Clay Sparkman
I originally published this article in September of 2009 on this blog.
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, 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.
Tags: hard money investing, hard money lending, hard money loans, investing, loan underwriting, private money investing, private money lending, private money loans, trust deed investing, trust deed lending, trust deed loans
