Clay Sparkman
I realized early on that one of my greatest challenges in the private money lending business was to educate brokers, borrowers, and ultimately lenders regarding private money lending–what it is and when and how and when it should be used. So many people know so little about it, and those who think they know quite often embrace vastly inaccurate ideas and misunderstandings.
It is quite amusing to watch people’s eyes glaze over when they ask me what I do at a cocktail party. Usually that conversation doesn’t last very long. People who aren’t interest are very uninterested. However, people who are interested–and they are certainly the minority, this is a niche area after all–are immensely interested and seem to be insatiable. I often have to terminate conversations with potential borrowers, brokers, and investors after an hour or so and suggest that we get back to it and cover the material over a series of one or more future conversations.
Moving on, I decided that it was one of my missions in life to educate agents and potential users of private money. 16 years later, I don’t know how much progress I have made, but I keep on trying. Certainly that is what this blog is about.
I thought it might be informative to duplicate here the FAQ that I publish on my company website. Keep in mind that it is directed primarily toward brokers and borrowers, though much of the information will be of interest to investors and potential investors. And also note that it is about private money mostly, but does discuss the topic from a Fairfield-centric point of view.
At any rate, I hope you get something out of it.
Private money FAQ
Private money is often misunderstood. Many industry professionals know very little about it, and fallacies and misconceptions tend to dominate the collective wisdom.
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 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 generally charge a loan fee equal to 5% of the gross amount of the loan. We also charge a doc prep fee ($500 or more, depending on the size of the loan), a property inspection fee ($650 or more, depending on the location of the property), and a collection account setup fee which is based 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?
We generally don’t have a pre-payment fee but occasionally we have a 3-6 month minimum interest clause minimum interest clause for our loans. For instance, it means that if a borrower repays a loan in 3 months or more, there is no penalty. If the borrower repays the loan, for example in 2 months, then the borrower will have to pay an extra month’s interest out of escrow at closing.
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 time lines 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 100% of the total 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: see the Rehab and Construction Loan FAQ.
We have been known to close loans in a matter of a week, but more typically, you should figure on 2-3 weeks. (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 this article on our website for a detailed description of how to prepare a proper value analysis.
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, Click Here.
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.
- First, run the concept by us. You may call and discuss the loan with us, or you may e-mail a summary, or you may use our online loan submission engine, which will walk you through the process. If we like the project concept and feel that the numbers are acceptable, we proceed to the next step.
- We review a complete loan packet. We ask that this be sent via overnight mail or delivered to the office (fax copy is not acceptable).
- If all this checks out, we ask the borrower for a deposit (generally $1,000 to $3,000). This should be in the form of a cashier’s check or money order. If requested, we provide a conditional loan commitment letter at this time.
- 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) facts or parameters of the loan are 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.
How does the construction money get disbursed?
From time to time, as a borrower completes the construction of a project, the borrower will submit a draw request to Fairfield Financial. Fairfield will review this request and, upon approval, release funds either directly to the subs/suppliers (if requested to do so) or to the borrower (if the borrower has already paid the subs/suppliers). Fairfield is responsible for ensuring that (a) the work is completed to an appropriate quality standard (this may require an on-site inspection which will incur a fee specified in the Loan Agreement), (b) the project is on-budget (or if not on-budget, appropriate adjustments are made), and (c) that all subs and suppliers get paid for their work on the project.
What needs to be included in a private money loan package?
A private money loan packet is generally fairly straightforward. For a list of our packaging guidelines, please Click Here
— Clay (clay@privatemoneysource.com)
