3 Ways To Avoid The Guessing Game With Y...

game Guessing games are fun... when you’re 5 years old, and not a real estate investor.

When it comes to your livelihood and financial security, however, guessing games are not all they’re cracked up to be.

Hey Moguls, Patrick Riddle at your service. Today I want to talk about avoiding guessing games when working with private lenders. Forming connections with private lenders is a crucial part of being a real estate investor. Learning how to handle these deals in a professional and efficient manner will win you the respect of your private investors – and this is exactly what you need to build your reputation and your business.

So, to help you out, today I want to outline the 3 essentials when structuring a deal with your private lender. These are the basics – the fundamentals, if you will – that every REI needs to grasp before conducting business with private lenders.

It’s vital to be as specific as possible when working with a private lender – especially when discussing the rate and time frame. You should also understand how the lender would like to receive their interest. Leave no stone unturned; the clearer you are upfront, the less likely any misunderstandings or errors will mar your good name.

Now, let’s get into the 3 essentials of working with a private lender...

Essential #1: Determining the Lender’s Rate of Return

At the beginning of my REI career, I offered a 12% annualized return to my private lenders. But, this number was never set in stone.

It’s crucial to communicate with your private lenders that your rate of return is always dependant on the specific property and the present time. Various property deals, which are conducted at different times, will have varying rates of return.

If you always offer a high percentage, such as 15% returns for instance, private lenders are likely to be skeptical of your motives. In most cases, I’ve found that 8% to 12% is typical. But – again – the percentage will fluctuate with different properties and at different times.

The bottom line here is that you should ensure that both you and the private lender are 100% on board with the rate of return that is agreed upon. Then, you’ll be ready to discuss Essential #2...

Essential #2: Specifying the Loan’s Time Frame

If you’re on the fence about how long the loan’s time frame should be, always ask for more time than you think you’ll need to repay it. Better safe than sorry, right?

But, seriously, the more time you have, the more flexibility you’ll have. You never know when a flip will experience unforeseen delays or a lease option buyer will need more time to become qualified.

Consider these quick tips when determining your time frame:

No Prepayment Penalty: This one is critical. Make sure there’s no pre-payment penalty if you pay off the loan early. The note should be structured so that you are only paying for the time that you will be using the money. So, if you borrow money for 1 year but pay it off in 6 months, you’re golden.
An Extension Clause: On the other hand, you don’t want to get yourself into a sticky (and expensive) situation if you’re unable to pay the loan off completely in the allotted time frame. To avoid excessive overages, a good safeguard is to add an extension clause to your note. It may state that if the loan is not paid in full in the specified time frame, the interest rate will increase by 2% for the first additional month and an extra 2% for the next month. Make sure you include a cap on the interest rate! This will motivate you to pay back the loan on schedule, but will also prevent you from being financially punched in the gut, if you need more time.

Essential #3: Deciding on a Payment Schedule

In my REI business, I’ve paid interest monthly, quarterly and even annually to my private lenders. In the end, it’s best to ask your lender what their preference is. To you, it won’t make much of a difference.

timing If the lender doesn’t have a strong preference, I usually recommend paying the interest quarterly or annually, simply because this makes less work for me (plus, I get to hold on to the money for a longer period of time).

Really, you have a ton of flexibility in this area. The main goal is to meet your needs and the needs of your lender. Here are a few options to consider…

Defined term with payoff of principal and interest at the end
An example of this would be a $100K note for 12 months at 8% interest per annum (with no prepayment penalty, and an option to extend for 3 months). At the end of the 12 months, you would pay the lender back $108K in one lump sum.

This method is usually the easiest for you, as the REI, because you only have to worry about making a payment once. It reduces the paperwork/man hours you would need to make monthly or quarterly interest payments.

Defined term with monthly or quarterly interest payments and payoff of principal at the end
Let’s use the same example as mentioned above ($100K note for 12 months, 8% interest per annum, no prepayment penalty, option to extend for 3 months), but this time the interest payments will be made monthly. In this case, you’d divide the 8% interest by 12 months (which means you’d pay about $666.67 per month to the lender). At the end of the 12 months, you would pay back the principal ($100K).

Of course, this method is a little more work for you. But, it can be a great way to entice private lenders who are on the fence about lending you money – because it creates a passive source of monthly income for them, and they start seeing the results of their investment in just one month (instead of at the end of the year).

Application: Forging Powerful Relationships with Lenders

relationship And that’s really all there is to it. Working with private lenders isn’t as intimidating as many people make it out to be. All it takes is a little organization, clear communication and well-defined expectations to create a deal that is mutually beneficial.

As you apply these essentials, you will create strong connections with private lenders. And this will open up many opportunities that might not have existed for you before.

Sealing the Deal

How do you work with private lenders? Have you had an instance where expectations weren’t clearly communicated and this caused a hairy situation? Share your thoughts and stories below.

Make contact. Whether through referrals or online research, start making contact with reputable private lenders in your area. Build a connection with them (don’t immediately start talking about a specific deal, but instead share your business strategy, the types of properties you seek, and ask the lender about their preferences when making an investment).

Be clear. When negotiating a deal with a private lender, always be crystal clear about your expectations. Make sure everything is in writing, and that both you and the lender are on board with the terms of the agreement.

Be responsible. Pay back your loans in the allotted time frame. Avoid using your extension time period at all costs. When you pay off your loans in a responsible manner, this will be the most powerful way to increase the success of your REI business, because lenders will want to work with you again in the future.