When I was answering a question about private lenders recently from a newer investor that I’m mentoring, I was reminded of something…
Of how easy it can be for those early in the game to misunderstand the value of what they bring to the table in the investor-private lender relationship.
Many investors overlook or mistakenly downplay that value in their own mind and end up being way too generous or give up the farm when borrowing money from private lenders.
But, the moment you realize the big value proposition that you’re inviting private lenders to participate in, is the moment you’ll stop giving away the farm and level up your game for each and every deal.
So, here’s the question I was asked from my mentoring student, who I’ll call Peter.
“I’m buying pre-foreclosures subject-to the mortgage and the arrearage amounts vary widely from deal to deal. I’m trying to expand my business, and I have an investor who may put $100,000–$200,000 into my business. I want to pay the investor 12% interest for the time we need the money, usually 30 to 45 days, plus a percentage of the profit per deal. Does this make sense?”
Well… not so much.
First, Peter is being overwhelmingly generous!
Look, 12% is more than you need to pay in this market for the use of the money, and then to also tack on a percentage of the profit per deal — no, sir.
So, with short-term lending, yes, you generally will have to pay a little bit more — but not 12%. It does require the type of private lender who doesn’t mind their money going out, coming back, going out, coming back – which can be more expensive — but assuming that they’re insisting that their money be collateralized at all times, meaning there will be a note and mortgage on the property on every deal, 12% is more than I think you need to pay..
Now, the lender could provide you with a personal line of credit. Or, you could collateralize it with another piece of property that you are holding, keep the money and just roll it into the next deal and the next deal. This would be ideal if you’re dealing with the type of lender who prefers the money not to come back over and over again.
And for that, in this market, I would expect to pay about 3.5%–4%.
Money In, Money Out…
Again, some private lenders don’t want the active involvement of having to put money out, then getting it back, then putting it out again. So when that’s what’s happening you may find yourself pushed toward more of a “professional” private lender, and they are more costly than your friend, family member, or acquaintance.
And even with hard money lenders right now, if you’ve got decent credit and some of your money in the deal, you’re looking at 1 point and 9%–10%. But that’s going to take a 720 FICO and probably 20%–30% of the total project value of your money in it.
So, that’s some context for what’s out there.
Now, Peter also mentioned giving the lender a piece of the profit on the deal…
That’s fine… but(!) the way I see it, there is no need to pay interest AND a piece of the profit from the deal. For me, it’s one or the other, not both.
Why This Doesn’t Surprise Me…
It’s simple. Peter is newer to REI and doesn’t fully understand the value that he’s bringing to the table…
I’ve seen it time and time again — when people are new to the business, they often think that they need to make the deal super sweet or the lender won’t take the deal.
And, in general, that thinking is sound…
However, I know that Peter has at least a deal (or more by this point) under his belt and we have an environment where people are chasing “yield”, A.K.A. a decent return on their investments. Because interest rates are so low, and there’s so much cash competing for some kind, heck any kind of yield, people who are otherwise highly risk adverse are “willing” to get into extremely risky investments when they otherwise would never be.
For example, if they could make any sort of yield on bonds, in a savings account or CD — anything worthwhile — that’s where they’d be.
But because they can’t, the otherwise risk adverse are chasing yield down rabbit holes where, by comparison, they’re in very risky investments. For example, the stock market, junk bonds or a fund they don’t have control over and where there’s massive counterparty risk, or even crypto assets — places they’d normally never be.
They just want to earn 3% or 4% on their savings account or yield-on bonds — but that’s just not available and hasn’t been for many years now.
Remember THIS About Private Lenders…
I bring this up because I want you to know this and remember this…
I want you to understand that you’re really the one in control here.
Because you’re the one who has what they need. A safe investment that offers higher than normal yield.
So… don’t give up too much.
Again, if you can get it collateralized on something you’re going to hang on to, so the money isn’t going in and out, in and out — 3.5%–4%, maybe a teeny bit more — ought to blow their minds.
Because it’s safe.
They’ve got a note and a mortgage or a deed of trust, and they’re making an interest rate that they couldn’t get otherwise, without being in the stock market or any of those other risky investments.
You have the power with private lenders — so own it.
And if you need extra guidance on dealing with private lenders, I suggest you check out my Using Private Lenders To Grow Your Real Estate Business training. This training will walk you step-by-step through the process of working with private lenders for any type of deal (plus some added bonuses). You can learn more here.
What’s your experience when working with private lenders? Let me know in the comments!