Matching the Lender to the Loan – Part Two!
Last week I was telling you about a “Fictional” story of Real Estate Investor James and his Private Lender Terry. James bought a house and borrowed money privately from Terry to buy, renovate and sell this investment. Things quickly went wrong.
I put “Fictional” in quotes because this is based in fact. Actually I put together a couple of worse case scenarios from actual lenders and investors. Nothing can ruin a relationship faster than money. Fortunately, it can be prevented with a little forethought and communication.
If you missed last week’s newsletter you can read it below.
James could have prevented this situation by finding another lender. Terry needed her money in 9 months because of a previous commitment with the money. James did not take into account that he may need to have more than one exit strategy. He didn’t take into account that things may not always go just right. He should have put a safety factor into the timeline. Unfortunately, it seems that things never go the way we plan.
Remember the old saying; “Man plans and God Laughs.”
Unfortunately, like most investors, James would rather have gotten the money right away so that he did not lose the deal and the potential profit. He saw close to $95,000 gross profit and he wanted to get started. Nothing wrong with being anxious to make money but you need to think ahead at what could go wrong as well as what could go right.
When planning, I always have a contingency for both time and money. If something looks to take 6 months I will plan for 12. If I figure that I could sell retail I analyze what could happen if I need to discount or sell creatively.
In this story, James only planned on selling retail. He did not anticipate what would happen if he would need to sell on lease option or seller financing. If he had, he would never have promised to pay of the note in 9 months.
At month 9 he could not pay off the note. He was in default. What could he have done differently?
1. Talk to the lender, starting in month one. Give status reports and updates along the way. At least on a quarterly basis, preferably once per month.
2. At month four James should have been asking Terry if he could extend the loan term out because of the selling situation. Terry may say yes. Things could have changed in her life as well. If not James should start to look for another lender.
3. Once he finds a lender that will better match the loan he could then do a “refinance” closing, swapping out one loan for the other. I would be communicating with both lenders to ensure they understand what is going on.
That would have been the cleanest way out for both the lender and the investor. They would still have had a good relationship; James could have borrowed money from Terry in the future.
Due to these circumstances Terry was forced to foreclose on James. Terry was in second position and had to begin making payments on the first mortgage. Terry spent 150+ days foreclosing on the property and in the end had a property worth $325,000 but it cost her $245,000 + in legal costs. She ended up making about $80,000 because James couldn’t sell the property. She then had the option to sell it or to turn it into a rental.
At the end rather than have Terry foreclose, James could have given Terry the deed in lieu of foreclosure. James would have admitted his mistake and done everything he could have to mitigate the loss to Terry. Terry would have gotten the property, rather than go through the foreclosure process, and would have saved almost 5 months worth of hassles.
Either way, the foreclosure would have been prevented if James would have found a lender that was looking for a longer term investment rather than 6-9 months. There are plenty of people like that out there; you just need to find them. It would have been better for all involved.
By the way, James didn’t just mess up on the loan he ruined his real estate investing business. Terry would have spread the word and nobody would ever lend money to James again, and they shouldn’t.
This is why I advocate protecting your private lenders above all others. It can ruin you and your business. Whether intentional or not, you can really harm people and their lively hood. This is why there are tough securities laws. If this is done intentionally, it can be determined to be fraud and you can be prosecuted.
This can easily be prevented by being realistic going into your transactions and with continual communication.
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