I always get a lot of questions about how to handle the private money, so I'd like to go over a few of the basics.
- Touching the Money.
- Co-mingling funds.
- When do the payments start and end?
- Touching the Money
Sometimes when people hear the kind of interest, I pay they will get so excited about loaning me money that they want to hand me a big check right on the spot. This is not the way to handle the situation. I want them to send the check to my closing attorney or title company just before the closing.
I know that some of you are so eager to launch this new phase of growing your business that you really want to grab that first check but don't do it.
Here is why. You have promised the lender that the money is secured by real estate. So you don’t want to touch unsecured money.
This is the procedure: have a quick meeting of the minds with the private lender, and then they send the wire to the closing agent for closing. Nice, neat paper trail and well-informed lenders.
- Co-mingling funds
Here is a common scenario: You will have two lenders who each have a small amount to loan. With the combined amount, you have enough funds to cover a particular property. Question: Can you just put the money together and have them share the first mortgage? The answer is no. But you can if you take additional steps as I’ll explain below.
Now my procedure is to give a lender a first mortgage on a property. If I need additional funds, I can give another lender a second mortgage after explaining to them that the first mortgage holds a stronger position. Larger amount of money gets the 1st mortgage, and the smaller amount of money gets a 2nd mortgage.
You cannot co-mingle funds. BUT... if you do some paperwork with the state, possibly pay a fee, then you can pool money and put all private money lenders in 1st position...
- When do the payments start and end
This is a little tricky for some real estate investors to understand. The best way to structure this is to start paying interest from the day of closing to buy. Then it stops on the day of close to sell. Now at the time of sale, you will find many private lenders will want you to hold on to the private money so you can keep paying them interest.
I do not do that. I want the money secured by real estate, so I never keep the money in the gap between properties. It might end up getting spent on something else. Besides, why would you want to keep the money? The reason real estate investors think they want to hold onto the money is because they are fearful that the lender won’t give it back. Have no fear. The lender will be begging you to take their money on the next deal. Your job is to get them that next deal.
My job is to make repairs and get the place lease optioned, rented, or sold so it is producing income to cover the interest payments I need to make to the lender. I can get this done in lightning speed because I have 100% of the lender’s private money. So I don’t have to beg a bank or hard money lender for draws.
I continue paying interest to the lender as long as their money is on the property. When the property sells, they get a check at closing for their principal and interest.
I ask them if they want to loan their money on another property. Nearly all will say yes and then, their interest payments start again at the next closing to buy.
So, they earn interest while the money is loaned – from the day of purchase to the day of sale.
On short-term loans, I came up with an “Alan’s Rule of Thumb”. If I have someone’s money less than 90-days, on a house I wholesale, I pay a minimum of 90-days interest on all loans on properties sold under 90-days. I just feel it is fair with the lender since they took the time to move their money for a short period of time.
The lesson here is to run a professional operation and have your handling private money rules in place.
You'll be much happier in the long run.