Lean in. We’re going to let mortgage brokers in on a little secret: There’s a ton of money to be made in private lending, and brokers today have a unique opportunity to cash in on this interesting scenario.
At a time when Dodd-Frank is putting the squeeze on traditional bank lending, private lenders are proving to be a much more viable and reliable option for developers and investors, and those who are tapping this unknown resource are experiencing a boon in taking advantage of a new profitable stream of income.
With limited funding options in today’s real estate market, it’s private lending that’s proving to be the path forward. But rest assured, the broker is always protected, and very well compensated in these transactions.
The key to success, however, is to first establish a relationship with a private lender, before the customer comes in looking for a loan. This can be a real game changer.
While no lending scenario is the same, the mortgage broker is always the liaison. The bottom line is that with every different lending scenario, private lending provides a myriad of options to create an innovative financing solution.
It may be all the same in a residential deal, but in a private lending scenario, for commercial loans on residential homes, every deal is different.
For example, a mortgage broker may have an investor who owns all kinds of properties and wants to buy another property. Or, the broker may have an investor who just wants to buy a property to fix and flip it.
Then there’s how to qualify the borrower: Some have a lot of cash on hand; others have very little, but have great equity. It’s all about working with that borrower to find the right solution for a private loan.
Traditional vs. Private
First, let’s review the differences between traditional bank lending versus private lending:
We begin with the purchase of an owner-occupied house, i.e. homeowner is moving into the house. This of course is not a deal that private lending underwrites. However, if the purchase is a non owner-occupied home, while some banks may like it, private lending lives on it.
And when it comes to the purchase of a home that’s in foreclosure, some banks may approve it, depending on whether the home has a certificate of occupancy; private lenders do these types of deals all day long.
For traditional bank financing on mixed-use properties, it depends on the bank’s appetite. Some banks in more urban areas are comfortable with mixed-use. Private lenders on the other hand covet the opportunity to finance mixed-use properties. It’s a win-win scenario for private lenders, brokers, and developers with rents downstairs of a commercial nature and apartments upstairs for residential living. It’s a perfect situation for the diversity of income.
Even for borrowers who have filed for bankruptcy, while lots of banks are turning these customers away, private lenders are a viable solution, especially if the borrower is coming out of bankruptcy better than ever.
With traditional banks, it’s all about fitting that borrower into a box. Private lenders take into account a series of outside variables. We don’t know exactly how the borrower’s poor credit score is going to impact the loan. However, if the borrower has cash, and is making money, then a private lender will do that loan. If the borrower’s score got beat up because of foreclosures or short sales in 2009, 2010, or 2011, it’s not an issue for private lenders.
We want to know exactly what’s going on today with that borrower – not what happened in the past.
For distressed properties, i.e. if the property is beat up and has the opportunity to be repaired, private lending is exactly where it can help investors succeed.
And for investors with multiple properties, while many banks will place a cap on the amount of properties a borrower can have on their books, private lenders don’t have a cap. It’s all about track record. We want to know that the borrower is churning through those properties and making money.
Advantages of Using a Private Lender
Intelligent Lending Criteria
Private lenders can establish their own lending criteria, which gives an investor a greater opportunity to qualify for a loan. This means there’s nobody in Washington DC telling me what my rate is going to be, or telling me what the credit score has to be on my borrower. It’s our money, so in the commercial world, we’re going to set the rate and we’re going to set the term. So if we don’t get paid, it’s our problem, not the taxpayers’ problem.
A borrower can receive funding for a distressed non-owner occupied property, rehab property and new construction.
When traditional lenders can’t provide investors solutions, private lenders have more room for negotiating and can come up with creative answers. For example, if a borrower owns a home with a lot of equity that they’re renting out, and they don’t have cash, we will be happy to put a mortgage on that existing property, pull out some cash, and put that towards a new home that they would like to purchase.
It’s these creative solutions that private lending does all the time.
Alternative Loan to Value
A private lender may lend a higher Loan to Value than a traditional bank.
Quick Loan Closing Time
Private lenders will typically respond to all loan inquiries within the same day.
Closing in two weeks, no problem.
This is precisely where private lending really shines over traditional bank lending. Most private lenders will provide short-term, bridge financing for Straight Acquisition, Acquisition/Rehab (fix & flip), Refinance, Cash-Out and Lines of Credit.
The flexibility and ability to close quickly can provide borrowers with a clear business advantage and afford them a competitive edge based on speed.
While a traditional loan can take up to ninety days to close, private lenders can often close a loan in as little as two weeks, or even a few days. This can give the borrower a greater sense of security early on in the loan process.
How do brokers make more money?
Some brokers like to have minimal involvement, while others like to have heavy involvement. The amount of compensation earned depends on the broker’s level of involvement and the loan scenario. It’s just that simple.
On the minimal side, maybe a broker’s business is booming and he/she doesn’t have time to deal with a private loan, then he/she would hand it off to the private lender. Once the deal is final and we close, we send the broker a point, and the check gets cut at closing.
If the broker wants to be actively involved in the private loan, and wants to control the deal, we will ask the broker to help collect documents and put the package together, and then split the points at closing.
All fees that are earned by the broker are disclosed on the commitment letter up front. Origination fees are charged up front, and private lenders split points with the mortgage broker.
Broker fees are memorialized on the HUD and a transaction-specific agreement is provided. There’s no ambiguity.
A check is sent directly to the broker at closing.
Basic Loan Qualifying Factor
Traditional rules apply in the world of private lending, and the common sense approach works every time when it comes to underwriting. It all comes down to income, credit, and equity. If they have two out of the three, then we’re going to do that deal. If the borrower only has one, then we’re going to have a problem.
Exit strategy is at the top. The first question is how will the borrower pay us back? Since most loans are only 12-18 months, exit strategy is key. We want to know how we’re going to get paid back.
Experience and background are fundamental. We like to know that the people we’re dealing with know what they are doing. As great as the HGTV shows are when it comes to fix and flip, it’s not the real world education that we’re looking for when it comes to making private loans.
Existing leases also help when qualifying a loan. This shows good solid income upfront, and typically comes to play when buying a multifamily home or small apartment complex.
Of course, cash reserves cure all problems. When a borrower with a poor credit rating comes to us after declaring bankruptcy, but has a great track record of fixing and flipping homes, and has $200K in cash, we’re going to make that loan.
Private loans are not for everyone, but can be a financial game-changer for those with poor credit or those who are self-employed. Mortgage brokers have a unique opportunity to grow and expand their own business through this creative funding source as well. Rather than disregard private lending as cumbersome or out of reach, brokers should embrace the chance to make money outside traditional forms of bank financing.
Jeffrey Tesch is Managing Director of RCN Capital LLC, a national, direct private lender. He is responsible for the day-to-day operations of RCN, including sales growth initiatives, underwriting review with compliance oversight and leadership of senior level strategic planning. Joining the Company in 2010, Tesch led efforts to develop a national brand in private lending with the best practices and transparent products for a diverse customer base. Since RCN’s inception, Jeff has personally underwritten over 1200 loans and overseen $250M+ in originations. Jeff’s previous real estate experience was as an investor in both commercial and residential properties, ranging from single family homes to commercial retail centers. Jeff currently serves as a member of the American Association of Private Lenders’ (AAPL) Ethics Advisory Committee.