Are Private Money Loans a Scam?
Whether you are just starting out in the real estate investing business or are an REI veteran, it’s common knowledge that there can be concerns with private lending. Because our industry is less regulated than the banking system, your apprehension might be justified.
Even while most lenders are ethical and have your best interests at heart there are always a few bad apples. Small issues like a lack of forthrightness, punctuality, sincerity, or communication can also be troubling. Luckily, most scam lenders are easy to spot among the more reliable, trustworthy bunch of honest lenders. So without further ado, here are our top four red flags that might signal you are dealing with a scam private lender:
1) Hidden Fees
Hidden fees are charges that the client was never told about during application process because the lender believed withholding such information would be advantageous to them. The lender might try to prevent the client from noticing these fees until its too late. This isn’t too hard because the fees are typically minimal in the grand scheme of the closing costs.
This practice is, without a doubt, an unethical way of conducting business, yet it is one of the simplest ways to rack up dollars for suspect lenders. Once a borrower has gotten as far as the closing table, they will accept just about any fee.
That being said, every lender is different and will have minor differences in fees, interest rate, and points. These are not cause for raising the red flag unless they are coming out of the blue. Be sure to research the fee structures ahead of time and ask questions if you are unsure. A reputable lender will be upfront with you right off the bat.
2) Lack of Ability to Fund
When borrowing from a conventional lender, you rarely have to worry about them running out of money. This isn’t the case with private lenders who are managing their own funds without oversight.
Many lenders will individually back their loans and because of this, too much will be reliant on and determined by one high-net worth individual backing the loan.
Unfortunately, RFG receives a handful of calls per week from investors who have lost their deposit, lost out on a property (or properties) because a lender promised them the moon, but in reality, simply could not take on another project. It’s unfortunate that these investors were duped into believing a lender could fund them when they really couldn’t.
Be especially wary toward the end of the year when smaller lenders might be running out of funds to lend. It is almost impossible to know for sure whether this could happen to you, but we suggest doing your research to see if a company has a history of bailing on a transaction. Use a search engine with the lenders name and the words “scam” or “reviews” to find out if a lender has an unfavorable track record with this.
3) Lacking Proof of Being a Legitimate Company
In The Wolf of Wall Street, there is a scene when Jordan Belfort is making his first penny-stock sale. He is selling “Aerotyne” stock. He blatantly lies and says, Aerotyne International is a cutting edge tech firm out of the Midwest, awaiting imminent patent approval on a new generation of radar equipment… In the middle of that sentence, they cut to a double-doored, beat up shack in the middle of Indiana with a street sign above the doors. As a real estate investor who borrows thousands of dollars, it’s vital to know who is gathering your personal information and potentially lending you said dollars and verify it. Be sure the lender is legitimate. They may tell you they lend at 8% interest, or don’t charge points, but if they can’t provide you with references or contacts, there’s a problem. Furthermore, if you can’t even find an email address, or physical address, you may have just contacted an “Aerotyne.” If this is the case, move on.
4) A Cut of the Profit
Recently, we’ve seen an increase in the number of lenders looking for more than just the interest from their loans –they want a cut of the profits as well. While this is not entirely unethical, we believe in sticking to what you are good at. In our case this is lending. We want our borrowers to be successful flippers and that means leaving the profit from the flip in their hands.
We get a lot of calls from investors who ask if RFG will simply lend the money and not take a cut. This is due to the investors encountering many lenders that want a piece of the pie. The most recent call was from an investor who had worked with a private lender for a couple of years. He had found a property that he was sure to make a good profit on. The private lender would always take a cut, but for this particular project, they decided to form a new LLC and took the property from the investor who found it. Taking a cut is fairly common, but there are lenders willing to simply lend the money an leave the profits with you.
False red flags: Don’t panic about these!
Many borrowers worry about things that are really just business as usual. These are our most frequently asked questions:
Should I worry about Application Fees?
Blog writers and lenders alike have brought this concern to the forefront to try and deter investors from certain lenders. This could go either way, because yes, there are some scammers out there that will try to make their money one application fee at a time, but let’s be frank — to make a living one application fee at a time wouldn’t work and really isn’t even worth the scammer’s time. If you have done any research at all, you’ll know that the application fee is going to good use. It should never be more than a few hundred dollars though.
What if I am getting a hard sell, or pressure to act immediately?
Any time there is a large transaction, you will receive overwhelming, but unnecessary pressure. This includes when you are buying a car, a primary home, or even a set of steak knives. There’s no rush in buying that set of steak knives, but there certainly is immediate action required when you are bidding on a property that hundreds of other investors are looking at. You should be rushing to acquire funding if you need to close on a property in a week. A lender may say to act quickly and if they are legitimate, you’d be wise to heed that advice.
Originally published at rehabfinancial.com on November 15, 2016.