3 Touchstones Every Private Lender Needs to Fund Your Deal

A few weeks ago, I did a terrific blog post on deal structuring that described how to craft win-wins with your private lender. Specifically, we talked about the pros and cons of a partner versus a rate-of-return deal structure. Make sure you check that out because it’ll help make today’s post a little easier to digest…

So, now I want to talk a little bit more about structuring deals for your private lenders. In today’s blog, you’re going to learn the three essential touchstones that every lender needs to fund your deal.

So exactly what do I mean by three touchstones? Well, if we dig into the good ole Merriam-Webster Dictionary, we find that the definition of touchstone is:

A fundamental or quintessential part or feature.

That fits perfectly because in this blog, you’ll get a good grasp on those three fundamental pieces that your private money lender will need before your deal can be funded.

When working with your investor, leave nothing to guesswork. When presenting an investment opportunity, be as specific as you can with your offer in relation to the rate and time frame. Then, ask the prospect how they would like to receive their interest. Listen and learn!

Touchstone #1 Determine the lender’s rate of return

When I first started getting private money, I offered a 12% annualized return. But,

when I followed up with someone and offered a deal to them, that didn’t mean I still offered the same terms.

I let prospects know when I showed them the presentation initially that we were

currently offering X% but that didn’t necessarily mean I would continue offering the

same rate. Determine what specific rate you’ll be offering based on the deal that you need financing for at that time.

This can be chalked up to human nature, but sometimes when a potential investor sees an offer of “15% returns safe,” they may be skeptical. They’re thinking “What’s the catch? Is there some kind of a scam here?”

In my opinion, people are more receptive to a rate of return between 8% and 12% at the high-end. It’s whatever you feel comfortable with for your cash flow – and/or

whatever the lender feels comfortable with.

Touchstone #2 Time frame of the loan

Based on your exit strategy, what would be the ideal time frame for the investment loan? Always ask for more time than you think you’ll need. The longer the time frame allowed paying back the loan, the more flexibility you’ll have…

If things don’t work out flipping a property as quickly as you thought or a lease option buyer isn’t able to get qualified in the time frame you wanted, there’s already a safety net built in with additional time.

Quick Tip #1: Make sure that the note is structured to pay only for the time that you are using the money. For example, if you borrow money for a year and pay the loan off in full after six months, you pay the investor only for the six months that you borrowed the funds. Make sure there is NO PREPAYMENT penalty. This allows you to set a 12-month note, but to pay it off in a shorter time frame if you want to without penalty. You pay the interest rate on the money only for the time you have it.

Quick Tip #2: A good safeguard to add to your note is an extension clause. For example, I state that if the loan is not paid back within the time frame allotted, the interest rate goes up 2% for the first additional month and 2% the next month. The loan is then capped at that interest rate until it’s paid in full. This gives me an incentive to pay the loan back on time, but also gives me added flexibility if extra time is needed.

Touchstone #3 Payment schedule

For the third and final touchstone, you need to be clear in how the investor will receive their interest…

Will it pay out monthly? Quarterly? Annually? Or will the interest accrue until the property is sold?

My goal is always to meet the needs of the investor the best I can. If an investor wants to receive the interest monthly, that’s how it’s paid.

In my own business, I’ve set up monthly payments, quarterly payments, and annual payments with investors. As I said, I’m always looking for what fits the needs of the investor. What are they looking for? What makes the most sense to them?

Of course, if they want to receive interest but they don’t really care how it’s paid out, I prefer to go with quarterly or annual simply because it’s less work. Also, it allows you to hold on to the cash longer.

My suggestion here is that you not get caught up by over-thinking how to structure the loan. You have so much flexibility here. The loan can be structured in

virtually any way you can dream up. Try to keep it as simple as possible while meeting everyone’s goals.

Here are a few suggestions…

Simplest

Defined term with payoff of principal and interest at the end.

Here’s an example: $100,000 note for 12 months at 8% per annum – with no prepayment penalty – with an option to extend for 3 months.

You borrow the $100,000, and at the end of 12 months you pay the lender back

their $100,000 plus the interest ($8k in this case) in one lump sum.

Convenient for some lenders

Defined term with monthly or quarterly interest payments and payoff of principle at the end.

Here’s an example: $100,000 note for 12 months at 8% per annum – no prepayment penalty – with an option to extend for 3 month, and with monthly interest payments.

You borrow $100,000, and each month you pay the pro-rata interest due for each month. In this case, you can divide 8% by 12 to find the monthly interest paid to the lender (which is about $666.67 a month).

At the end of the loan term you pay the lender back their principal (and/or any other outstanding interest) of $100,000. This can be a headache to manage for the real estate investor. However, it’s a great way to get new lenders in the door who are looking to create a passive income. They immediately see results (aka, you sending them money) rather than having to wait an entire year to get any of their money back.

Bottom line

Now you have it – the 3 essential touchstones needed in order to correctly (and profitably) set up a private money loan.

If you follow these guidelines, you’ll become quite the popular person with your investors. They’ll be quick to want to work with you again. And again. And… well, you get the picture.

What’s your experience?

Are these guidelines new to you? Or is this something you’ve practiced? Or – perhaps you have a few tips of your own you’d like to add to the mix. We’d love to hear from you. Leave your comments below.