S.E.C. Real Estate Observer

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As many of you know, I have been involved in short term mortgage financing for many years. Like every business, there are critical things that have to be incorporated into the transaction. Below, based on my experience, are the top 10 things to remember when you’re involved in lending your funds and taking back a short-term mortgage.

1. Get a “heavy” real estate attorney to create your documentation. Don’t be reluctant to pay top dollar to “create” the right document for you. Once you’ve settled on “standard “documentation you can utilize a “middle of the road” attorney who is more reasonably priced for your future closings. Have your attorney research the usury statutes of the state you’re operating in. These statutes will define the maximum interest rate you can charge. Remember, each state has its own rules and regulations.
2. Don’t lend to a complete stranger. Find your prospects through referrals of other brokers or persons you know and respect. Check up on the borrower. Obtain a ‘tri-merge” credit report. Get a Net Worth Statement, even if it’s rough (and have him/her sign and date it.)
3. Forget about amortization! Since the loan were discussing is short term, amortization is somewhat meaningless. Also, and very importantly, it will make your record keeping so much easier at tax time. All payments will be either all interest or all principal.
4. Insist on monthly payments.
5. Always state the purpose for the use of the funds in your loan agreement so that the funds must be deployed toward a specific property you both have agreed upon.
6. As much as possible, loan on projects or properties that are “self-liquidating” in nature. In other words, pick those loan opportunities where the loan repayment will be available from the proceeds of the project itself, such as a rehab.
7. Forget about second mortgages! Stick to first mortgages until you have done many (several dozen) transactions. Seconds have many implications that can “complicate your life.” In eleven years in this business I’ve only lent on a second mortgage basis once.
8. Insert in your documentation a cross default provision that creates a default in your agreement if the borrower is in default in any other agreement for borrowed money. It’s next to impossible to monitor this. However, it allows you to declare a default under your agreement if you become aware that the borrower is in default on another loan.
9. Loan relatively modest sums to start. Get comfortable with your documents and your borrowers before you loan large amounts.
10. Always insist on a personal guaranty of the borrower if the borrower himself/herself is not the entity that is borrowing the funds.

It is critical to remember that the above is just a “sampling” of the items that must be considered. Many more issues, such as the issue of appropriate collateral, must be evaluated before documents are executed.

This method of creating an income stream can become extremely enjoyable and financially satisfying, as it has for me. However, it can quickly become a “nightmare from hell” for those who are not cautious and financially knowledgeable and who don’t have top-flight legal representation.

I hope this may be of help to those of you reading this article.