How to Mitigate Risk in Private Loan Transactions

One of the primary functions of a private lending company is to oversee and underwrite each loan application received to determine if its a loan to fund or pass on. It is essential to go through this process, as it is one of several security nets used to single out good deals from bad ones.

You should be aware that most private lending transactions always stem from clients that were refused or cannot qualify with standard lenders. They are labeled high risk because of it. And it is up to your private lending company to dig deeper and use their experience to determine if this is a loan to proceed with.

This underwriting process is comprised of two key elements :

  1. the client, and
  2. the property

When it comes to the client, several documents are requested and analyzed prior to giving any go ahead to move forward:

  • recent credit report
  • proof of income
  • proof of last year’s personal income taxes

These documents help to eliminate any situation where money could be owed by the borrower which could supersede your mortgage claim. Also it will determine if the borrower has the means to be able honor his or her new loan commitment to you.

When it comes to the property, the required documents are :

  • proof the property taxes are up to date
  • a proper title search showing all and existing leans on the subject property

These documents also help to eliminate any situation where money could be owed by the borrower on the property which would supersede your mortgage claim.

Note: A full appraisal is also usually ordered in order to determine what the subject property is really worth in today’s market.

Last but not least, your private lending company should always have an exit strategy before entering any deal.

Two classic examples come to mind:

  1. If the purpose of the loan was to pay off bad debts so the borrower could maintain a proper credit rating and refinance a short time after your loan, then your exit strategy is defined by being paid off by another lender.
  2. If the purpose of the loan was to give a bit of cash flow to the borrower while the property is for sale, then your exit strategy would be the sale of the property with your loan paid off by the buyer’s new lender.

In conclusion, when choosing a private lending company to assist in your transactions, make sure there is a real process in place to always filter out the good deals from the bad, largely by assessing proper Risk Management techniques. And be sure to always start with the underwriting procedure outlined above.

As a private lender, you should ONLY be interested in secured loans against real estate.

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