Learning the Private Lending Basics
The lack of traditional lending nationwide has left many borrowers and potential investors unaware of what their options are and what an opportunistic time it is to invest in real estate deeds of trust. There is an abundance of information to evaluate when looking at the different investment options that are available, and some of the terminology and phrases can be intimidating to the novice borrower and investor. With that in mind, here are some key terms and differences to familiarize yourself when determining which investment is right for you.
Definition of a Trust Deed Investment
The loan is comprised of two basic components: a promise to repay the debt, known as the promissory note, and a recorded document that is evidence of the debt, known as the deed of trust, also referred to as a trust deed on a mortgage. Once the trust deed or mortgage is recorded, the promise to repay the loan is secured by a “lien” placed on the property.
Trust Deeds vs. Mortgages
The advantage of a trust deed over a mortgage is a shorter foreclosure process. With the judicial foreclosure proceedings required with a mortgage, it may take as long as a year to acquire clear title to a defaulted property. Under the non-judicial foreclosure trust deed’s power of sale clause, this effort is reduced to as little as 120 days. The most significant difference between a mortgage and a trust deed is that there is no right of redemption following the trustee’s sale. The trustee’s sale is absolutely final and the purchaser can take possession immediately.
Senior (First) vs. Junior (Second) Positions
Junior liens are behind senior liens in priority when the security is realized and debts are paid. Because the second trust deed is in a subordinate position to the first trust deed, the junior lien holder is in a relatively higher risk position than the first trust deed holder. In the event of a default, a senior lender would usually give the junior lender a last chance to step in and make the delinquent payments. Moral of the story: You always want to be in a first deed position on a loan.
Why Borrowers Choose Private Money Loans
- Quick Funding of a Time Sensitive Loan
- Reduction of Red Tape and Paperwork Hassles
Traditional lenders require substantially more documentation than private money lenders and have more stringent loan committee processes.
Flexibility and Creative Problem-Solving
Private money lenders are more creative with complex loan situations. They can offer options like cross-collateralization of other properties, or offer more flexible terms than traditional lenders.
- Nature of the Loan and Market Conditions
The constant change in market conditions in the real estate market forces conventional financial institutions to take even more time and, thus, have become even more conservative in approving loans. Private money lenders, on the other hand, have the ability to assess the property or project’s risk and charge an appropriate fee for the perceived risk.
- Borrower Circumstances
These are not just limited to credit problems or a past or current bankruptcy. Private money is used by a wide variety of borrowers ranging from very high net worth individuals to sophisticated real estate investors and developers, all of whom prefer the speed and the simplicity of completing the loan process to credit-challenged borrowers who have limited choices for finance.
Banks and conventional financial institutions normally take much longer than private money lenders to close a loan due to certain regulatory processes and long lines of potential borrowers awaiting approval.
Another important factor to keep in mind when determining the right lender to work with is licensing. The majority of loan originators in California are licensed by the Department of Real Estate (DRE). The DRE licenses individuals and corporations to originate and broker loans. They must pass an exam and keep up with continuing education to maintain their license. In 2010, another regulatory agency, the Nationwide Mortgage Licensing System (NMLS) was created to regulate securities brokers and dealers. It provides a basis for coordination among the states for mortgage supervision and consumer protection and will prevent, for example, mortgage originators or brokers with complaints or violations on their records from moving to a different state and starting over. It is important to look at the licensing credentials of any firm you are considering.
Now that most of the terminology and ideas associated with private lending has been simplified, how do you choose the best lender? The best approach to take is to seek out lenders that are licensed and have the knowledge and experience to take the borrower and investor through a successful transaction. Make sure to research the lender you are working with, ensure that they have a direct approach, are sensitive to the transaction, and that you are comfortable and well-informed on every aspect of the deal. Most importantly, keep in mind that with real estate prices remaining on the decline, it is a great time to invest in real estate trust deeds.
Sacha Ferrandi is a licensed Real Estate Broker with the California Department of Real Estate, a licensed Mortgage Loan Originator with the Nationwide Mortgage Licensing System and a partner at Source Capital Funding, Inc., a leading lender that specializes in the underwriting and funding of residential and commercial real estate loans. For more information please visit, www.source-capital.com. Sacha can be contacted at (858) 705-6144, or via email at firstname.lastname@example.org.