(Note: I posted the following on my broker blog recently. It is oriented to toward brokers, but at the same time, I think it would be quite useful to those trying to get a handle on investing in private money loans and trying to better understand the process.)

Private money is often misunderstood. Many industry professionals know very little about it, and fallacies and misconceptions tend to dominate the collective wisdom. As you know, as a subscriber to this list, I have made it my mission to try to educate professionals regarding the realities of private money. In this capacity, I spend a lot of time answering questions about private money. I figured it was about time to prepare a FAQ on private money and share it with this group. So here you go.
-What is private money used for?

Private money is generally used as a bridge: a way to get from point A to point B. It is generally a short to medium term solution (1-6 years), and there is nearly always an exit strategy going in. It is used for all types of real estate secured financing: commercial retail, restaurants, hotels/motels, marinas, elder care facilities, industrial, agricultural, raw land, land development, construction, rehab, multi-family, single family homes, manufactured homes, and floating homes. For a list of our private money loan programs, click here.

-What are the interest rates?

Private money rates generally range from 10 to 15%. The rate is determined by looking at a combination of factors: (a) LTV ratio, (b) strength of borrower, (c) condition/desirability of property, (d) actual cash-in or real equity contributed by borrower. Typically our rates fall in the 12-13% range. A list of our loan guidelines may be found here.

-What fees are involved?

We charge a loan fee generally equal to 5% of the gross amount of the loan. We also charge a doc prep fee ($675 or more, depending on the size of the loan), a property inspection fee ($500 or more, depending on the location of the property), and a collection account setup fee ($470 or more, depending on the size of the loan). There are no hidden junk fees.

-Can the fees be paid from the proceeds of the loan?

Yes, if there is enough equity in the project. This is frequently the case.

-Is there a pre-payment penalty?

Most of our loans have no pre-payment penalty.
-Why would anyone pay those kinds of rates and fees for a loan?

There are many reasons why a borrower would choose to use private money over a cheaper institutional option. For example, professional real estate investors like to use private money when buying because they are able to make offers which are not constrained by long timelines and numerous rigid conditions. Often times speed is a very significant factor in completing a profitable transaction and in those cases it often makes sense to pay for a short-term private money option rather than loose the deal. Frequently the condition of a property won’t allow for the initial financing with conventional money, and in those cases private money may be used. Often the type of property is a factor: banks don’t like lending on raw land and lots, but private money lenders are more inclined to do so. Cash leverage is another factor. Fairfield Financial, for example, loans based on the true value of a property, not the purchase price, so sometimes we lend most of the acquisition cost for a property.. The structure of the deal may be a factor. Most private money lenders allow the buyer to establish their equity through the mechanism of a seller carry back; banks won’t do this. The list goes on and on.

-What is the most common use for private money?

Our most common loans are probably construction, rehab, and land development loans. We have an entire FAQ devoted to these loans at: http://www.privatemoneysource.com/articles/rehabfaq.php

-How fast can private money loans close?

We have been known to close loans in a matter of a few days, but more typically, you should figure on 10-15 business days. (Keep in mind that it is only possible for us to move quickly if the borrower, broker and other third parties are moving quickly as well.)

-is an appraisal required?

Some private money lenders require them. We don’t. Evidence of value is a critical part of the private money loan process. However, it is our opinion that a good set of comps is just as effective in establishing value as a good appraisal. Many of our borrowers are professional investors, and we feel that they are qualified to perform the value analysis. This allows us to streamline the process. However, it is important to note that putting together a god set of comps is hard work. See the following article on our website for a detailed description of how to prepare a proper value analysis: http://www.privatemoneysource.com/articles/comps.php

-As a mainstream mortgage broker, I don’t see much of this type of thing. Why should I be interested in private money?

To be perfectly frank, it is my belief that mainstream mortgage brokers are being squeezed out of the industry. Lenders are ramping up their operations to better provide online loan sourcing directly to borrowers. We saw a similar thing in the travel industry over the past years. The travel agents that have survived, and even thrived, are the ones who effectively established niches within the industry. It is my belief that the same will be true for mortgage brokers. Plain vanilla loans can be easily processed in an assembly line fashion which easily translates to the world of the novice and a web browser. Niche lending, on the other hand, tends to be a hand-crafting of sorts, and cannot be easily automated. Look at private money. There are no absolute rules. Many factors must be considered in making a decision and frequently those factors are intangible. Ultimately a high degree of thought work and common sense is involved. Private money will always be a people process. So if you tell me, I am not interested in private money because I don’t do unusual loans, I say to you, You might want to reconsider.

-As a mortgage broker bringing you this transaction, how do I get paid?

It is simple. You bring us a borrower. We price the loan to you. (Think of yourself as a wholesale buyer.) You price the loan to your client, adding your fees as appropriate. You stay involved in the loan (or not) as you choose, and prior to closing, you submit a fee demand to escrow and receive a check directly from the title company. For more information on this topic, see: http://www.privatemoneysource.com/brokers.php

-Why do they call it hard money?

It is difficult to find an answer to this question. I’ve heard plenty of speculation. Some people say that it’s because the money is used for hard to do loans. Others say it is because the loans are hard to get or hard to pay. It is my belief that it is called hard money because traditionally it has been real money in the sense that it is not borrowed. Institutions loan borrowed money, and in this sense they loan soft money. However, I must point out that things have changed a bit over the years, and these days a good deal of hard money is in fact borrowed. (I would guess as much as 50%.)

-How do I go about doing a private money loan with Fairfield Financial?

There are basically four steps.
(1) First, run the concept by us. The best way to get started is to provide us with a high level summary of the loan. You may e-mail a summary, or you may use our online submission engine, which will walk you through the process. It is quite simple to use. You will find that at: http://www.privatemoneysource.com/loanproposal.php
(2) If we like the project concept and feel that the numbers are acceptable, we provide you with a rough quote.

(3) Once you approve the rough quote, we provide you with a list of items that we need to receive and review in packet form.
(4) We then review this loan packet. We ask that this be sent via overnight mail or send via e-email, as a single Adobe or Word attachment.
(5) If all this checks out, we ask the borrower for a deposit (average amount = $1,000). This should be in the form of a cashier’s check or money order. We provide a conditional loan commitment letter at this time.

(6) We send someone out to inspect the property.
(7) If the property checks out, we draw up the documents and close the loan through escrow.

-Is the deposit check refundable?

If we close the loan through escrow, the deposit is applied as a credit to the loan fees. If we don’t close the loan because (a) the borrower does not or cannot perform or (b) the project upon inspection is “significantly” different than as represented, we keep the deposit to reimburse us for our costs. Otherwise, if Fairfield fails to perform for any reason, we return the deposit to the borrower.

-What needs to be included in a private money loan package?

As I said, we provide a list specific to your loan scenario. However, if for a list of our general packaging guidelines, please see the following: http://www.privatemoneysource.com/packaging.php

– Clay (sparkman@lendicom.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

From time to time, I post a prospectus for a loan that we are currently in the process of placing. This serves three purposes: (1) It gives readers a window into the kinds of loans that we are placing, (2) It provides an example of how are loans are initially presented, and (3) It gives investors the opportunity to inquire about the investment if they are interested in doing so.

The prospectus, which is shown here, is the high-level presentation, or executive summary, of the loan.  Having read the prospectus you should have a pretty good idea what the loan/borrower/project is all about and what this loan looks like as a potential investment.

When an investor wishes to fully evaluate a loan investment, we send a full packet in Adobe Acrobat format (generally between 50 and 200 pages) password protected, and with all backup documentation to support and inform the investor in detail regarding the known relevant particulars of the loan.

Please note that this prospectus has been redacted (name and address info) since it is being broadly distributed. If a particular investors is interested in evaluating a loan, then of course the presentation is not redacted.

If you are interested in discussing private money loans in general or this one in particular, you may contact me at sparkman@lendicom.com or Kris Gillmore, who is coordinating this loan, at 503-319-7294, or gillmore@privatemoneysource.com.

Kristopher Gillmore

Fairfield Financial Services, Inc

3327 SE 50th St, Portland, OR 9706

Phone (503) 319-7294 / Fax (503) 419-4219 / E-mail: gillmore@privatemoneysource.com

REAL ESTATE PROSPECTUS

SECURED LOAN

Cash out refi of SFR in Tahuya, WA

Loan Details

1. Loan Amount: $200,000
2. Term: 36 Months
3. 6 months minimum interest
4. Interest Rate: 13%
5. Monthly Payments: $2,166.67  Interest Only
6. Security:  Deed of Trust in 1st Position security interest in real property at XXXXXXXXXX, Tahuya, WA 98588
7. Current Value by Appraisal:  $390,000
8. LTV based on Appraisal:  51%

Loan Overview

Mr. xxx is the owner and president of a software development company, YYY, Inc.  Beginning in 2002, both the company and Mr. XXX’s family experienced some setbacks which would ultimately put him behind on his payroll taxes.  Mr. XXX’s attorney is ready to file the taxes, but they are waiting for the funds before they file.  The estimated cost of the payroll taxes is $137,000 + interest.  A detailed letter of explanation has been provided.

In 2010, Mr. XXX’s mother in law passed away, leaving the free and clear (minus 2009-2011 property taxes) subject property to Mr. XXX and his wife Mrs. XXX.  The borrowers have requested this loan to pay the back payroll taxes.  The borrowers have a great emotional attachment to this house, so their intent is to keep this property as a vacation home and exit this loan with a conventional refi.  If the payments are too much to handle, they would then consider renting the property.  As a 3^rd option, if they are unable to refi and/or find a suitable tenant they would sell the property to exit this loan.

Property

The Subject property is a 2 story 2,321sf house located on the Hood Canal in Tahuya, WA.  There are 3 bedrooms, 3 baths, and the house sits on a .15 acre lot.  Photos and more details of the property can be found in the appraisal that has been provided for your review.

Valuation

A recent appraisal with an inspection date of May 31, 2011 has been provided.  Four comps were used by the appraiser to value this property, leading to a suggested value of $390,000.  There is a large range in the date of these sales, and the appraiser does make adjustments to the price given the declining market.  A search of Zillow.com shows a number of houses (of reasonably comparable size) for sale in this area ranging from $310,000 to $795,000.  Given the decrease from original list prices on the higher priced homes on the appraisal, and the overall feel of the market right now, $390,000 seems to be a reasonably conservative estimate of value.

Income

Mr. XXX states a monthly income of $8,180 and Mrs. XXX states a monthly income of $5,000.  In addition, Mr. XXX sold a portion of his business and has been receiving monthly payments of $5,000.  There is a balloon due on May 1, 2012, in which Mr. XXX should receive approx. $100,000.  A copy of this note has been provided.   Mr. XXX and Mrs. XXX state a combined a net worth of $341,402.  A 1003 has been provided for your review.

Credit

A recent credit report has been provided showing scores of 655, 627, and 644 for Mr. XXX, and scores of 686, 698, and 705 for Mrs. XXX.  Please note – there are red flags on this report with regard to the SSN entered for Mrs. XXX.  When this credit report was pulled, 6124 was incorrectly entered as the last 4 digits of Mrs. XXX’s SSN, when it should have been 5124.

– Clay (sparkman@lendicom.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

One of my long term objectives with this blog is to eventually walk with you through all of the private money loan processes and procedures, from the moment of conception until death (death of course not being a bad thing in my chosen metaphor, but simply meaning loan payoff, workout, or foreclosure).

This post deals specifically with the loan packet submission process (not quite conception, but in the early infancy stages you might say).  When working with either brokers or borrowers, it is very important to be specific regarding precisely what items are needed in order to properly review the loan in detail.  Presumably at this point, you will have reviewed the loan in concept, via a verbal interview or some form of written summary or submission and would like to take the next step and review a detailed paper (or electronic) packet.

It is also important at this point to very clear with brokers or borrowers regarding how and where and in what form to submit the packet, and if you require a deposit, as we generally do, this would be the time to ask for it.

And so, these are the guidelines used by my company, Fairfield Financial.  We have developed these over the years and they are pretty good, but keep in mind that these are only guidelines and that each situation is unique and may require additional underwriting items that are not mentioned here.   Also keep in mind that there is an element of style or expectation involved here, specific to the individual lender.  Our goal is to attempt to obtain all information that might have more than a negligible impact on the decision process.  You want to be thorough, but you don’t want (I think) to ask for every possible imaginable item.  (That would make you too much like a bank now, wouldn’t it?)

When submitting a loan proposal, please include:

• Residential loan application (1003) or equivalent (MUST BE SIGNED BY BORROWER)
• Signed and completed Fairfield Disclosure Forms
• Current tri-merge credit report (if loan is submitted by broker; if borrower submits directly, Fairfield will pull report)
• Trio of subject property (or other type of detailed spec summary)
• A good comp set, appraisal, or some other objective and transparent case for value
• Photo(s) (if not included in an appraisal)
• Cover sheet describing/summarizing parameters of loan
• Preliminary Title Report(s) for all properties
• Payment history on all loans encumbering the subject property (or properties)
• Payoff quote on present loan(s)

If borrowing entity is corporation

• Company financials (income statement and balance sheet)

If purchase

• Valid executed earnest money agreement (contract to purchase)

If credit history is rough

• Explanation of circumstances
• Supporting documentation to show status of resolved items

If present loan is in default

• Explanation of circumstances

If raw land or builder ready lots

• Supporting documentation (government correspondence/code) to address development plan and demonstrate likelihood of completing development according to plan
• Copy of zoning documentation and explanation of possible land uses
• Description and status of utilities and access to the lots
• May want signed affidavit from Borrower regarding completion status of lot(s)

If floating home

• Copy of registration
• Recent float survey
• Copy of lease (if slip is leased) or owners certificate (if slip is owned)

If leased land

• Copy of lease on land (or usage permit)

If 2nd or subordinate position loan

• Copies of notes and Deeds of Trust for all superior loans
• Payment histories and statements for all superior loans
• Payoff statements for all superior liens

If construction/rehab loan

• Summary of project
• Builder credentials
• Copy of contractor’s License, bond and insurance
• Detailed line item budget
• Supporting documentation to backup detailed line item bids/estimates
• Plans (if floor plan is new or changing)
• Copies of permits already obtained

If Income Property

• Copies of all leases and rental agreements pertaining to the property.

Our Guidelines:

Region:

Alaska, California, Colorado, Florida, Idaho, Georgia, Montana, Nevada, New York, Oklahoma, Oregon, Texas, Washington, and Wyoming

Loan Amounts:

$50,000 minimum, no maximum

Interest Rates:

10 – 15% on firsts

Term of Loans:

1 – 5 years

Amortization:

Interest only

Broker Fee:

Typically 5%

Other Fees:

Document preparation: $675 to $2,900; Collection account set up: $470 plus $1 for each $1000 of the loan amount; Property inspection: generally $250 to $1000

Pre-pay Penalties:

None

– Clay (clay@privatemoneysource.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

Most private money investors choose to work with brokers.  However it is a decision that each private money investor must make independently and with great care—to use or not to use a broker.

The essence of the matter I think is this.  If you want a full-time job (and some investors certainly do) then you may well decide to go it alone (without a broker), and essentially setup your own office geared toward managing the various aspects of investing in private money loans and hard money loans secured by trust deeds and real property (including promotion, underwriting, risk assessment, loan servicing, and workout/recovery).

If you don’t want a full-time job and are interested primarily in hands-on investing (in my opinion there is no such thing as hands-off investing in this niche), then you will want to shop for and eventually select a qualified broker to “partner up” with.

This post will be primarily of use to the former type of investor–as the first step in the process of placing trust deed secured loans is finding quality borrowers that meet your criteria.  This is not an easy thing.  At Fairfield, we receive about 300 loan requests per month these days and of those we end up pursuing maybe ten in a typical month.  On average maybe six of those will survive our underwriting process, be presented to one or more of our investors, and ultimately be closed through escrow and thus actualized as an investment.

If you are faced with this challenge, a web based tool known as Lendicom.com may be of interest to you.  The site is geared toward commercial lending, and allows borrowers and brokers to sign up and submit specific loan proposals to lenders who have also signed up online.  The lenders may be institutional or they may be singular individual investors.

If you are a hard money lender looking directly for commercial loans to fund, you may sign up as a lender and create an account that allows you to specify detailed criteria regarding the specific types of loans that you would be interested in and your particular criteria.  Then from time to time borrower proposals that meet your criteria will be submitted to you.  You may choose to either decline or pursue these proposals.  Ultimately if you place a loan which came to you through Lendicom, you pay 25 basis points to Lendicom (or a quarter of a point).  Otherwise you pay nothing for the use of this service.

In the interest of full disclosure, I am an officer and a part owner of the company that offers this site.  So consider me biased.

Still, I recommend that you check it out at the link below and see what you think.

www.lendicom.com

– Clay (clay@privatemoneysource.com, 503-476-2909 or 800-971-1858)

Clay is Vice President of Fairfield Financial, a primary source for private money loans since 1964.  Fairfield works with a broad range of private money investors, in a broker capacity, finding, underwriting, presenting, closing, servicing, and when necessary, assisting in the workout of difficult loans.

When evaluating loan requests, this is the fundamental question:  what exactly do you want me to do for you?  It is impossible to count the number of times that I have receive loan packets or proposals that didn’t include a loan summary or any clear description of the request.  The process of evaluating a loan must begin with a well prepared summary of the loan proposal.  (This item might be called a loan summary, an executive summary, or a cover sheet.  We call it a Prospectus.)   I don’t know why borrowers and brokers are so reluctant to provide such a fundamental item when attempting to secure private funding for real estate projects.  I suspect that it has to do with the way banks operate.  They don’t require a summary so why should we?  And beyond that, I think that many brokers and borrowers simply don’t know what to include in a summary.  One of the ways that we have gotten around the problem is by including a loan submission form on our website which walks the broker/borrower through a simple electronic form.  At least in the initial stages of the application process, this seems to provide much needed guidance.

Ultimately, however, we will not accept a loan packet or submission which is not accompanied by an adequate summary, and if the summary is quite good, we will probably tend to be much more receptive to at least considering the loan proposal at hand.  For today’s post, I am including a sample of a prospectus (redacted) that we prepared for submission to our private money investors.  We actually place our prospectus on top of all the relevant documentation, data, photos, etc., scan it into Adobe, and then e-mail a link and password to our interested investors, so that they may review the loan proposal in its entirety.  Here then is what we consider to be a well informed prospectus.  I recommend that all private money investors insist on adequate documentation and don’t settle for less.

Clay Sparkman

Fairfield Financial Services, Inc

2727 NE Hoyt St, Portland, OR 97232

Phone (503)476-2909, e-mail clay@privatemoneysource.com

REAL ESTATE PROSPECTUS

SECURED LOAN

Purchase and rehab on 4-plex in Las Vegas, Nevada

Loan Details

1. Loan Amount: $130,000
2. Term: 2 yr
3. Interest Rate: 13%
4. Monthly Payments: $1,408.33 Interest Only
5. Construction Holdback Account: $54,750
6. Security:  Deed of Trust in 1st Position security interest in real property at xxxx Bassler Street, North Las Vegas, NV 89030
7. Completion Value by Borrower Estimate / Comps is $220,000
8. Completion Value LTV by Borrower Estimate / Comps is 59%
9. Conservative Completion Value is $195,000
10. Conservative Completion Value LTV is 67%

Loan Overview

This is a purchase and rehab construction loan for a 4-plex in Las Vegas, NV.  The property will be purchased as a bank REO for $78,000.  The borrower (hereafter referred to Flip Guy for the purpose of this sample) is bringing $13,000 to escrow in order to demonstrate some cash investment on his part, and requesting $54,750 to complete the construction on the property.  Flip is experienced flipping homes in Las Vegas, and has rehabbed over 200 properties in this area.  He currently holds 62 properties in his inventory.  42 of these homes are free and clear and all but 5 of his properties are rented and producing income.  Flip reports that these 5 properties are for sale.

Flip Guy has successfully completed four loans with Fairfield over this past year and a half.  In each of these loans the construction was completed and the properties were listed in under a month.  Both houses were sold and the loans paid in full well before the loans matured and Flip has never been late with a payment.  Before and after photos of two of these properties are provided as an example of his work.  In addition, Flip has provided before and after photos of a similar 4-plex that was not financed through Fairfield.

In each of Flip’s previous loans, his exit strategy was to sell the properties.  For this loan, he intends to refinance the property and hold it as a rental.  To be safe, he has requested a 2 year term, although he anticipates that he will be able to exit this loan in approximately year.  He will pursue a take-out loan as soon as the rehab is completed, which should take 1-2 months.  Flip will hold title to this property under his company, xxx, LLC, and he will personally guarantee this loan.

Property

The subject property is 3040 SF and has 4 units, each with 2 bedrooms and 1 bath.  The 4-plex was built in 1963 and sits on a .21 acre lot.  The 4-plex is structurally sound, but is in need of cosmetic repairs.  Flip plans to update and modernize each unit of this house.  He will replace the flooring, paint, update the kitchen, and landscape the property to add curb appeal.

This property is approximately seven miles northeast of the Vegas strip and one block east of the Las Vegas Blvd.  It is located in a neighborhood that is primarily working class rentals.  There are three 4-plexes neighboring this property and they are all reported to be in good condition.

Valuation

Completion Value Comps by Borrower

To determine the completion Value, the borrower utilized 7 comps in a close proximity to the subject property that range from $209,900 to $249,900.  Three of these comps are sales, while the other four are current listings.  Three of these listings have sales pending, but those pending prices are unknown.  Based on these comps, Flip estimates that the property should be worth $220,000 once the repairs are made.

Analysis of Comps by Inspector

Based on the average price/unit of all comps and listings, the value of the subject property would be $224,408, which supports the borrower’s estimate of value.  However, when the average rent is broken down to a conservative price/SF, and multiplied by the average gross rent multiplier (see inspection report), a value of 194,803 is suggested.  In addition, if the average sale price/SF is multiplied by the size of the property, it yields a value of $193,982.  Based on these calculations, the inspector suggests that it would be reasonable to consider $195,000 as a conservative value for this property.

A field report is available for review.

Market Trends

Altosresearch.com is a website that provides real time market data for single family homes, and was used to evaluate the Las Vegas market trends.  Average home prices, time on the market, and the current home inventory are all considered in the evaluation of this property.

Average home prices have continued to fall over the past year, and the median home price as of Nov 29, 2009 is $119,928.  There appears to be a significant decrease in the rate of this fall over the past few months, and in the past 30 days prices appear to be relatively stable.  Seven day averages show a very slight increase.

The average time on the market in Las Vegas area has been steadily declining over the past 8 months, and has dropped from 175 days at the high point in April 2009 to a157 days as of Nov 29, 2009.

The current home inventory is one of the most important factors to consider.  A decreasing inventory is often a precursor to stabilizing market.  Since its high point in April 2009, the home inventory has decreased by approximately 20%.  There is a current downward trend in the home inventory which could potentially explain the decrease in the rate at which home prices have dropped over the past few months.

Market trend graphs are available for review.

Flip’s first loan, the Pinedale property, sold in just less than 5 months from the time of listing.  Flip’s second loan, The Ashbrook property, was sold in just less than 8 months from the time of listing.  His next two loans, the Bengal property and the Almondwood property, each sold in approximately 3 months after the property was listed.

His average turn time is compatible with the expectations based on current market trends.  The price point at which Flip purchases these homes, his ability to rehab them quickly, his realistic approach to time on market, and the decreasing home inventory, seem to support his business model.

Process

Las Vegas does not require any permits for the type of work that will be performed, nor do they require a contractor’s license.  The borrower will be ready to go as soon as the loan is funded and plans to have the house completed in approximately two weeks.

Income

We were provided with a signed 1003 for Flip Guy, which states a monthly income of $55,000, and a net worth of $5,245,000.  Flip states that his monthly income is a combination of the rental net income and proceeds from the properties that he flips.  A copy is provided here for your review

Credit

Flip Guy has a mid credit score 686.  This is typical for rehab developers who use bank cards for construction financing.

– Clay (clay@privatemoneysource.com)

I’m going to make a list today of twenty-five important questions that I believe an investor must ask prior to funding any private money loan transaction.  I’m not going to elaborate much on each particular item here, but will drill down on each of the individual items in future posts.  For the sake of simplifying this discussion to a reasonable level, I’d like to start with several assumptions: (1) we are only talking about loans secured by real property, (2) we are only talking about first position loans, and (3) we are not talking about land development or raw land loans.  (Each of these exceptions, if removed, would be good for another whole list of special questions; we’ll save those particular scenarios for future discussion.)

(1) What is the Loan to Value (LTV) ratio of the loan you are considering and how does that fit with your own risk limits regarding this particular loan and property type?

(2) If this is a value-added loan (construction, rehab, or development), what is the front-end LTV?  Font-end LTV refers to the LTV immediately after the close of escrow but prior to any construction/development or disbursement of construction holdback funds.  (I generally reference this as FLTV, and it is understood that LTV, for a project actually refers to the LTV upon completion of the construction/development and full disbursement of any/all hold-back funds.)

(3) How confident are you of the value?  The “L” part in LTV is easy.  It is the “V” part that can be quite difficult to accurately determine, and in fact it must be understood that any such determination (no matter how good) is only an estimate.

(4) What are the recent market trends for the area in which the property is located?  Given the real estate market of the past two years, this question is particularly relevant.

(5) How is the borrower’s credit?  What is the mid-score, what are the issues, if any, and what is the trend?

(6) If the loan is a refi: how is the borrower’s pay history on the existing loan?

(7) How much “skin” will the borrower have in the game at the close of escrow?  In other words, how much cash or additional collateral is the borrower bringing to the table?

(8) If this is a real estate development or investment loan or a loan to a business owner occupying his own property: what is the relevant experience and background of this borrower?

(9) What is the purpose of the loan and how will the funds be utilized?

(10) What is the term of the loan?

(11) Can the borrower afford to make payments OR does the loan scenario otherwise involve an adequate interest reserve?

(12) What is the borrower’s plan/exit strategy, and how likely is the borrower of success?

(13) What is the borrower’s net worth and how liquid are the borrower’s assets?

(14) If there are one or more structures on the property, will you be listed as loss payee on a hazard insurance policy at the close of escrow (or prior to the beginning of construction if new construction is being funded)?

(15) If there is a construction hold-back, who is administering this and do you trust them to do so effectively?

(16) Have you reviewed the operative preliminary title insurance policy and approved any liens that your title insurance policy will be listing as exceptions to your position?

(17) Is your loan compliant with all state and federal disclosure and usury laws?

(18) Will all taxes be paid current at closing?

(19) What is the likelihood that there are any serious hazardous waste issues associated with the property?

(20) What is the likelihood that there are any wetland issues associated with the property?

(21) If relevant: what is the status of all required permits, entitlements, or other government approvals?

(22) What is the likelihood of one or more construction labor/materials liens taking precedent over your lien position?

(23) Does the loan size/amount, location, type etc. allow you to obtain optimal diversification?

(24) What is your plan for servicing the loan?

(25) If the loan involves a fractional interest, how comfortable are you joining with the other lenders involved in the loan?

So that’s my list for now.  There is nothing special about the number twenty-five, and I may well have left off some very important items, so please provide feedback as to which items you agree with, which ones you don’t, and what other items you might feel absolutely must be on a list of this sort.

– Clay (clay@privatemoneysource.com)