How to Negotiate with a Private Lender

Flipping homes can be a profitable side gig or a fulfilling career. Whether you are investing in real estate full-time or part-time, growing your profits depends on maximizing the value of each vendor you are working with. On the one hand, it’s paramount to control your costs. On the other hand, you need to ensure that your vendors are motivated to be reliable, fast, agile, and creative. Successful home flipping is a long-term process that involves several vendors. The most important are your real estate agent, contractor, and private lender. Today, let’s explore how to negotiate with your private lender to ensure you get the best deal.

To negotiate “the best deal,” identify what that “best deal” means to you.

Before you start comparing private lenders to each other, take some time to do a bit of soul-searching. What is the most important thing you are looking for in a private lender? What elements of their service or programs are essential to you? Knowing the answers to those questions would require preliminary research on how private hard money lending works.

You might have purchased a primary residence in the past and are familiar with conventional lending. In the last ten years, conventional loans became commodities with slight variations in interest rates and loan officer personalities being their only differentiators. This is not the case with private lenders that have vastly different requirements regarding experience, credit scores, income verification, borrower contribution, capitalization requirements, and transaction profitability.

This is why “the best deal” could mean different things to different borrowers. Shopping for the best rates might make perfect sense for a seasoned rehabber with plenty of funds and perfect scores, while a new real estate investor might be looking for a reputable private lender willing to lend to first-time rehabbers. We had experienced borrowers for whom the best deal was to secure their next private loan without the help of a co-signer they’ve relied on in the past. We also had borrowers who wanted to transfer their business to a local lender with efficient servicing. For them, “the best deal” was finding a DMV lender who would release their construction draws quickly.

Identify a couple of preferred lenders and negotiate from there.

Focusing on rates alone can spell trouble for experienced and novice investors. Still, we get several phone calls that start with the question: “What are your rates?” Not “Can you do this deal?” not “Can I qualify for financing?” but “What are your rates?” No wonder many lenders are tempted to throw any ridiculous number a caller might be impressed with. What they strategically forget to mention is that you need to have eight flips in the last year, have $100K in reserves, and have credit scores of 800+. And wait, you also need to prove you can walk on water! The good news is that those rates can be reduced even further if you can effectively demonstrate your ability to turn water into wine.

Your first task as an investor negotiating with a private lender is to avoid being manipulated. Don’t take me wrong: pricing is super important. But it should be viewed in the context of the entire package you’re receiving from your private lender. And bear in mind that promising specific pricing is not the same as closing at this pricing. This is why it’s crucial to understand how your private lender of choice works, where their money comes from, and what their industry reputation is. For more information, please read our article on how to choose a private lender.

When negotiating with a private lender, put your best foot forward

Our pricing at New Funding Resources is commensurate with the risk we take by lending to a particular borrower. Borrowers who represent less risk will receive lower prices. Riskier loans and borrowers are priced higher to compensate for that additional risk.

What is “risk” in private lending?

Before we discuss what makes one borrower riskier than another, let’s talk about what risk means for private lenders like us. Losing all or a portion of our funds in the transaction is at ultimate risk. However, lenders typically view risk broader than that. They are also weary of the possibility of late payments, incompetent renovation management, using construction funds for other purposes, or poorly thought-out exit strategies. In other words, lenders are concerned about the high cost of servicing such loans and managing such borrowers.

To negotiate with private lenders on pricing, you need to convince them that your transaction is worth their risk and that you are unlikely to create any additional servicing work for them while your loan is outstanding. Here are some ways to do it.

Real Estate Experience is a Key

Unlike with the stock market, where “the past performance is not an indicator of the future results,” past experience of flipping homes is a great predictor of how much risk the borrower represents and how much hand-holding they would require. Experienced real estate investors are in a solid position to negotiate with private lenders and typically can qualify for better pricing than a first-time newbie. Seasoned investors are more likely to correctly estimate their rehab budget, manage the construction process better, and pay off their loans on time. In other words, they represent less risk to a private lender than a novice.

Bear in mind that when it comes to real estate experience, lenders are looking for a documentable track record of a borrower taking possession of the property’s title and selling it once the renovation is completed. Tangential experience such as “helping” someone buy or rehab an investment property indicates that you might be familiar with some aspects of home flipping but ultimately bore little responsibility for the transaction’s success (or failure).

Have Ample Reserves

Private lenders love lending to borrowers with a plenty of money of their own. Why? Because it lowers the risk of borrower’s default. The lending term for the borrower’s capital is “borrower’s reserves.” While even the most well-heeled investors prefer to use leverage to buy real estate, the reserves can be used to make timely payments on a loan or pay for unexpected expenses during the renovation process. In contrast, a borrower strapped for cash is likelier to be late on payments and cut corners during the renovation process.

Maintain a Strong Equity Position

The majority of borrowers are looking for maximum leverage. In other words, they prefer to finance as much of the purchase price and rehab budget as their private lender allows. From the private lender’s perspective, however, the higher the leverage they provide, the higher the risk. If the focus of your negotiations with your private lender is the price of their financing, consider sweetening the deal by contributing more towards the transaction.

A strong equity position also provides excellent leverage (no pun intended) when negotiating with a hard money lender on a non-pricing aspect of the transaction. For example, some experienced borrowers prefer not to escrow their renovation funds with a lender. Though not escrowing those funds increases the lender’s risk, in the past, we’ve made several exceptions for the borrowers willing to contribute more funds to the transaction or who already have substantial equity in their property.

Find Transactions with Exceptional ROI

A real estate transaction with the potential to generate higher-than-average profit lowers the risk for both the borrower and the lender. A non-arm length transaction could be a good illustration. For example, let us assume that your grandmother decided to sell the house to you at a significantly discounted price. Because of this substantial discount, you might be able to effectively negotiate with a private lender to lower your financial contribution to this transaction way below their typical minimum.

The more strengths you have, the better your negotiating position with a private lender. It makes sense that a borrower with extensive real estate experience, substantial capital, and a strong credit profile represents lower risk and can command better terms on their private loan.

A first-time rehabber, in contrast, is an unknown entity. This is why many private lenders refuse to deal with them outright or charge them draconian and non-refundable application fees. At New Funding Resources, we have a good track record of working with new rehabbers and have a knack for choosing borrowers well-positioned to succeed with their fix-and-flip.

Negotiating techniques that do not work

Not that we’ve covered how to negotiate with a private lender effectively, but let’s talk about what negotiating tactics do not work. There are at least three that I can think of.

Having a mentor

Having a mentor is always good for your career. If you are a real estate investor with limited experience, timely and actionable advice or a vendor recommendation could be life-saving. However, it will not help you negotiate a better deal with your hard money lender. Why? Because your mentor bears no legal responsibility for your loan’s performance or your transaction’s success. So unless your lender is willing to form an LLC with you and co-sign your private loan, their existence is of little relevance to a private lender.

Attending an expensive real estate seminar

I might be harsh, but attending a real estate seminar that charges you a wazoo of money for the information that is widely available for free is not an indicator of an investor’s savviness. If you have extra funds, do yourself a favor and save them to build up your capital reserves for your next fix-and-flip.

Being combative

It’s one thing to be a tough negotiator and another to be a pain. When you are negotiating with a private lender, remember you are the one asking for money to borrow. You might be a potentially profitable client, but it is worthwhile to maintain a certain degree of decorum. No one wants to lend money to someone who is combative and rude.

To successfully negotiate with a private lender (or any other vendor you are working with), you need to convince them to view you not as a one-off transaction but as a long-term partner able to generate repeat good-quality business. Your contractor will prioritize your projects over others if you a consistent source of renovation business for them. Your agent will work harder for you and be willing to negotiate her commission down if you consistently use her to buy new properties and sell your existing ones.

Relationship with a private lender is no exception; this is why at New Funding Resources, we behave more like a partner rather than a lender. We are not only interested in collecting our funds on time but in you succeeding with your transaction and doing more business in the future. To learn more about our programs, contact us at 240-436-2340.