The choice to become a private money lender is quickly growing to be the popular choice for investment portfolios. The benefits of private money lending can be substantial when it’s done correctly, and more investors are beginning to realize that this fantastic alternative investment can produce safe, consistent returns – even in times when most other investments are failing to meet their expectations. Here’s how you too can learn about private money lending and start earning double-digit returns in your portolfio:
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We’re constantly adding new information to the site that will help guide investors that are looking for a better alternative. Private money lending and Trust Deed Investing can be a complicated process, or you can make it easy and align yourself with the experts. See what MMG Capital has to offer and just how we can help you today.
Use this Guide
This information has been developed specifically for the beginning lender. Despite the growing popularity of alternative investments, and of private lending in particular, there are still an overwhelming number of investors that are unfamiliar with private lending and all of its benefits. If you’re looking for a place to learn about private lending, let this guide be your starting point. Browse through all of our article topics that cover a majority of subjects that will be of interest to you as a new lender.
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Complete an Investor Profile
If you think that you would like to become a private money lender, request an investor kit from us. Once you receive it, complete the Investor Profile to indicate that you would like to be considered for future MMG Capital Investment Programs.
Conceptually, private money lending isn’t difficult to grasp. Chances are, you already understand the basics of a loan transaction. If you’ve ever purchased a home or a car, you’ve witnessed the essentials of the process. A lender agrees to allow a borrower to use their money for a specified purpose and period of time, and the borrower agrees to pay a specified rate of interest to the lender for the use of that money. In a secured transaction, the borrower also must provide the lender with collateral that can be liquidated or sold in order to repay the loan in the event that the borrower should fail to meet its obligations.
Like any investment, there are certain risks that you need to be aware of and understand. However, what’s more important is that you understand how to nullify these risks. Most if not all private lending risks can be diminished or eliminated completely if you properly structure your loan transactions.
Liquidity
You must be sure that you won’t need your capital returned during the term of any loan that you make. Unlike a share of stock or publicly traded bond, private money loans are not readily saleable and thus are not considered a liquid investment. Loans mature at the end of a fixed term, and although you hope that they will pay off at the end of the term or sooner, some loans won’t pay off until a later date if the borrower isn’t able to pay as expected. In this case, it may be necessary to renegotiate the terms of the loan or to foreclose on the secured collateral.
MMG Capital has addressed the issue of liquidity with the creation of the Investor Liquidity Program. Investors that participate in MMG Capital Investment Programs have the option to withdraw their funds at any point during the term of a loan that they’ve made. For more information, take a look at the program details.
Collateral Valuation
The most important part of making a private loan is properly securing it with collateral. If you’re not a real estate expert, you run the risk of improperly valuing property and putting yourself in an extremely risky position. Especially in down markets, it’s not only necessary to leave a sufficient equity position in your collateral, it’s also necessary to account for the potential of further market decline, accrued interest and legal fees that will need to be paid to foreclose.
Title
The potential for there to be defects in the title of a property can cause headaches for a private lender. However, insuring your lien position properly with title insurance can eliminate many of the risks associated with these title defects and even for fraud.
Documentation
There are a number of state and federal laws that govern loans secured by real property. The way that you transact a private loan can be more of a liability than an asset if you don’t adhere to these regulations. Making mistakes in your documentation can not only expose you to the possibility that your borrower could find a loophole in your loan agreement and to avoid repaying your loan, but it could also subject you to the possibility of making an invalid loan and having regulators impose fines or forgive your borrower’s debt.
MMG Capital closes each one of its transactions with a competent attorney. Many private lenders do not utilize an attorney for their transactions and as a result put themselves at great risk of loss.
Default
When you make a private loan, you hope that your borrower will make all of their interest payments on time and repay the balance of their loan within the agreed upon term. However, there is always a risk that it won’t happen that way and that you’ll have to enforce your right to collect on your borrower. Even if you have properly secured your loan, there are a variety of risks inherent in the foreclosure process: risk of time, accrued interest, diminishing returns, accruing fees, declining market values, distressed sale value, foreclosure laws, the potential of ownership, etc.
What’s important to note, however, is that like other risks, all of these risks can be mitigated or eliminated by properly structuring your loan with these risks in mind and sufficiently securing your loan with collateral.
As we’ve mentioned before, the concept of private money lending isn’t a difficult one. However, actually doing it can be highly involved and tricky at times. Learning how to utilize private money lending takes time, but once you fully understand it, it becomes very easy to see just why private money lending and trust deed investing is such a safe, consistent, valuable tool in any investment portfolio.
If you’ve made the decision to start utilizing private money loans as an investment vehicle, the next decision that you need to make is how you’re going to invest. We recommend that no matter how you choose to invest that you don’t go it alone. Like MMG Capital, there are many private money lending firms that you can invest with until a time when you feel like it’s appropriate to venture out on your own. However, if you’re not even planning on making a career out of private money lending, these firms can be an extremely valuable resource to you for years to come by providing private money lending information and opportunities for you to participate in.
These are the different structures that you will encounter when you look for private money investment providers:
Buy Existing Loans
Some private money lenders are actually private money brokers. Rather than making private money loans, they negotiate private money transactions with borrowers and then attempt to sell those loans to investors. In some cases brokers never actually make the loan. Instead, they hand the loan off to you to fund yourself. In other cases, the broker will make the loan and then “sell you the paper,” stepping out of the way so that you can step into the shoes of the lender. You can also buy existing loans from lenders that they need to get off of their books. These can be performing or non-performing loans. In addition, you can buy pools of loans which are typically distressed.
Pros
There is less work to do and less uncertainly when you purchase a note that has already been originated. There may already be a history of the borrower making payments. There also may be an opportunity to purchase notes at a discount which can increase an investor’s yield.
Cons
You run the risk that the existing loan was not originated or serviced properly. You also run the risk that a non-performing loan will require foreclosure, which can be an extremely lengthy, complicated and costly process – especially in certain states. You can perform due diligence to mitigate these risks, but your information is only going to be as good as the broker or current lender can provide you.
Invest in a Mortgage Pool
Some private money lenders will raise private investor funds in a single entity with the purpose of lending that money. The lender, or “manager,” makes all of the investment decisions and funds loans from the pool of investment capital. The aggregate return from all of the loans made by the pool are shared by the investors in proportion to the amount of capital that they contributed.
Pros
Your investment is diversified among a wide variety of loans and you don’t have to make any individuals investing decisions because all decisions are made by the pool’s manager.
Cons
By the same taken, you don’t get to make any of your own investing decisions and have to rely on a manager to properly secure your capital. In the event that the manager becomes insolvent or fails to manage the pool properly, you may be left with dozens or even hundreds of loans that have to be foreclosed on in order to liquidate your investment.
Fractionalized Loans
When a loan is fractionalized, multiple investors participate in a single loan and their ownership of the loan is recorded by a security instrument. For instance, 10 investors could each contribute $10,000 to make a $100,000 loan. All returns and rights of these investors are tied to a single note. In most cases, fractional note investors will create a single entity for the purpose of managing the note and designate a manager to make certain decisions.
Pros
Investors can diversify by investing in parts of multiple notes as opposed to putting all of their eggs in one basket.
Cons
Every investor that participates in the note must agree on foreclosure procedures and other important investing decisions if a manager is not given absolute control over. One investor that is in disagreement can cause significant problems to the group as a whole.
As was very common during the high point of the real estate market in recent years, hard money lenders will sometimes agree to make what is called a “junior lien.” A lien that is in second position or subordinate to a first lien is a type of junior lien, as is any lien that is further down the line – such as a third or fourth lien.
What this means is that your right to collect against the collateral that you have secured is subject to all senior lien holders (usually the first lien holder) collecting all of their unpaid balance, accrued interest and fees first. Needless to say, this can equate to an extremely risky situation even if your loan-to-value is low. It’s possible that you could end up in a situation where you are required to payoff the first lien or reinstate the first lien. In other words, the borrower’s burden could become your burden. In the worst case scenario, an event of default wipes out your second mortgage completely because the market has declined.
A good question to ask yourself when considering a junior lien is: “If the borrower defaults, would I want to buy the property for the cumulative balance of both liens? And if so, do I have the resources?” If the answer is ever no, it would likely be wise to walk away and wait for the next deal.
We already know who the major players are in a private money loan transaction, but it’s also important to know what role they play in the process of funding a loan and what they’re responsible for. In most cases, a company like MMG Capital will be watching over this process on your behalf, so many of the functions will be invisible to you. However, by understanding the pieces that make up the puzzle, you’ll become a better investor and prepare yourself to ask the right questions.
The Due Diligence Process
The period between the time that a borrower comes to a private lender with a loan request and the day that the loan is actually closed and funded is what we call the due diligence period. This is the time when all of the stated facts surrounding the borrower, the collateral and their situation are verified and checked.
One of the most important functions performed during the due diligence process falls on the title company. The title company gathers information about the borrower and the borrower’s asset(s) involved in the loan transaction. In the case of a purchase transaction, the property being purchased is included. A number of searches are run on the borrower to determine whether or not there are any outstanding liens or judgments against the borrower and/or any easements or encumbrances against any property involved in the transaction. Once the title company gathers its information, it prepares a preliminary title report which serves as an offer to provide title insurance on the subject property. This is what ensures the lender that the borrower has the legal right to grant them a lien on the property as security for a loan and that there aren’t any other liens that will take priority to it (unless the lender agrees to them).
While the title company is fulfilling their role, the lender is responsible for what’s called “underwriting” – it’s the process of fact checking, verifying, analyzing and processing the information that the borrower is providing in order to qualify for a loan. In some cases, a good underwriter needs years of experience to be able to accurately assess, value and approve financial information.
Settlement and Closing
After the due diligence period, a formal closing or settlement will be set. You will often refer to this time period referred to as “the closing table” because this is the short time period when the lender and the borrower formally agree to the terms that they prearranged when they negotiated the loan. Closing documents are signed by the borrower and given either to the title company or a third party escrow company responsible for ensuring that they’re properly recorded. The escrow or settlement agent may also act as a transaction intermediary,handling loan proceeds from the lender and disbursing them to the appropriate parties, including the borrower.
The time that it takes to get from loan origination to actual loan closing can take anywhere from 1 week to several months depending on the size and complexity of a loan transaction. On average, it will take 2 to 3 weeks since there is always plenty of work to be done by the lender and other third parties responsible for different pieces of the loan funding process.
You may be thinking, “Boy, private lending sounds great and I’d love to participate.” You also may be thinking, “Boy, I wish I had more capital available to invest!” In today’s day and age a lot of investors that were once flush with cash and disposable income are saying the same thing. The average American isn’t very liquid as it’s become more and more difficult to save in rough economic times.
What most people don’t know is that the greatest source of investment funds don’t actually come out of investors’ pockets. Instead, savvy individuals are using their retirements accounts, including 401k’s, SEP IRA’s, Roth IRA’s SIMPLE Plans, pensions and profit sharing plans to invest passively in private loans. And when they do, the best part about their investment is that it’s still shielded by the tax-free or tax-deferred status of their retirement plan!
The majority of individuals think that it’s impossible to invest in anything other than stocks and bonds in their retirement plan, but that’s because they haven’t been introduced to the SELF-DIRECTED IRA. They’ve also been told by their retirement plan custodian that stocks and bonds are all that they offer. But you’re about to know better – you’re about to realize that utilizing a SELF-DIRECTED IRA you can invest in just about anything that you want from within your retirement account!
What is a Self-directed IRA?
A Self-directed IRA is a retirement account like any other. A traditional self-directed IRA allows you to save and grow your wealth tax-deferred until you are ready to begin withdrawing funds during your golden years. A self-directed Roth IRA allows you to save and grow your wealth tax-free until you are ready to begin withdrawing funds. The real difference in what the account custodian will allow you to invest in. Self-directed IRA custodians like Pensco Trust Company (www.pensco.com) and Equity Trust Company (www.trustetc.com) are two of the largest and most respected self-directed IRA custodians in the country. By rolling over your current retirement account to one of these custodians or starting a new self-directed account with them you will now have the ability to invest in private loans, real estate, precious metals, and other alternative assets directly from your retirement account.
How to Get Started
If you’d like to explore the options presented to you by a self-directed IRA custodian, you should start by contacting several custodians to see which one is going to be the best fit for your account. Once you’ve selected a custodian they’ll help to guide you through the rest of the account setup process and get you ready to invest in your first private loan utilizing a self-directed IRA.
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type of junior lien, as is any lien that is further down the line – such as a third or fourth lien.
What most people don’t know is that the greatest source of investment funds don’t actually come out of investors’ pockets. Instead, savvy individuals are using their retirements accounts, including 401k’s, SEP IRA’s, Roth IRA’s SIMPLE Plans, pensions and profit sharing plans to invest passively in private loans. And when they do, the best part about their investment is that it’s still shielded by the tax-free or tax-deferred status of their retirement plan!
