Lawyer for private loan for purchase or real property in New York City

It is not unusual for some people to get private loans from friends, family members, or other private creditors to purchase real property. These loans are normally extended, either because the debtor has exceptional credit or due to the familial or fraternal relationship the creditor has with the debtor.

Because the loan is taken not from a financial institution but a private lender, a customized agreement needs to be drafted. This agreement will usually include the normal terms of any standard loan agreement with some special provisions carefully crafted to reflect the intentions of both the debtor and creditor. A real estate litigation attorney can help draft this agreement for you.

Why People Use Private Real Estate Loans

Private real estate loans come up in a wide range of situations. A parent or grandparent wants to help a younger family member buy a first home but does not want to make an outright gift. A business partner has the cash and wants to back a real estate purchase by someone they know and trust. A real estate investor needs short-term bridge financing to close on a deal before a conventional loan can be arranged. A seller offers to finance the purchase themselves, taking back a note instead of receiving the full sale price at closing. In each of these scenarios, a properly drafted loan agreement and a properly recorded mortgage protect both sides.

The Promissory Note

The promissory note is the core document. It says how much money is being lent, what the interest rate is, when payments are due, and when the loan must be paid off in full. A well-drafted note also addresses prepayment, late charges, default events, acceleration, and which party pays legal fees if collection becomes necessary. New York law caps interest rates: rates above 16% per year may run afoul of civil usury limits, and rates above 25% per year can constitute criminal usury under Penal Law Section 190.40. Parties who are unaware of these limits sometimes draft a note that turns out to be unenforceable.

The Mortgage and Other Security

The loan agreement and the promissory note are personal obligations. They do not, by themselves, give the lender any claim to the real property. To turn the loan into a secured loan, the borrower has to sign a mortgage that creates a lien on the property in favor of the lender. The mortgage must be recorded in the county clerk's office (or the City Register's office in New York City) to give the lender priority against later mortgages, judgments, and other claims. Recording also requires payment of mortgage recording tax in New York. We coordinate the recording, calculate the tax, and ensure the lender's lien is properly perfected.

Title Insurance and Lender Protection

Even on a private loan, the lender should obtain a title insurance policy to confirm that the borrower owns the property free of prior liens and to insure the new mortgage as a valid lien against the property. Skipping title insurance to save a few hundred dollars at closing can mean losing the entire loan if a prior lien turns up later.

Loan-to-Value, Down Payments, and Reserve Requirements

One of the protections built into commercial lending is the loan-to-value ratio. Banks rarely lend more than 75 to 80 percent of the appraised value of a property. Private lenders should think about the same constraint. If the borrower puts no real money into the deal, the lender bears all the downside. A reasonable down payment from the borrower, plus a reserve for taxes and insurance, reduces the risk that a market dip wipes out the lender's collateral.

Special Concerns for Family Loans

Family loans deserve extra care, both for legal and tax reasons. The IRS requires that loans between family members carry interest at the applicable federal rate or be treated, in part, as a gift. Below-market loans can trigger imputed interest income to the lender. Forgiving a loan in installments is a common way to bridge into a structured gift, but the documentation has to be in place from the start. We work with clients to make sure their family loans hold up to IRS scrutiny and do not create unintended tax consequences.

What Happens If the Borrower Stops Paying

When a borrower defaults, the lender's options depend on what was put in writing at the start. With a recorded mortgage, the lender can foreclose on the property and force a sale to satisfy the debt. Foreclosures in New York are judicial, which means they go through court and can take many months. Without a recorded mortgage, the lender is left with a simple breach-of-contract action, no priority against later creditors, and no claim to the real estate. We have seen too many cases where a relative lent six figures, never recorded a mortgage, and then watched the property get sold or mortgaged to someone else, leaving them with nothing but a worthless promise to repay.

Subordination and Refinancing

Private loans frequently sit alongside other mortgages. If the borrower already has a bank mortgage, the private loan can take a second-position lien behind the bank. If the borrower later refinances the bank loan, the private lender may be asked to sign a subordination agreement, agreeing that the new bank loan takes priority. The terms of that subordination should be negotiated and not signed casually.

Use of Funds and Construction Draws

Some private real estate loans are used to acquire raw property, others are used to finance renovations or new construction, and many are a combination of both. When the loan finances construction, the loan documents should include a draw schedule, requirements for lien waivers from contractors, requirements for inspection before funds are released, and remedies if the project goes over budget. We have seen private construction loans run far over budget because the lender released all the funds at the start and the borrower walked off the job halfway through.

Personal Guarantees and Co-Borrowers

If the borrower is a single-member LLC or another shell entity created to hold the property, the lender often wants a personal guaranty from the individual behind the entity. The personal guaranty makes the individual personally liable if the entity defaults. There are different flavors of guaranty: full recourse, limited recourse, springing recourse (sometimes called a "bad-boy" guaranty), and carve-out guaranties. The right one depends on the deal. A guaranty that is too aggressive can scare a good borrower away; one that is too soft leaves the lender with no real teeth.

Insurance Requirements

Every private real estate loan should require the borrower to keep adequate property and liability insurance on the collateral, name the lender as an additional insured or mortgagee, and provide certificates of insurance annually. If the property burns down and the borrower has let the insurance lapse, the lender is left with a worthless lien on a pile of ashes.

Tax Reporting and Form 1098

Private lenders who receive more than a threshold amount of interest from a borrower in a year may need to report the interest to the IRS on Form 1098, depending on the nature of the loan and the lender's status. Borrowers, in turn, may want documentation of interest paid in order to claim the mortgage-interest deduction on their tax return. We help clients on both sides set up the tax reporting correctly from the outset.

Documenting the Closing

At closing, a private real estate loan typically involves the borrower signing the note and the mortgage, the lender disbursing the funds, and the mortgage being delivered for recording. If the loan is being used to finance a purchase, the lender's funds usually flow through an escrow at the title company. We attend the closing or close the transaction ourselves so that nothing is missed.

Common Pitfalls We See

The most common problem we see with private real estate loans is the handshake deal. Two relatives, two friends, or two longtime acquaintances agree on a number, hand over a check, and never put anything in writing. By the time the relationship sours and one side wants out, there is nothing to enforce. The second most common problem is the do-it-yourself note found online. These notes are usually missing critical provisions, may run afoul of New York usury limits, and almost never include a recorded mortgage. The third common problem is a properly drafted note paired with a mortgage that never gets recorded. Without recording, the lender has no priority and no real claim to the property if other creditors arrive first.

Talk to a Real Estate Attorney Before You Lend or Borrow

Purchasing real property is a major investment, and offering a loan is a big commitment, so it is important to always have a real estate attorney represent you when making these investments. Should you need assistance, we at the Law Offices of Albert Goodwin are here for you. We have offices in New York City, Brooklyn, NY and Queens, NY. You can call us at 212-233-1233 or send us an email at [email protected].