How do you evaluate the borrower for a private lending deal?

This may come as a bit of a shock, but the borrower is actually the LAST thing we look at when evaluating a private money lending deal.

Don’t get me wrong. The borrower is still important. As I always say, “deals don’t do deals, PEOPLE do deals.” You have to get the PEOPLE part right, but only after you’ve established whether you’re even looking at a viable deal in a geographic market you want to lend in. 

But let’s assume you’ve vetted the property/project and it’s a good one. Let’s assume it’s in a geographic market you like.

Now it’s time to vet the borrower. At a high level, we’re trying to gauge their character, experience, and resources. Things like:

• Their integrity
• Their past experience with selecting good properties and using debt responsibly
• Their financial wherewithal to make interest payments and absorb mistakes (especially renovation mistakes)
• Their ability to design and manage the execution of the renovation
• Their ability to successfully market and resell the property

So how do we get a read on those things? 

We vet the borrower in 6 steps.

Step 1: ‘Can they explain the deal?’ check — We do this on a phone call. We ask them to explain the deal, then we shut up. We let them talk. Ideally, they’ll tell us about why they like the deal, the renovation scope of work, the deal’s expected duration, what they’re seeing from comps, etc. But sometimes not.

If, after listening to the borrower explain things, you can’t concisely repeat the merits of the deal back to them, it’s often a sign that the borrower doesn’t have focused expertise. That’s a cause for pause in my book.

Step 2: Real estate experience check — how many times has the borrower run this playbook before? We want to see that they’ve successfully flipped similar properties, with similar price points and Scopes of Work, and that they’ve hit their target After Repair Values, rehab budgets and project durations.

Step 3: Credit check — Pretty simple…do they pay their debts on time? Is their FICO low enough to be a red flag? At the very least, I’d use a service like XXXXXX to do a free soft credit pull. Anything under a 620 is a no-go for me.

Step 4: Background check — Does the borrower have any felonies, bankruptcies, or foreclosures in their past? Any professional licenses? If so, any lawsuits, revocation, etc? There may be extenuating circumstances here, but generally, these are red flags that can allow you to quickly say NO and move on to the next deal.

Step 5: Reference check — How quickly can they provide 3 character references? How credible are the individuals they provide? You should also do 1-2 unsolicited reference checks, pulling from people you find on their LinkedIn and background check.

Step 6: Assets & income check — Is their current liquidity greater than or equal to the sum of a) their equity contribution to the deal and b) 12 months of monthly payment reserves? Here we also look at their other debts and monthly payments — often on other private loans — to get a firm grasp of their cash flow situation.