Ask Nelson about hard money lending

[Nelson]

I brought up in another thread how I do some hard money lending and a few people asked me about it. I promised a new threat talking about it, so here goes.

 

There are two facets to the business. I try to do the majority of my lending against physical real estate. Since I'm convinced Canada is in a bubble, my max LTV is usually 65%, although it's usually much lower. You can get between 8-12% fairly easily doing this. Sure, there are risks, but I find I really minimize them by keeping my LTV low.

 

The other facet is unsecured lending. This is a little trickier because even if you have collateral, it's usually not even worth the principal of the loan. If the guy is buying a $10,000 car, he's pretty much upside down from day one. Rates are much higher (24-36% annually), and over time you'll have a 3-10% write-off rate. When times are good your write-offs are low. They go up as the economy falls.

 

I got started approaching the banks and mortgage brokers to tell them I was in the business. It just snowballed from there. A good mortgage broker will give you a steady stream of customers, and customers will refer their friends. I usually like friend referrals because if guy b doesn't pay I can put pressure on guy a.

 

If somebody gets more than 30 days behind on an unsecured payment I just sue. I do small claims court, it's easy if you have your paperwork in order. On mortgages I wait until 90 days before foreclosing. I've never had a mortgage go bad, obviously the unsecured stuff goes rotten every once in a while. I'm fortunate that my partner (my dad) is willing to go to court when the time comes.

 

After write-offs, we've easily averaged 15% returns over the last decade. That's going down as we shift towards more private mortgages, but so is our risk.

 

Any other questions I'd be happy to answer.

[Gamecock-YT]

What's been your biggest write-off?

[valueinvestingideas]

Thanks for the thread Nelson.

 

How did you start relationships with mortgage brokers? What amount of capital did you need to get started and taken seriously? what are the overhead costs in terms of paperwork, legal, etc

[Potato]

I don't understand the customer base. Who has enough equity in their house for that LTV, yet needs to pay those rates (esp. with a mortgage broker)?

 

How do you check that there aren't other liens on the property?

 

How does your loan generally get repaid? (specifically what I'm thinking is whether people are taking small loans from you and then paying you back out of their employment earnings, or if paying you back depends on getting a prime or alt-a loan from another lender)

 

Do you do any affordability checks? (debt ratios, budget workups, business plans, etc.)

[muscleman]

Are you operating as a bank? How did you get the license?

Are you attracting deposits to do your lending or are you using merely your own money?

How did you get a mortgage broker to work with you instead of with other lenders? Do you pay a referral fee to them for each closed deal?

[Pelagic]

Thanks for starting this, interesting topic.

 

Do you have a relationship with other hard money lenders whom you can refer business to and vice versa when you can't make a loan yourself?

 

How much time/effort on your part is the paperwork end of the business?

 

What's the most interesting thing someone has asked to loan money for?

[NewbieD]

Wikipedia has a pretty good article:

https://en.wikipedia.org/wiki/Hard_money_loan

 

Never heard of this type of loan where I live (Sweden).

[Nelson]

What's been your biggest write-off?

 

$10k car loan, guy paid down until he hit $7k over the course of about 30 months. Collected enough in interest it wasn't that bad, and we successfully sued him. We just can't find him to collect on the judgement.

[Nelson]

Thanks for the thread Nelson.

 

How did you start relationships with mortgage brokers? What amount of capital did you need to get started and taken seriously? what are the overhead costs in terms of paperwork, legal, etc

 

We've really only had relationships with a couple of brokers. We just called them up, told them the types of loans we were willing to do, and let them bring us business. The first one was great, sending us quite a few deals. The second one not so much.

 

You can get started in this business with just $10 or $20k. We find our customers are really only looking for that much most of the time. They're usually looking to consolidate other bills into one payment, or they have a temporary cash flow problem. I've never had a mortgage broker or a banker ask how much capital we had.

 

Mortgages are all done through a lawyer, we pay about $750 per transaction. Usually that gets charged back to the borrower through a $1-3k loan fee. If a broker is involved, we charge $3k and use $2k to pay them. With unsecured debt the form is just a standard promissory agreement, which has held up in court for us time and time again.

 

We have an office, which we use for other stuff besides this. So overhead isn't bad. We also did the business for years without an office too, just going to people's houses. 

[Nelson]

I don't understand the customer base. Who has enough equity in their house for that LTV, yet needs to pay those rates (esp. with a mortgage broker)?

 

How do you check that there aren't other liens on the property?

 

How does your loan generally get repaid? (specifically what I'm thinking is whether people are taking small loans from you and then paying you back out of their employment earnings, or if paying you back depends on getting a prime or alt-a loan from another lender)

 

Do you do any affordability checks? (debt ratios, budget workups, business plans, etc.)

 

Our market is small, no doubt about it. And when the banks were throwing out HELOCs like it was nobody's business we didn't get much. But now they've tightened up. Once you've been rejected by the bank you don't have much choice. We also have the advantage of being in a small town with limited competition in this space.

 

Pulling title for the house is easy in Alberta. We do it as due diligence, and then the lawyer does it again when they're registering the mortgage. 

 

Most loans are standard. Guy has a job, guy borrows money, guy repays from employment earnings. We're more careful with unemployed guys, obviously. We've done stuff where an unemployed guy only has to pay a small amount back monthly until they get a job and then the payment increases. Unemployed guys are always secured with lots of equity. We probably say no immediately to 80%.

 

Only one loan I can think of was refinanced with another lender, and he rolled up a bunch of other debt into it. The rest they pay off.

 

Since we're usually rolling up debt, we check affordability ratios. It's usually very obvious when the ratios are too high. But at the same time, you can't be set on 40% total debt service like the banks are. That's when equity comes into play. If you're at 40% LTV and the debt ratio is a little high, you don't sweat it so much. At 70% that's probably a deal we'd say no to.

[Nelson]

Are you operating as a bank? How did you get the license?

Are you attracting deposits to do your lending or are you using merely your own money?

How did you get a mortgage broker to work with you instead of with other lenders? Do you pay a referral fee to them for each closed deal?

 

We are not a bank. We don't attract deposits or anything like that. We're just guys who lend money. There's no licence needed.

 

We're the only lenders in town, which helps a ton. If you were competing with other private lenders my advice would be give great service to brokers. Do stuff like make quick decisions. Brokers want the path of least resistance.

 

Like I mentioned above, a loan fee gets added onto the principal. Total fee of $3k is what we usually do, with $1k to us for lawyer's fees and $2k to the broker for doing the loan. If the loan is smaller (between $10k and $20k), the broker will usually take less.

 

We've evolved to the point where we don't do many broker deals anymore. The one mortgage broker in town quit, lol. Tempted to get into the game, but I'm not especially bullish on real estate in general.

[Nelson]

Thanks for starting this, interesting topic.

 

Do you have a relationship with other hard money lenders whom you can refer business to and vice versa when you can't make a loan yourself?

 

How much time/effort on your part is the paperwork end of the business?

 

What's the most interesting thing someone has asked to loan money for?

 

We're the only ones in town, basically. At least that we know of. No idea where these guys go when we say no.

 

Paperwork is easy. It's just standardized forms we basically copied from competitors.

 

Storage lockers. Buddy wanted money to expand his business of buying storage lockers. That was a fun diversion from cars and consolidating debt.

[muscleman]

Are you operating as a bank? How did you get the license?

Are you attracting deposits to do your lending or are you using merely your own money?

How did you get a mortgage broker to work with you instead of with other lenders? Do you pay a referral fee to them for each closed deal?

 

We are not a bank. We don't attract deposits or anything like that. We're just guys who lend money. There's no licence needed.

 

We're the only lenders in town, which helps a ton. If you were competing with other private lenders my advice would be give great service to brokers. Do stuff like make quick decisions. Brokers want the path of least resistance.

 

Like I mentioned above, a loan fee gets added onto the principal. Total fee of $3k is what we usually do, with $1k to us for lawyer's fees and $2k to the broker for doing the loan. If the loan is smaller (between $10k and $20k), the broker will usually take less.

 

We've evolved to the point where we don't do many broker deals anymore. The one mortgage broker in town quit, lol. Tempted to get into the game, but I'm not especially bullish on real estate in general.

 

Thanks a lot! Have you ever thought of becoming a bank, attract deposits and grow into a bigger lender?

[Potato]

Thanks Nelson!

[bizaro86]

Are you operating as a bank? How did you get the license?

Are you attracting deposits to do your lending or are you using merely your own money?

How did you get a mortgage broker to work with you instead of with other lenders? Do you pay a referral fee to them for each closed deal?

 

We are not a bank. We don't attract deposits or anything like that. We're just guys who lend money. There's no licence needed.

 

We're the only lenders in town, which helps a ton. If you were competing with other private lenders my advice would be give great service to brokers. Do stuff like make quick decisions. Brokers want the path of least resistance.

 

Like I mentioned above, a loan fee gets added onto the principal. Total fee of $3k is what we usually do, with $1k to us for lawyer's fees and $2k to the broker for doing the loan. If the loan is smaller (between $10k and $20k), the broker will usually take less.

 

We've evolved to the point where we don't do many broker deals anymore. The one mortgage broker in town quit, lol. Tempted to get into the game, but I'm not especially bullish on real estate in general.

 

Thanks a lot! Have you ever thought of becoming a bank, attract deposits and grow into a bigger lender?

 

I shouldn't speak for Nelson, but the hurdles of starting a bank are pretty high in Canada, my impression is higher than the US. There are very few small banks here.

 

Nelson, I'm curious, how do you compete against places like the cash store/money mart? It seems like that would be what people would think of first and it would be more convenient. Or is your town small enough not to have that? I've often considered going into this business (in Calgary, where I live) but have never pulled the trigger. Do you find yourself getting smaller, loans from brokers as well? I'd be interested, but for diversification/portfolio size reasons probably wouldn't want to lend more than 20k to one borrower, which wouldn't cover a mortgage refinance, obviously. Do you write second mortgages as well?

[Nelson]

Are you operating as a bank? How did you get the license?

Are you attracting deposits to do your lending or are you using merely your own money?

How did you get a mortgage broker to work with you instead of with other lenders? Do you pay a referral fee to them for each closed deal?

 

We are not a bank. We don't attract deposits or anything like that. We're just guys who lend money. There's no licence needed.

 

We're the only lenders in town, which helps a ton. If you were competing with other private lenders my advice would be give great service to brokers. Do stuff like make quick decisions. Brokers want the path of least resistance.

 

Like I mentioned above, a loan fee gets added onto the principal. Total fee of $3k is what we usually do, with $1k to us for lawyer's fees and $2k to the broker for doing the loan. If the loan is smaller (between $10k and $20k), the broker will usually take less.

 

We've evolved to the point where we don't do many broker deals anymore. The one mortgage broker in town quit, lol. Tempted to get into the game, but I'm not especially bullish on real estate in general.

 

Thanks a lot! Have you ever thought of becoming a bank, attract deposits and grow into a bigger lender?

 

Bizarro86 is right, it's hard to become a bank in Canada. I think there's zero chance of that happening. Attracting capital isn't an issue so far, since we prefer to self fund. The way we see it is we're already doing risky loans, we really don't want to add another layer of risk on top of that.

[Nelson]

Are you operating as a bank? How did you get the license?

Are you attracting deposits to do your lending or are you using merely your own money?

How did you get a mortgage broker to work with you instead of with other lenders? Do you pay a referral fee to them for each closed deal?

 

We are not a bank. We don't attract deposits or anything like that. We're just guys who lend money. There's no licence needed.

 

We're the only lenders in town, which helps a ton. If you were competing with other private lenders my advice would be give great service to brokers. Do stuff like make quick decisions. Brokers want the path of least resistance.

 

Like I mentioned above, a loan fee gets added onto the principal. Total fee of $3k is what we usually do, with $1k to us for lawyer's fees and $2k to the broker for doing the loan. If the loan is smaller (between $10k and $20k), the broker will usually take less.

 

We've evolved to the point where we don't do many broker deals anymore. The one mortgage broker in town quit, lol. Tempted to get into the game, but I'm not especially bullish on real estate in general.

 

Thanks a lot! Have you ever thought of becoming a bank, attract deposits and grow into a bigger lender?

 

I shouldn't speak for Nelson, but the hurdles of starting a bank are pretty high in Canada, my impression is higher than the US. There are very few small banks here.

 

Nelson, I'm curious, how do you compete against places like the cash store/money mart? It seems like that would be what people would think of first and it would be more convenient. Or is your town small enough not to have that? I've often considered going into this business (in Calgary, where I live) but have never pulled the trigger. Do you find yourself getting smaller, loans from brokers as well? I'd be interested, but for diversification/portfolio size reasons probably wouldn't want to lend more than 20k to one borrower, which wouldn't cover a mortgage refinance, obviously. Do you write second mortgages as well?

 

There used to be a Cash Store in town. It closed up shop about two years ago. We like to think we ran it out of town, but it probably had something to do with the issues surrounding the parent company. I believe they went bankrupt and then the operations were bought by Easy Financial.

 

We found it wasn't that hard to compete with them. They insisted on doing withdrawals from bank accounts. If they tried to take money on a certain day and it wasn't there, borrowers would get hit with NSF and late fees of something like $50. Our customers were telling us there was no option for them to pay cash. We sort of stumbled upon that advantage.

 

To be honest we just put the word out we were looking to do loans. We got a broker on our side and it snowballed from there. We've done very little advertising.

 

The majority of secured loans we do are second mortgages. The biggest one we have outstanding is $50k, but most are between $5k-$20k. We find that if you go much over these small loans the borrower just gets in over their head. If you're worried about diversification -- a valid concern, btw -- just tell brokers you're interested in doing smaller loans.

 

Our split right now is about 80/20 secured to unsecured. We don't like to go nuts with the unsecured stuff, even though the rates of return are much higher.

 

It's tougher to break into this business in a bigger city because there's more competition. There are already much bigger private lenders out there, and many of them won't venture beyond their own city's borders. You can differentiate yourself by a) ripping borrowers off less and b) giving brokers the path of least resistance.

 

An example: many private lenders are happy to give someone a year mortgage at say 10%, all while charging a loan fee of 2%. They keep half, the broker gets half. This is standard in the business. A year later the customer has to qualify again. They're happy to do the loan again, but charge another 2% loan fee even though nothing has changed.

[oddballstocks]

This is a fascinating thread, and it's showing me how little of Canadian borrowing I understand.

 

Is it common for someone to pay 10% to get a second mortgage?  Usually the rate on a second here is higher, but not much.  We have had two (different houses), both about 1% higher than the first.  So if the first is 4.25% second would be 5.5% or so.

 

Unsecured credit is cheap as well, someone with good credit can get a car loan in the 0-5% range.  An unsecured loan for home improvement is cheap, saw a sign at Allegheny Valley Bank offering a 10yr loan at 2.49% up to $50k max.

 

I'd always heard of hard money lenders as people who charge high rates but can get a lot of cash on the spot.  For example if you're a real estate investor and bid on houses at an auction.  You might have a hard money lender who can come up with $100-200k in cash on the spot and tide you over until you get traditional financing on the house.  You pay a 10-20% rate, but it's only for a month.

 

But understandably your situation in Canada is much different than here.  Is it hard to get credit at a bank?  Why would someone come to you for a loan verses going to a bank?

[bizaro86]

This is a fascinating thread, and it's showing me how little of Canadian borrowing I understand.

 

Is it common for someone to pay 10% to get a second mortgage?  Usually the rate on a second here is higher, but not much.  We have had two (different houses), both about 1% higher than the first.  So if the first is 4.25% second would be 5.5% or so.

 

Unsecured credit is cheap as well, someone with good credit can get a car loan in the 0-5% range.  An unsecured loan for home improvement is cheap, saw a sign at Allegheny Valley Bank offering a 10yr loan at 2.49% up to $50k max.

 

I'd always heard of hard money lenders as people who charge high rates but can get a lot of cash on the spot.  For example if you're a real estate investor and bid on houses at an auction.  You might have a hard money lender who can come up with $100-200k in cash on the spot and tide you over until you get traditional financing on the house.  You pay a 10-20% rate, but it's only for a month.

 

But understandably your situation in Canada is much different than here.  Is it hard to get credit at a bank?  Why would someone come to you for a loan verses going to a bank?

 

I have a number of HELOCs from large banks (both personal residence and rentals) that are floating rate, currently 3.2%, which seems like a reasonable rate to me. But I have a good job/credit rating, and the LTVs are at 80%. They're mostly undrawn, but I like to have access to cash if bargains come up (especially RE, where sometimes a cash quick close gets you a deal).

 

I'm not sure how that compares to the US, but a prime credit can access tons of money in Canada, imo. Hard money would be for people who don't qualify at a bank, bad credit, etc. I'm considering it as a spread business (borrow on my Heloc at 3.2%, lend at 8-10%).

 

I'd be curious, Nelson, how bad is the credit of your typical client? Presumably they have jobs, but do you pull credit? If so, what do you look for?

[Nelson]

This is a fascinating thread, and it's showing me how little of Canadian borrowing I understand.

 

Is it common for someone to pay 10% to get a second mortgage?  Usually the rate on a second here is higher, but not much.  We have had two (different houses), both about 1% higher than the first.  So if the first is 4.25% second would be 5.5% or so.

 

Unsecured credit is cheap as well, someone with good credit can get a car loan in the 0-5% range.  An unsecured loan for home improvement is cheap, saw a sign at Allegheny Valley Bank offering a 10yr loan at 2.49% up to $50k max.

 

I'd always heard of hard money lenders as people who charge high rates but can get a lot of cash on the spot.  For example if you're a real estate investor and bid on houses at an auction.  You might have a hard money lender who can come up with $100-200k in cash on the spot and tide you over until you get traditional financing on the house.  You pay a 10-20% rate, but it's only for a month.

 

But understandably your situation in Canada is much different than here.  Is it hard to get credit at a bank?  Why would someone come to you for a loan verses going to a bank?

 

No, it's not common for someone to pay 10% on a second mortgage. The rate bizaro86 pays is about average. We're definitely catering a very small part of the market. 

 

I'd say 80% of our customers have been to the bank and were rejected. The other 20% come to us because of convenience, a general distrust of banks, or because they've dealt with us before. Probably half our loans out currently are with repeat customers. Word of mouth helps too.

 

These people pay a higher rate because their credit is garbage. We do a lot of consolidation loans, and people are usually in pretty rough shape before they ever come see us.They're usually at the point where they're getting threatening phone calls or letters. We've saved a few people from foreclosure too.

 

A 650 FICO score is usually what you need to get a mortgage in Canada. I'd say our average borrower is in the 500-550 range. We don't mind so much because we're secured with plenty of equity. Go ahead, don't pay. We'll just take your house. Nobody wants to lose their house.

 

There's no real estate auction market here, so we've never done anything like that. We've done stuff like flips plenty of times. But the majority is debt consolidation.

[Nelson]

This is a fascinating thread, and it's showing me how little of Canadian borrowing I understand.

 

Is it common for someone to pay 10% to get a second mortgage?  Usually the rate on a second here is higher, but not much.  We have had two (different houses), both about 1% higher than the first.  So if the first is 4.25% second would be 5.5% or so.

 

Unsecured credit is cheap as well, someone with good credit can get a car loan in the 0-5% range.  An unsecured loan for home improvement is cheap, saw a sign at Allegheny Valley Bank offering a 10yr loan at 2.49% up to $50k max.

 

I'd always heard of hard money lenders as people who charge high rates but can get a lot of cash on the spot.  For example if you're a real estate investor and bid on houses at an auction.  You might have a hard money lender who can come up with $100-200k in cash on the spot and tide you over until you get traditional financing on the house.  You pay a 10-20% rate, but it's only for a month.

 

But understandably your situation in Canada is much different than here.  Is it hard to get credit at a bank?  Why would someone come to you for a loan verses going to a bank?

 

I have a number of HELOCs from large banks (both personal residence and rentals) that are floating rate, currently 3.2%, which seems like a reasonable rate to me. But I have a good job/credit rating, and the LTVs are at 80%. They're mostly undrawn, but I like to have access to cash if bargains come up (especially RE, where sometimes a cash quick close gets you a deal).

 

I'm not sure how that compares to the US, but a prime credit can access tons of money in Canada, imo. Hard money would be for people who don't qualify at a bank, bad credit, etc. I'm considering it as a spread business (borrow on my Heloc at 3.2%, lend at 8-10%).

 

I'd be curious, Nelson, how bad is the credit of your typical client? Presumably they have jobs, but do you pull credit? If so, what do you look for?

 

Most of our clients have garbage credit. The worst FICO score I saw was in the 460 range. Guy had about four credit cards which were all in collections and a trailer loan which was three months behind. Oh, and he was about two weeks away from losing his house.

 

But he only owed $50k against a $200k property. We wrapped up the existing mortgage and the other loans into a new loan at $80k, charged him 10%, and he paid faithfully for years. He was late a few times and cheques bounced a few other times, but whatever. That's expected. At $20 per late payment and $30 per NSF cheque, be as late as you want. (We waive late fees all the time, btw. If somebody is a few days late once out of every six months I'm not going to be a jerk. But if you annoy me, you bet your ass I'm charging that.)

[Nelson]

One more thing to add: Alberta is a non-recourse province, the only one in Canada. So we add a personal guarantee to all our loans, which the lawyer says gives us the right to go after a borrower personally if they don't pay. I'm not sure if it'll hold up in court or not -- the only people we've sued have been on the unsecured side.

[muscleman]

Since you self-fund, and your return on equity is over 15%, what's your return on assets? I assume it is also 15% given you use no leverage? So the interest rates of your loans are well above 15%?

[bizaro86]

One more thing to add: Alberta is a non-recourse province, the only one in Canada. So we add a personal guarantee to all our loans, which the lawyer says gives us the right to go after a borrower personally if they don't pay. I'm not sure if it'll hold up in court or not -- the only people we've sued have been on the unsecured side.

 

That is interesting to me. I knew about non-recourse in Alberta (I looked into it extensively when I was buying foreclosures in 2009-2010, as I took on a lot of debt at that time, and wanted to know my downside). I was under the impression the only exception to the non-recourse law was insured mortgages, but if you can put a personal guarantee in that would make me more interested in doing 2nd mortgage lending, especially in this real estate environment.

 

One more question, (sorry!) do you have a third party appraiser you trust or do you form your own opinion of collateral value for real estate?

[Nelson]

Since you self-fund, and your return on equity is over 15%, what's your return on assets? I assume it is also 15% given you use no leverage? So the interest rates of your loans are well above 15%?

 

No debt, so ROE and ROA are the same. A reasonable amount of leverage would really goose returns, but we like keeping it small for diversification purposes (I don't want my whole portfolio in this) and so we can pick off what we think are the best deals. That's why we're focusing more on the secured stuff lately too. Fewer headaches.

 

When we were bigger into the unsecured part of the market, we were doing between 15-20% ROE/ROA, but that's down slightly now. At a 80/20 secured vs. unsecured split, we're probably at about 12-13% today. Secured part of the portfolio averages just about 10%, while the unsecured part is a little higher than 24%.

 

My experience is if you want to make more money, focus on the unsecured part of the business. Way more headaches (and writeoffs), but great returns.