no idea about non-recourse loans. I am so glad that I took the time and energy (several months) to read all the books and information I could find. Education is very powerful!!!!

Disclaimer: I do not use Entrust and I have no political view of the article.

Article I read today..

SELF-DIRECT WEALTH MAKES NEWS
Something good is going on for the retirement industry when presidential candidate Mitt Romney is called out by the incumbent president for having uber-smart accountants and lawyers build his personal wealth through self-directed retirement plans. Suddenly astute investors want to work out how he did this.

“An industry cannot buy this sort of promotion, ” says Hubert Bromma, CEO and founder of The Entrust Group. “We are here to help investors set up and keep compliant their self-directed IRA accounts.”

The recent news that Mitt Romney has managed to accumulate millions of dollars in his self-directed IRA has caught attention from the media as well as individuals planning for retirement. Romney’s impressive results have many investors expressing interest in following successful tax-deferral strategies.

“Investors are beginning to realize that true self-direction doesn’t just mean that an investor may select from a list of stocks, bonds or mutual funds,” says Bromma, “but may invest in any asset legally permitted by the IRS. As a result, people are looking at self-directed IRA options more closely, especially given our current economic state.”

[cldrunner]

It would be interesting if you could report back to us in a year or two if they actually fixed their credit, and refinanced with a real bank to pay you off...

I'm amazed they aren't just renting... I can't believe they are willingly paying 9.5% interest with such a huge downpayment.

User avatar
HomerJ

I expect these owners will clean up their credit in 3-5 years and then refinance at lower rates. Who knows 9.5% maybe low in 5 years........
In the meantime RenoJay makes a great return!!

[RenoJay]

Regarding some of the comments...

1. The broker is introducing me to the borrowers and walking me through the process, but ultimately I am making a first lien loan directly to the borrowers and can see it filed online. Also, I met with the lawyer who drew up the promissory notes and asked a bunch of questions. There are things like this where a broker pools investor money. I would not participate in that because it introduces broker risk. In my case, it is direct lending and even if the broker gets hit by a bus I hold a note on the property and first lien.

2. Regarding why the borrowers are buying and not renting, in my area (of Nevada) home prices are easily 40% - 50% below where most of these people had purchased previously. So there's a conceivable equation where they come out better to default on the expensive house, and take out a 10% loan on the cheap house. Given that they're bringing hefty down payments, from my perspective the greatest risk is if the equity in their homes evaporates so there's nothing to claim if they stop paying. That said, I believe we've already had our major drop and are on the uptick at this point. I could foresee someone turning a house into a meth lab (thereby destroying all equity), but that's why I meet with the borrowers personally to see if their "story" seems to hold water. The reality is that these borrowers are professional people, but they're not spreadsheet types like us Bogleheads. They tend to realize overall that they can't afford where they were and that they can afford the new payment of a loan to me, but I don't feel like their analysis goes much beyond that. Furthermore, they tend to "fall in love" with whatever house they want the loan on...something most of us would try not to do. Then, when they discover that regular banks won't touch them, they ultimately get referred to my broker two weeks before they're supposed to close on the house.

I'm not claiming this is risk free, and maybe in a year I'll be back eating crow, but for now it seems pretty solid. I was extremely skeptical until I started meeting the borrowers in person and realizing that they simply have a different financial view of the world than we Bogleheads.

[dandan14]

This is very interesting, because I've been seeking out a similar deal. However, I'm not looking to lend to consumers.
What I've been thinking about (and apparently these deals are plentiful) is doing hard money lending to house flippers. From what I've read, the going rate is 4 points with 12%. Lending 65% of after repaired value. First position on deed.

In return for this higher potential return, the risks are:

You over appraise the "after repaired value" and thus lend too much. When the house sells there may not be enough to pay off the loan.
The middleman disappears with your money. You foreclose, but you get the unrepaired house.
The middleman runs out of money and needs more to complete the job. You either have to lend more, foreclose, or try to sell uncompleted.
Foreclosure costs and legal fees eat into returns.

[RenoJay]

This is very interesting, because I've been seeking out a similar deal. However, I'm not looking to lend to consumers.
What I've been thinking about (and apparently these deals are plentiful) is doing hard money lending to house flippers. From what I've read, the going rate is 4 points with 12%. Lending 65% of after repaired value. First position on deed.

In return for this higher potential return, the risks are:

You over appraise the "after repaired value" and thus lend too much. When the house sells there may not be enough to pay off the loan.
The middleman disappears with your money. You foreclose, but you get the unrepaired house.
The middleman runs out of money and needs more to complete the job. You either have to lend more, foreclose, or try to sell uncompleted.
Foreclosure costs and legal fees eat into returns.

I had considered this kind of loan, but I think the risks you outline are accurate and were out of my comfort zone. If I wanted that kind of risk, I'd probably just flip the houses myself. You can also lend to regional/local builders which is possibly a bit safer than to house flippers. Going rate, I believe, is around 10%. Also you could lend to people buying multi family properties/apartments, but this seems messy in the event you need to take ownership. For my loans, I figured owner-occupied with plenty of verifiable equity and motivated, income-qualified borrowers was likely the safest option given my desire for these investments to be hands-free and hopefully mess-free. The best advice someone gave me before I got into this was "Only lend on properties you wouldn't mind owning." Seems like good advice. Also, from my perspective, I feel safer lending $200k on a $400k house than lending $30k on a $60k house, because it seems an owner can easily destroy $30k worth of equity by ignoring routine maintenance, leaks, etc. So all of my loans have been around $200k or so.

[cldrunner]

I had considered this kind of loan, but I think the risks you outline are accurate and were out of my comfort zone. If I wanted that kind of risk, I'd probably just flip the houses myself. You can also lend to regional/local builders which is possibly a bit safer than to house flippers. Going rate, I believe, is around 10%.

I am working with a local builder. Loan is 3 years 12%. Builder pays closing cost on rental home used as collateral first lien. This frees him to build and sell as many spec homes as he can in three years while I sit with a home that has a LTV around 70% of loan. The costs are lower than doing separate deals for each home. Not into the rehabbing scene.

[Abe]

.

The best advice someone gave me before I got into this was "Only lend on properties you wouldn't mind owning." Seems like good advice.

"Only lend on properties you wouldn't mind owning."
Yes, that is good advice. The only thing I would add to that is: for the amount of money you put in.

[Abe]

Abe, I've heard of this. Can you explain more how it works, how to find good deals, what the risks are, what the realistic yields are, etc.? I saw some book by a guy who claimed he was once homeless and became a billionaire doing this.

Can go here for information on discounted paper: http://papersourceonline.com/faqs/