For both lenders and borrowers, all aspects of loan servicing are critical for success—from initial contact to loan repayment.

Running a successful private lending company means working with borrowers to try to meet expectations about the performance of their loans. That requires planning for mutual success. Anyone selling and servicing loans knows that offering the right product starts with the qualification procedure, then educating and communicating the process, and having the tools and infrastructure to support a successful outcome for all involved.

Tip #1: Communicate Early and Often

Both investor and lender must remember that structuring and servicing a loan begins with the very first phone call. The first mistake a lender can make is to start the clock but wait to define “servicing” until after the loan closes. By gathering enough information, building rapport, clearly defining loan qualifications, and setting draw management expectations (and requesting a precise budget for the transaction), the lender can structure a deal that makes sense for the investor from initial contact to payoff of the loan.

Asking for a specific list of expenses should be the beginning of everything. When it comes to a fix-and-flip or fix-to-rent loan, it’s critical to examine all the details (e.g., addition of square footage, changes that may cause significant permitting delays, the schedule for purchasing and receiving materials to complete a project on time within the correct cost). In addition, ground-up construction projections magnify the need for a detailed budget, starting with the categories, descriptions, details, and phases or timing of work, including supporting the contractor and subcontracting cost. All this and more must be considered before addressing the servicing component.

The budget should be allocated by product type. The more information the investor provides, the better. The line item requested to draw on should be included in the budget or statement of work. It is essential to manage expectations: One of the significant challenges of servicing is communicating how and what percentage of line items are released. Because most lenders have their own rules, when people don’t accurately detail their budget and request a partial release, issues may arise.

Borrowers need to separate their line items into two components: one for rough work and the other for the finish. Consider, for instance, a budget for plumbing for a three-story townhouse. The lender might grant a draw of $25,000, as stated in the budget. However, the inspector discovers the first and second floors are completed but the third floor still needs to be finished. That’s why separating the budget by floor or by rough and finish is suggested. That way the inspector can review the work, document it as complete, and give a draw based on the information provided. Generally, the more detailed the budget, the easier the draw release. Many lenders provide their own template for investors to use to detail the work to be done.

Tip #2: Start Small

Remind new investors they can evolve after proving they can stick to a plan, manage projects down to the dollar and yield consistent margins.

A responsible lender tries to educate novice investors about the value of having a plan and adhering to it. The terms buy, hold, and sell cost may seem straightforward, but there is a roadmap to profitability within them. Once a budget is established, it must be strictly followed.

Lenders will often ask for reserves either at the time of closing or as a part of their underwriting process to ensure the borrower can afford the loan. Even though a lender cannot prevent the borrower from using credit cards to pay for materials or contractors, the lender can ensure the investor is aware of the potential risks. Many investors take on too much debt, have a lower FICO score, exceed the budget, and eventually fail to make the profit they were expecting from the flip, leaving the lender with an extended loan or, worse, one that is in default.

Most lenders will use credit or FICO scores as well as experience as their primary underwriting drivers. Often, the amount of the rehab budget compared to the purchase price matters. Lenders generally price loans with the cost of funds in mind.

An open discussion about a borrower’s wants, needs, and general plan helps determine the proposed loan structure. These conversations lead to the final determinations of the terms (i.e., 12, 18, or 24 months) and interest computation. Then, along with a borrower’s projected timeline, everyone involved can begin calculating expenses and profits. Therefore, it is essential to communicate clearly with the customer. The language in the closing documents or post-closing communication should ensure the borrower knows who to contact and what the loan entails.

Tip #3: Ask for Advice or Assistance

As a lender exploring the ideas of self-servicing, you must ensure an effective loan servicing process for all stages of the loan.

The fact remains that there is a lot involved in loan servicing, whether you are servicing 10, 20, 200, or 2,000 loans. Remember, this is a small, mutually supportive industry. Do not be afraid to call on your peers for operational advice.

The real estate investment loan industry operates in a world with high-touch, high-level customer service. Lenders servicing loans may need help to match customer service expectations. The questions lenders must answer include:

• Can you do the self-servicing?
• Can you manage the draw processes, payments, accounts payable, accounts receivable, and all processes the industry requires?

If the answer to either question is “no,” then outsourcing is the best alternative. Customer service methods for loans always have a cost/benefit aspect. For example, determining the costs based on the organization’s size and portfolio of loans, combined with the level of service customers expect, shape the approach to handling loan servicing.

Lenders must be aware of their financial and personnel capabilities when servicing loans. During the past 15 years, the market for resales and repairs has become more intense and challenging. Any lender considering servicing must think through long-term and short-term objectives. Don’t overlook the ability to respond to draw requests, select the right inspection partner, get lien releases if needed, grant loan extensions, and do collections.

Poor servicing is a guarantee an investor will not return to the lender for the next loan. Setting up the servicing system properly requires discipline, clearly defined roles, customer service standards, and the right personnel (e.g., for asset and draw management, accounting, and collections).

Tip # 4: Upfront and Ongoing Education Is Critical

Too many borrowers go through the process of being qualified and signing final documents without fully understanding how draw processes or lien releases work. Additional communications explaining these key topics, sent post-closing, is always a good idea.

Another example of loan servicing includes issuing a lien release when sending a draw. The lien release is like a certificate of completion, assuring that everything is complete, and all the payments have been made to those doing the work. This should be filled out and signed by the general contractor or the property owner (if they will be doing the work). When dealing with a ground-up construction project, the lender should get a list of subcontractors from the general contractor and have them sign the waiver releases. This is beneficial for both the lender and the investor, because it ensures the county will not find liens when the house is ready to be sold. Otherwise, the lender will end up with a property with many unpaid bills.

For both lenders and borrowers, all aspects of loan servicing are critical for any real estate investment financing and project success. Clear expectations and open communication are important to all parties being able to fulfill their responsibilities.