Let’s look at the private money loan negotiation process from a lender’s perspective. In order to negotiate the best deal for your private money loan, or hard money investment, it is important to understand how a private money lender earns income and what income sources are available as an investor in a private loan.
The PML’s income can come in a variety of forms and from a variety of sources:
- Points – Paid by the borrower as part of their closing costs.
- Underwriting or Other Fees – Paid by the borrower as part of their closing costs.
- Referral Fees – Paid by another PML for referred business.
- Loan Servicing – Paid by you to the PML, if the PML services the loan.
- Late Fees – Paid by the borrower for not making a payment on time.
- Foreclosure Fees – Added to the borrower’s loan balance.
- Renewal Fees – Paid by the borrower to renew the loan for an additional term.
Let’s look at each type of income.
Calculated as a percentage of the loan amount. 1 point = 1% of the loan amount. A PML may simplify the closing costs by charging private money lending points without detailing separate underwriting or other fees, or may charge points in addition to other fees. The amount charged depends on the transaction, agreements between the parties, loan-to-value (LTV), risk and complexity. Here’s an example:
The borrower is charged 3 points (3%) upfront on a $500,000 loan, or $15,000. The PML generally receives a majority of the points. In some instances, a PML may agree to pay a referral fee to another PML for bringing either the borrower or investor to the transaction. The PML may also agree to share a portion of the points with the investor.
The distribution of the points paid upfront, might look like this:
- $8,000 to the PML
- $3,000 to the referring PML
- $4,000 to the investor
It is common for an investor to request ½ to 1% upfront for funding the loan to increase their yield, but this fee is negotiable between the investor and the PML.
Underwriting or Other Fees
Underwriting fees are charged to the borrower in addition to upfront points. Some private money lenders will charge them, and some won’t. While some fees will simply “pass-through” the private money lender, such as appraisal and credit report fees, others are their source of additional compensation. Examples are:
- Underwriting Fee – A flat dollar fee, typically between $750 and $2,500, depending on the complexity of the loan. Sometimes this is incorporated into the points, but may be a separate additional charge.
- Processing Fee – A flat dollar fee charged for the processing of the loan.
- Document Preparation Fee – A flat dollar fee charged for the preparation of the loan documents. Sometimes these fees will be pass-through because the PML is using a private company to generate the documents and sometimes this fee will just be additional income to the PML.
A predetermined dollar amount or loan percentage negotiated between private money lender for referred business. If a borrower is referred to a private money lender, chances are part of the fees the borrower is paying will cover a referral fee to the other PML. Due to the specialized nature of private money lending, each PML cannot be “all things to all clients.” The loans they can fund are dictated by the investors they represent, therefore making referrals common.
This fee is paid by the investor to the private money lender if the lender services the loan. The PML collects the loan payments, keeps all necessary records, provides applicable reports and interacts with the borrower. Servicing fees vary and can be a flat fee per month, or a percentage of the loan balance (e.g. 1/4 to 1% of the original loan amount, calculated annually and paid monthly.) The lender may also collect additional late fees, etc that are paid by the borrower during the loan servicing period. Traditionally, the late fee income is split 50/50 between investor and loan servicer. Here’s an example:
Assume you originated a $500,000 loan at 10% interest and agreed to pay the private money lender a 1% servicing fee. The servicing fee will be 1% x $500,000, or $5,000. The $5,000 servicing fee will be charged on a monthly basis at the rate of $416.67 per month ($5,000 ÷ 12).
If the borrower’s monthly payment is $4,383.34, the PML would first deduct their $416.67 servicing fee and disburse the net amount of $3,966.67 to the investor.
Late Fee Income
If the borrower pays after a date specified in the promissory note, a late fee is charged. Traditionally, a loan servicer splits late fee income with the investor 50/50, but is paid to the investor when the borrower pays the late fee.
The fees generated during a foreclosure may or may not be paid to the private money lender. Many lenders provide foreclosure services and therefore are a profit center for the PML. In other cases, the PML may outsource all foreclosure services and share in none of the foreclosure fee revenue. Traditionally this income is not shared with investors.
The fees are paid by the borrower for renewing an existing loan with the mutual consent of the investor. If you have a good quality, on-time paying borrower, you will likely want to renew the loan and keep your funds earning a return. It is common for a borrower to pay, either upfront or added to the principal of the loan balance, a renewal fee.
Every private money lender has a slightly different business structure so their income may be derived from one or any combination of the sources discussed. As mentioned previously, some private money lending fees may be shared with the investor. When you are selecting a lender, ask about how they manage their business, and what fees they are willing to share with investors. This will help you work through the loan negotiations faster.
For more information on shared fees see “Investor Income – Earnings Beyond Interest.”