Private Lender Document Preparation and Legal Consulting Services
While most consumers only know the big banking institutions with respect to mortgage lending, there’s an entire industry of real estate investors, private lenders, note-buyers and local community banks holding mortgages. CPC Law effectively serves and represents these players in the mortgage-lending world.
Many of our investor clients understand and benefit from the virtues of private-lending and note-buying. Banking is one of the oldest and most profitable business models in history. Savvy investors know that they can be the bank through several proven business strategies.
In the real estate investing world, “note-buying” has become all the rage. Across the nation and certainly in Florida, investors are attending workshops and learning how to find, buy and profit from performing and non-performing promissory notes secured by mortgages.
Traditionally, only big investors such as hedge funds have been able to play the note-buying game. Big lenders, Freddie Mac and Fannie Mae have long offered for sale large bundles of notes known as “tapes” and wouldn’t bother talking to the smaller investors looking to buy one or a few.
Now, there is greater access to invest in this market on a smaller scale, often through note-brokers who’ll skim their fees off the top. As with any other real estate investing strategy, would be note-buyers should exercise caution to learn the game and avoid unscrupulous coaches and instructors promising riches in exchange for very high tuition fees. Among the brokers, there are also those seeking to unload the “junk” notes the hedge funds and other big players don’t want. There’s a lot of “steak” being peddled with no real meat on the bone.
One way our clients “become the bank” is through private mortgage lending. We’re careful to advise our clients, however, that residential mortgage lending is extremely well-regulated by government agencies.
The regulatory climate tightened considerably after the real estate crash and resulting global economic collapse around 2008. This catastrophe the lending industry and its Wall street partners caused was brilliantly documented in Michael Lewis’ book, The Big Short and its movie adaptation. The crash led to many government reforms, including the Dodd-Frank Act and the advent of the Consumer Finance Protection Bureau (CFPB). Some of the reforms have helped but others have done nothing to change the business climate that could one day lead to another free-for-all and eventual market collapse the usual suspects may cause.
Although an over-simplification, the main rule and guiding principle private lenders should follow is to avoid lending to owner-occupant borrowers. Most, if not all, of the lending safeguards and regulations the government has implemented apply only to residential, owner-occupied deals. Our investor clients follow a much safer and less-regulated path of lending only to other investors holding title to their properties in corporate entities (usually limited liability companies) or land trusts.
You can certainly still lend to owner-occupant borrowers, but this requires careful compliance with the applicable rules. The regulations cover issues including limits on interest rates and points charged and strict procedural and notice requirements the big banks all must follow now.
It’s worth noting that there are some “cowboy” investors who refuse to steer clear of owner-occupant lending and still don’t follow all these new rules. They’ve been known to do things such as tell borrowers they know will be living in the home to hold title in an LLC, as if this will free the lender of regulatory oversight.
Whether it’s a calculated, knowing strategy or simply ignorant and reckless business practices, the consequences can be severe. At CPC Law, we’ve seen cases where defaulting borrowers sued in foreclosure punch back with the help of effective consumer-law attorneys and counter-sue for the lenders’ regulatory violations.
These laws carry very stiff penalties and attorneys’ fees provisions for the winning party. It’s simply not worth the risk to lend to borrowers living in the property as a primary residence unless you’re going to strictly follow the law.
Another dangerous area for investors involves the world of securities laws and their violations. Whenever investors offer a return on the money they use from other investors, these deals run the risk of violating state and federal securities laws. At CPC Law, we counsel our clients on where the legal lines are drawn and how to steer well clear of the trap of unlicensed securities dealing.
When done right, however, private-lending can be a very lucrative investing strategy. There’s an entire sub-culture of real estate investors relying on the private or “hard-money” lending market as a source of money to acquire or renovate their properties. The market conditions are such that double-digit interest-only rates on balloon notes with points up front are the norm.
Additionally, private-lending is a nice, “passive” way to invest in real estate. When you lend money secured by real property, you’re actually investing in that property. This investment is passive because after the closing, all you have to do is collect your money in the form of high-rate interest payments. On the other end of the real estate investing spectrum are very active strategies including buying, renovating and “flipping,” as well as buy and hold investments where you become the landlord and assume all the burdens that come with that role.
This passive and profitable investment of private-lending can quickly become “active” and stressful when your borrower stops paying. That’s when pre-foreclosure resolution efforts will happen. If the default can’t be resolved to the lender’s satisfaction, there may be no choice but to file a foreclosure action.
Keep in mind, most private lenders are concerned about a prospective borrower’s ability to repay during the application stage, but it’s generally a much lower priority than it is with the big banks. Most private lenders evaluate the deal under an “equity-based lending” framework. This means the overwhelming concern for most private lenders is the loan-to-value ratio, or “LTV” in the deal.
LTV refers to the amount of the money lent in relation to the fair market value of the property at that time. Investor-buyers use the framework of after repair value (“ARV”) to calculate the market value of the property after they fix it up.
Cautious lenders will get data on the current market value in its as-is stage. Appetites for risk will vary greatly among private lenders, but most we’ve worked with require an LTV around no higher than 60-65% and maybe push up to the high 60s or 70%.
A good rule of thumb for a private lender is to do the deal if they would be willing to buy the property for the amount of their principal investment plus litigation costs and other categories of “breakage” such as lost interest income during litigation. This approach assumes the worst-case scenario of the borrower’s default and having to take back the property and eventually own it for the price of the loan plus costs.
The lower and more conservative the LTV, the greater “cushion” the lender has in the event falling market values like we saw when the bubble last burst. Reckless institutional lenders pushed up tolerable LTV ratios (including many extreme cases of lending above the market value by adding equity lines of credit to the purchase money mortgage at closing) and got burned badly when this Ponzi scheme collapsed, values plummeted and their collateral properties became “upside down.”
CPC Law represents private lenders through document-preparation services on their deals. We take a cautious approach to “expect the unexpected” and carefully draft the necessary documents for the closing, review the title work and represent the lender’s interests in the deal.
As the big-bank lending industry does, our investor clients pass the reasonable costs of our document-preparation services to the borrower at closing. If our client is able to select the title/closing-agent, our affiliated title agency, Esquire Title Company can handle the entire closing.
In most deals, we prepare the following legal documents for our private-lender clients. First, there’s the mortgage. Not to be confused with the Promissory Note, this is the document that gets recorded in the public records to secure payment of the note by the real property serving as collateral. In common verbiage, “note” or “loan” and “mortgage” are used interchangeably, but they have very different legal meanings.
The Promissory Note is the contract that creates a promise to pay back the debt. The note is not customarily recorded in the public records. It’s extremely important for the lender to safeguard the original note in the event it needs to be filed in court in support of a foreclosure. Although legal procedures exist in Florida to foreclose using only a copy of a note, it’s always better to have the original, especially to shut-down any potential borrower defenses arising from the loss of the original note.
The next document we usually prepare is known as an “Assignment of Leases and Rents.” This document is recorded in the public records and serves to protect the lender’s interests above and beyond the mortgage. In particular, it helps the lender intercept and collect tenant rental payments when the borrower stops paying the lender but continues collecting rents.
We’ll also draft a “Personal Guaranty” for our lender clients. Most investors avoid lending to owner-occupant individuals and instead deal with other investors for the reasons described above. As such, the title-owner of the property will likely be some entity such as an LLC or land trust.
The personal guaranty makes the individual behind the corporate entity or trust individually liable for payment. This will allow the lender to sue to collect not only from the entity title-owner, but from a human being. This safeguard generally increases the chances of getting paid by having another target in the foreclosure suit. Many companies such as closely-held LLCs have no assets. Although many individual distressed borrowers are “judgment-proof,” it’s better to have as many options as possible to pursue to collect the investor’s money.
If you’re an investor looking for legal help with private lending and lender document preparation, call CPC Law for your attorney consultation.