Private Money Financing - Making an Origination Determination

Mortgage brokers and real estate professionals have a variety of lenders for their clients, including private (“hard”) money lenders specializing in business purpose loans. While these lenders focus primarily on the equity of the collateral real property, the type of borrower and the purpose of the loan should be carefully considered before contacting these lenders. 

First, some important CFPB definitions:

• Consumer: A natural person to whom consumer credit is offered or extended. Trusts and Land Trusts are considered as Consumers.
• Entity: Corporations, partnerships, trusts, associations, churches, unions or fraternal organizations
• Statement of Use: A form, usually handwritten by the borrower, indicating how the borrower intends to use the borrowed funds. 

TYPE OF REAL PROPERTY SECURITY

The type of security doesn’t much matter when determining the private money loan purpose. An SFR can secure a loan made to a consumer if the loan proceeds meet the business purpose qualifications. A loan to a consumer secured by a commercial building, however, would not qualify to be a business purpose loan if the proceeds were being used for a personal, family or household purpose. That same loan, if obtained by the same entity which owns the commercial property, would be exempt and not require loan purpose qualifications. 

PERSONAL, FAMILY OR HOUSEHOLD USE = CONSUMER

?Another initial indication of a consumer-borrower is to determine if the loan funds will be used for “personal, family or household” use. If so, this will be a consumer loan which most private money lenders avoid. These types of loans include the purchase of or improvements to a primary residence. Also, unless the original loan funds had been used for business purpose, a rate-and-term refinance of a primary residence is also a consumer loan. 

ENTITY EXEMPTIONS

There is a regulatory exemption when loans are made to “other than natural person” under which most private money lenders operate. This includes established entities. The underlying real property which is securing the loan shall also be either in the name of the entity or one of the entity’s officers/managing members. 

BUSINESS PURPOSE EXEMPTIONS

The other type of exemptions relied upon by most private money lenders is for use of funds. The initial funding decision involves loan purpose, specifically whether or not the loan proceeds will be used primarily for a business purpose. There are 5 factors which are traditionally used to make this determination, which can be simply stated as:

• Borrower’s primary occupation vs how funds are used
• Borrower’s involvement with how the funds are used
• A loose ratio involving the effect on future income
• Transaction size
• Borrower’s statement of purpose

These are guidelines only, but they are intended to be used by private money lenders to make the most informed decision to either proceed or to inform the borrow that private money funding may be unavailable from that lender. 

Prior to contacting your lender, determine if the borrower may expand their potential lender pool by qualifying as either a business-purpose borrower or under an entity exemption, especially if the banks have said no or are a bit too slow.

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Andy Dick is the President of Showcase Investments, Inc., a CA DRE licensed private money lender for real estate investors, small business owners, construction loans, trusts and probates. He can be reached by email at [email protected]