Other People’s Money

Photo by UfaBizPhoto / Shutterstock The first time you loan a substantial portion of your wealth to a rehabber, you may worry about this being your new home—no matter what your relationship with your borrower. When you stop worrying, it’s probably time to stop lending.

Photo by Ardfern / CC BY-SA If you’re putting your money in Any bank, you might as well be putting it in The Bank, an Irish pub. You’d get more pleasure out of it, anyway.

Being a PML can earn you a Lot More Money than a bank CD. I think the rewards are worth the risk.

This post originally appeared on the Hermit Haus blog on 2016-09-08.

In a previous post, I talked about the advantages to Hermit Haus of using other people’s money (OPM). I mentioned that I prefer using private money to every other source. I prefer private money because I really do believe in the big Win-Win and spreading the wealth around a bit. This post deals with why becoming a private money lender (PML) is good for you as the lender.

Let me start out by saying I am a PML. I have helped fund several other people’s projects. I don’t like lazy money. I want my money working all the time—even when I don’t have a deal in progress. (Yes, that does happen sometimes. It seems like this business is always going from one extreme to another. Either you don't have any deals at all or someone accuses you of being a "house hoarder.")

What’s the Worst That Can Happen?

A few years ago, I was at one of those massive networking events with vendor booths all along one wall. I got to chatting with a hard money lender who was willing to fund 70% of the after repair value (ARV). At that time, I had been doing one deal at a time, mostly with my own money. I asked him about the risk of lending money on an undone house. "What's the worst that can happen?" he asked.

“I don't know. I guess I default on the note,” I said, somewhat naively.

“No,” he said. “that’s my best case scenario. Then I get a $200,000 house for $140,000, and somebody else has done the renovation, or most of it." He let that sink in. "The worst that can happen is you pay off the contract as written. Then don'tI only make 14% on my money.”

That was an eye-opening conversation for me. The worst that could happen was for the borrower to honor the contract. Wow!

Why Lazy Money Is Bad

Even though my hard money friend said the worst that could happen was that I paid back his loan, he was wrong. The worst that could happen was that I left my money in the bank. I want my money to work for me, not laze around in a bank. Here’s why:

Banks are pay ridiculously low interest rates. They can get away with these low rates because your money is “safe,” protected by government insurance. Even if the bank fails, you get your original deposits paid back. But that’s not really safe, is it? If you only get back what you put in you have really lost money. In fact, even at the interest rates banks pay today, you are losing money every day you let your lazy money vacation in a bank. Assuming the federal government’s core inflation rate of about 2.2% (January 2016), your money is worth 0.183% less every month. If you put $100,000 in a CD in January, it would be April before the interest rate you earned would overcome inflation. Think about that. It would be three full months before your money—including interest would buy as much as it would if you spent it all in January! And that’s with the highest paying CD I could find on the market today!

At the end of the year, your $100,000 would have grown to $101,124, but it would only be worth $100,939 compared to January. that’s still $939 more than you had to begin with, and compounding would continue to make it grow faster each year. But if you needed to have a million dollars to retire and maintain your current lifestyle, how long would it take you to get there? Would you even still be alive?

Why You Should Be a Private Money Lender

The only way to beat the bank is to BE the bank. Become a PML.

Let’s say you invested that same $100,000 with a reputable rehabber at 10% with one point paid at funding. You would earn $1,000 just for making the loan.

Think about that. You’d make almost as much money just for making a loan that could possibly be repaid the next day as you would for leaving your money in a CD for a full year. Then you would earn $833 in interest every month until the loan was repaid when the house was sold. that’s a lot more than the $183 the highest paying CD would give you.

Now as a PML, you could let your money compound, just as you would with a CD. But you could also take that interest payment every month and do with it what ever you want. Put it back for taxes. Make a car payment. Anything. What would it be like to drive a $100,000 car and have someone else make the payment for you every month? At the end of the day, you have the car and the $100,000.

The graphic at the right compares the money you'd earn as a PML to the money you’d earn in a CD. Even if one project finished and it took two months to find another project to fund, you’d still make $9,552 during the year. that’s $8,428 more than a CD. You’d make an additional $360 by letting the interest compound. Or you could drive an essentially free car.

The Bottom Line

The bottom line is simple. Find a local rehabber to work with. Fund their projects and let them do the work. Just make sure you have a good contract and a first position lien on the house. I would also recommend that you not loan more than 75% of ARV and stay involved with your rehabber. That way, if the loan goes south, you still have a $133,000 house for $100,000.

For more information about being a PML, sign up for our free booklet.

The Saddest Sentence in the English Language

This is how foreclosure feels. First there’s the dread of the inexorably rising debt as the event draws near. Then your house gets swept away in an impersonal flood of legal procedure. Photo by Carsten Knoche

This post originally appeared on the Hermit Haus blog on 2015-11-04.

Foreclosure is a financial tsunami.  It sweeps away years of good credit practices into a black hole of future agony.  For years, up to a decade, after a foreclosure,  foreclosed persons can’t escape the enormous gravitic pull of the black hole as it stretches pulls, stretches, and tears at them, trying to suck them down into a pit of financial oblivion.

Losing a house to foreclosure is just the start of a decade-long nightmare that makes Freddy Kruger look cuddly.

• It will be years before they can buy another car or truck, except at a “note lot” that specializes in taking advantage of people with poor credit—often by requiring them to come up with an astronomical down payment that covers the seller’s total investment in the vehicle.
• They won’t be able to buy another house, and since most apartment communities use credit score to qualify prospective tenants, they may not even be able to get a nice apartment.
• The foreclosing bank can file a 1099 showing the unpaid balance of the mortgage plus fees and additional interest as income, which causes the IRS to come after them for unpaid taxes on that income.
• Even in states that don’t allow creditors to garnish wages, the IRS can.

It’s a process that can be avoided. One of our primary goals at Hermit Haus Redevelopment is to help distressed homeowners avoid foreclosure. We have several tools to chip shore up against foreclosure in our tool box (buying the house for cash money is only one of them). And, of course, we make money doing it.  If we didn’t make money, we couldn’t continue to help more people.  And our whole reason for existing is to help as many people as we can.

But people have to let us help.  And that brings us to the saddest sentence in the English language.

Are you ready for it? Here it is:

“No, I trust my bank.”

Carol and I had been working to get a family to allow us to help them avoid a foreclosure.  Last Thursday, the homeowner said, “No, I trust my bank.  They said they would help us with the loan.”  Yesterday, the house sold at foreclosure auction.  The bank’s opening bid was higher than the after repair value of the house.  They really wanted it.

Please don’t trust the bank.  And please don’t let anyone you know suffer through the financial nightmare that is foreclosure.  Call us.  Call our competition!  Please, call someone who can help.