A case study in a first private loan structured for downside protection

No holdback because the borrower brought his own rehab cash is the part I'd underline for anyone reading this as a template. The second you're funding construction you're managing draws, and managing draws means inspecting work you did not scope. I have watched a cosmetic budget become a framing budget because someone opened a wall. Fifth deal or not, if his money runs out at 70 percent complete, your collateral is a house nobody wants to buy and you're the one deciding whether to finish it.

You stayed out of that. Good place for a first one.

The number I'd want you to sit with is the seven months. You got paid off early and then what? My guess is that $75k sat somewhere earning nothing for a while before the next thing appeared. Annualized returns on short paper assume you have a next borrower waiting, and most people don't for the first few years.

So the real yield over any period longer than one loan is your rate times the share of time your money is actually out. If you're deployed nine months out of twelve, 10.5 percent becomes something closer to 8. Still fine. Just don't build a plan on the headline.

Who collected the monthly payments? Did the payments just get sent directly, or was a servicer used? Loan servicing looks like one of the few service businesses in this space where the work is bounded and the same every month.

@tashaford30 the attorney line is the one I'd want beginners to read twice. $1,200 against a $6,094 gross is a fifth of the earnings, and I think a lot of people skip it on a small first loan for exactly that reason and then discover that a promissory note with nothing recorded is a lawsuit rather than a lien.

One correction to something I thought I knew: I assumed foreclosure timelines were roughly similar everywhere and they are not even close. Nonjudicial states can be a matter of months, judicial states can run past a year with a redemption period on top. That entire variable lives in the state you lend in, so anyone underwriting a downside case needs their own state's answer, not a forum average.

Add one more item to the keep list: get named as mortgagee or loss payee on the hazard policy and get the declarations page, not the certificate the borrower's agent emails. If the property burns in month four and the lender isn't named, that lender is chasing an insurance check that legally belongs to somebody else. Policies have been found lapsed for nonpayment two months earlier with nobody told. Proof of premium payment is worth asking for as well.

I pay 10.5 and 2 points happily, and it isn't because I can't get cheaper money. It's because you can close in nine days and a bank cannot. On a $128k cottage, three weeks of delay costs me the deal, and the deal is worth more than the $2,600 spread.

The thing that would make me pick your money over the next guy's is exactly what you did, an appraisal you paid for and terms that didn't change at the closing table. Lenders who reprice at the last minute get one deal from me.

What would you have done if he'd asked for the extension in month eight and you could tell the house wasn't going to sell at his number? That is where small lenders tend to get soft. Granting three more months at one point feels like earning a fee, and sometimes it is just funding the borrower's optimism with your own principal.

Small addition since nobody has said it: if you ever do take one of these back, you own a vacant house with utilities off in a market you do not live in. The first ninety days of a vacant takeback are ugly. Winterizing, boarding, someone driving by weekly, insurance that will actually cover a vacant structure because a regular landlord policy may not. Budget a few thousand for that in the downside case, never zero.

Sorry for the basic question, what is a point actually? Is it just a fee you keep either way, even if he pays off in month 2?

@megan_doyle15 I looked this up last week so I'll try: a point is one percent of the loan amount charged up front, so 2 points on $75,000 is $1,500, and it's earned at closing regardless of how long the loan runs. Which is why an early payoff actually helps the lender's annualized number, the fee gets spread over fewer months.

@tashaford30 the piece I still don't follow is first position. Does that just mean nobody else has a loan on the house, or is it possible to be in first position and still have someone ahead of you? I read that property taxes come before everything and I don't understand how that fits.

Yes, @kevin_lombard, unpaid property taxes and in most states certain government liens sit ahead of even a first mortgage, which is why lenders track whether taxes are current. First position means first among the voluntary liens.