Private Money Investing - The Lending Process

The Lending Process

A borrower seeking funds approaches a mortgage broker or private money lender and describes his borrowing needs. These include: 1) The amount of money sought; 2) The value of the property that is being pledged as security, or collateral; 3) A description of the property; 4) The use of funds.

The mortgage broker or lender then assesses the proposed loan, focusing on the value of the property being proposed as collateral. The maximum amount that may be borrowed is determined by establishing the amount of “protective equity” existing in the property.

For the private mortgage investor, this equity provides the cushion for the risk taken in extending a loan. In the event that the borrower defaults on the loan, investors recoup their capital by assuming the borrower’s equity in the property.

Protective equity is calculated by taking the liquidated value of the property (the price at which the property could be sold quickly, usually ninety days), and then subtracting any outstanding debt related to the property in the form of existing loans or tax liens on the property.

This amount is then compared to a Loan to Value (“LTV”) ratio. The ratio, established by the lender, represents the maximum amount that the lender will lend a borrower. It is expressed as a percentage of the total amount of protective equity, divided by a percentage.

This percentage varies primarily with the type of property that will form the basis of the collateral. Non-income producing or difficult-to-liquidate property carries the lowest ratio. So, raw, undeveloped land may carry a maximum LTV of 50%...if a lender will even consider using it as collateral. Rural income producing property, such as a small shopping center, may similarly carry a low LTV.

Example: Appraised land value = $1,200,000 Existing trust deed = $200,000 Equity = $1,200,000 - $200,000 = $1,000,000

LTV = 60% Maximum total Loan Amount available to borrower = 60% of $1,200,000, or $800,000. The lender may choose to place a $600,000 2nd Deed of Trust behind the $200,000 existing Deed of Trust or it may place a new single $800,000 First Trust Deed loan.

If the broker determines that the liquidated value of the property falls within acceptable limits, the broker prepares a loan package summarizing the underlying details. If a broker is not involved, the lender performs these functions in-house.

The borrower is advised as to an approximate amount of funds that may be borrowed, and is provided with a preliminary estimate of a range of interest rates and loan fees that may be anticipated. This advisement often comes in the form of a Letter of Intent or Letter of Interest prepared by the lender.

If the borrower agrees to these figures, the broker proceeds by doing one of two things: 1) He contacts individual Private Money Investors and solicits their direct investment in the loan. This is called FRACTIONAL INVESTMENT ; 2) Alternatively, he brokers the loan by contacting Private Money Lenders known to be interested in making loans of the size, type and location sought by the borrower. These lenders in turn create fractional investments themselves or are MORTGAGE FUNDS .