Portfolio and Private Money Mortgages

Nature abhors a vacuum. With the tightening in the mortgage market we have seen an increase in portfolio and private, also known as hard money, loans to fill the void created since subprime mortgage products have become extinct. The good news is that borrowers who do not fit in the box for a standard FHA, VA, or conventional mortgage now have options. The bad news is that rates, liquid assets after the closing for reserve requirements, "skin in the game", etc., will probably be higher. Skin in the game is defined as the amount of equity or down payment one has. Once in a great there is still some common sense in the mortgage environment, although it is not very common overall. Fortunately we have learned from the past, and borrowers with a 580 credit score, who can not prove their income and need 100% financing will not qualify. We have enough foreclosures already and some borrowers are train wrecks waiting to happen.

A portfolio loan is a mortgage that is held by a bank, as opposed to a loan that is underwritten to a set of specifications that would allow it to be sold on the secondary market. An example of a loan that meets a given set of specifications, that would allow it to be sold in the secondary market, would be the good old boring (but a thing of beauty these days) FHA mortgage. Portfolio loans are mortgages that lenders plan to keep and not sell. These loans are written to a set of standards that make sense but do not fit into the guidelines for a FHA, VA, or conventional mortgages. An excellent example of a portfolio loan would be the US Bank products that have loan to values over 80% and do not require mortgage insurance.

Private money loans may involve people known to the lender before the transaction, or it may be an arms length transaction where there is no history between the borrower and the person who lends the money. An example of the first type is grandparents lending grandchildren money to purchase real estate to live in or for investment. The lender receives a return that is superior to what they were earning in a savings account, the borrower may acquire an interest rate that is less than they would pay on the open market and/or be able to get a mortgage they would not qualify for in the traditional mortgage arena. A true win-win situation for all involved. If you are considering doing this, I strongly encourage you to seek qualified tax counsel to make sure you do not run afoul of any IRS laws that may impact what interest rate you need to charge to family members.

In an arms length transaction private money loans, funded by individuals or private investor groups, often have a minimum of criteria to qualify for a loan. The first two questions that private money lenders usually ask is: 1) how will you pay me back, and 2) do you have AT LEAST 25% equity or cash for a down payment. The money may be for a fix and flip or a short term "band aid" loan. A band aid loan is used to cure an immediate problem such as a pending foreclosure, etc., while giving the borrower time to get back on their feet. Private money lenders have more flexibility when looking at a loan. One example would be to cross collateralization the loan to make the deal viable. Cross collateralization, also known as a "blanket mortgage", is when the loan is secured by more than one property or additional collateral. This does not happen in the traditional mortgage market. Most arms length private money loans are due in less than three years. Rates on private money loans vary widely. Some private money lenders are charging up to 14% annual interest AND four points to borrowers with a dismal track record. There is a relationship between risk and return and those with the gold make the rules. It is what is.  

By the way, you can differentiate between a private money lender and a predatory lender. A private money lender is interested in getting his money back, while the desired outcome for a predatory lender is to acquire the property through a foreclosure. A true predatory lender wants the loan to default. Private money lending appears to fall within a gray area of the law, and private money lenders are not bound by the same stringent guidelines as banks or mortgage companies. If you choose to go this way, make sure you understand everything about the proposed new loan. Pay particular attention to when it is due, prepayment penalties, etc. Never forget that "if it looks too good to be true, something is wrong".

As always, do the numbers, and review everything carefully. Caveat Emptor is an old Latin phrase that means "let the buyer beware". It applies to every business situation, especially with private money loans.

Chip Allen

Crestline Mortgage Bankers

A Division of Universal Lending Corp

Direct: 303.947.2109

Fax: 303.987.0676

Loanchip@hotmail.com

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