In my last post, I described how Trust Deed Investing can be a stronger investment than stocks. To fully consider Trust Deed investing, we need to keep in mind some new terms such as ‘Loan-To-Value’, ‘Loan Term’, ‘As-Is-Value’ vs. ‘After-Repair-Value’, as well as several others. Understanding these terms completely and without any confusion is critical to your success. It is within these terms that you will determine your own level of risk.
Loan-To-Value can be easily described like this: The LTV for a $65,000 loan on a property valued at $100,000 equals 65%. Make sense?? Here’s a quick way to calculate the LTV: Loan / Value = LTV (Loan amount divided by the value equals LTV). Hint: NEVER go above 65% LTV with Trust Deed Investing.
‘As-Is-Value’ vs. ‘After-Repair-Value’ is simply the ‘current condition’ value (prior to any repairs that might be needed) compared to the After Repair Value of the property (the value once those repairs have been completed). Question: Will you lend on As-Is or ARV? For example: Most hard money brokers only go as high as 65% LTV of the purchase price. Some lenders only lend 65% of the as-is value. I’ll go as high as 65% of the ARV, with certain conditions. This is a strategic benefit that allows me to lend more money on a property. This results in more people calling me, and in turn, I can choose loans that are the best of the best.
- Value is the MOST important part of private lending. Great care must be taken when determining a conservative value. This is how we make safe loans.
- Rehabbers need to borrow money, and because we can lend up to 65% of the ARV, we can cherry-pick the BEST loans to lend on.
Loan Term is simply the amount of time a loan is written for. Is it 30 years? 15 years? 1 year? Or maybe just 3 months? The reason these differing loan terms exist is so a lender can build streams of income over periods of time. Also, lending for shorter amounts of time is another way to reduce the risk of market fluctuations.
Pre-Payment Penalty If you lend money on a property for one year, and they pay off the loan in 2 months, you haven’t gotten the return you expected. You spent some time doing your due diligence, and maybe you’re counting on this loan to provide you a solid yearly income. To minimize this scenario, you can put a pre-payment clause (say, 6 months) in your promissory note, and get a minimum amount of return on your money. This is a GREAT strategy to get your dollars working consistently over time.
These are just a few things to keep in mind when deciding to lend on a property. You’ll be able to reduce risk if you fully understand these.
Always do you homework on the value, the borrower, and the property.
Make loans that are safe.
Make loans that make money.
Do short-term loans that keep your liquidity high – You never know what’s going to happen in the real estate market next year. Why would you want to loan money for 5 years? You wouldn’t. Not right now. It’s too risky. And we’re lending on properties to avoid risk, right??
Are you starting to see how investing in Trust Deeds can reduce risk IF you do it the right way?