Understanding collateral and risk

Property valuations

Collateral is only as good as the property's real value. Valuations generally come from:

• Appraisals by a licensed appraiser, the most thorough option.
• Broker price opinions (BPOs) from a real estate broker, faster and less formal.
• Comparable sales of similar nearby properties.

For properties being renovated, there can be two values: the "as-is" value today and an estimated "after-repair" value. The after-repair value depends on work being completed and on future market conditions, so we'll always show you the as-is value too.

Loan-to-value ratio (LTV)

LTV compares the loan amount with the property's value. It's one of the most important numbers in any private loan, because it tells you how much the property's value could fall before your loan would be under water.

Lower LTVs leave more of a cushion. Remember that foreclosure costs, unpaid property taxes and the time to sell all come out of that cushion first.

First vs. junior liens

Lien priority decides who gets paid first when a property is sold or foreclosed. Priority is generally set by the order in which liens are recorded, with some exceptions such as property taxes.

• First lien: paid before any other mortgage or deed of trust. A first-lien lender controls the foreclosure process.
• Junior (second or later) lien: paid only after the liens ahead of it are fully satisfied. If a senior lender forecloses, a junior lien can be wiped out entirely. To protect itself, a junior lender may have to cure the senior loan's default or pay it off.

We'll always tell you the lien position of any loan or note we present, and what other liens are recorded against the property.

Title insurance, hazard insurance and recording

• Lender's title insurance protects you against defects in title and confirms your lien position, such as an earlier lien or a forged deed that wasn't found in the title search.
• Hazard insurance on the property should name you (or your IRA) as mortgagee or loss payee, so insurance proceeds after a fire or other loss help repay your loan.
• Recording the mortgage or deed of trust (or the assignment, for a note purchase) puts the world on notice of your lien and establishes its priority.
• Property taxes generally take priority over private liens, so confirming they're current, and stay current, matters.

Borrower performance

Collateral is the backstop. The first line of repayment is the borrower. Relevant factors include the borrower's experience with similar projects, their track record of paying, their plan for repaying the loan (a sale, a refinance or rental income), and how much of their own money is invested in the property. For a purchased note, the borrower's actual payment history is often the best evidence available.

Default remedies

If a borrower defaults, a lender's remedies typically include late charges, default interest if the note allows it, demanding full repayment, negotiating a workout or deed in lieu, and ultimately foreclosing on the property. Foreclosure procedures and timelines vary significantly by state. See how a default typically unfolds.

Investor protections we focus on

• A written summary of every opportunity: property, value and how it was determined, loan amount, LTV, lien position, rate, term and payment structure
• Closings through a title company or closing attorney
• Recorded liens in your name or your IRA's name (or recorded assignments for whole-note purchases)
• Lender's title insurance and hazard insurance naming the lender
• Copies of the note, the mortgage or deed of trust, and the closing documents
• Clear disclosure when a note is a partial interest, and what rights it does and doesn't carry

These describe how we aim to document opportunities. The specific protections for any investment are those stated in its own documents.

The risks you should understand

Private real estate lending is not a substitute for a savings account, and we don't describe it as safer than stocks, bonds or mutual funds. It has different risks, including:

• Loss of principal. If a borrower defaults and the property sells for less than the loan plus costs, you can lose part or all of your investment.
• Property value risk. Real estate values can fall due to the market, the neighborhood, the property's condition or unfinished renovations.
• Illiquidity. Private notes generally can't be sold quickly, and selling early may require a discount.
• Delay and cost of foreclosure. Foreclosure can take many months or longer, payments may stop during that time, and legal costs, taxes, insurance and repairs reduce what you recover.
• Junior-lien and partial-note risk. Junior liens can be wiped out by a senior foreclosure, and partial-note holders may have limited control or lien rights.
• Fraud, title and documentation risk. Errors or misrepresentations in documents, values or title can impair your position.
• Concentration risk. A single loan depends on a single property and borrower.
• Interest rate and reinvestment risk. A fixed-rate note may lose value if market rates rise, and early payoffs may leave you reinvesting at lower rates.
• No insurance or guarantee. Private loans aren't bank deposits, aren't FDIC-insured, and aren't guaranteed by anyone, including us.
• Legal and regulatory risk. Changes in law, lending regulations, or the treatment of an investment as a security can affect it.