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Loan Your Money Out: The True Passive Income

Mitch Stephen|By January 12, 2021

Episode 442: Loan Your Money Out: The True Passive Income

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REIS 442 | Passive Income

People who want to pursue different careers often turn to passive income sources to satisfy their expenses without losing focus on different goals. But without proper knowledge of how it really works and should be maintained, you might just well flush your money down the drain. To help out aspiring investors, Mitch Stephen discusses what it really takes to make such an income source work for you, the advantage of a collateral-based loan, and how to double your ROI even while facing bigger risks. He also goes deep into how the Loan-to-Value ratio works, which people to trust your loans with, and why he thinks real estate is still the best industry to start a passive income.

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I’m going to do a solo episode on passive income. People throw around the word passive without much regard. To truly be passive is a neat trick because it’s hard to find truly passive stuff. A lot of people know rent houses are passive. Rent houses are passive my butt. They’re not passive unless you’re hiring someone to take care all of it, and then they’re taking all your income. What’s the point? A lot of the landlords out there wish that they could make 10% or 12% so they go out there and they buy houses.

On paper, they’re supposed to make 15% or 18% ROI or even just 12% or 10% ROI, return on their investment. At the end of the day, the expenses eat them up and they don’t make anything. It’s a forced savings program and you’re waiting for the appreciation to drive the value of the house up way beyond what you owe on the house. As you’re paying the house down, the appreciation is going up. A lot of people buy into being a landlord or buy into the buy and hold strategy thinking that they’re going to make 10% or 12% or better and it usually doesn’t turn out that way at all.

Loan Your Money Out On Real Estate

I speak from experience. I’ve had 25 rent houses. They were killing me and I wasn’t making a dime. I could have been the worst landlord in the world or it’s just not a great process. When you’re a landlord, you’re responsible for everything from the back fence to the front mailbox and everything in between, every window, doorknob, garage door, sprinkler head, shower head, hot water heater, stove, refrigerator and AC, especially if you live in a hot place like Texas. We want to talk about being passive. How do you do that if you loan your money out? There are a lot of people that should be into this and aren’t in it. It is because the institutions, banks, power brokers, and money financial advisors are not telling you that you could easily loan out your money yourself and make way bigger rates of return.

In a way, you can’t say guaranteed because that’s not right, but a secure loan depending on what your collateral is. What happens when you loan your money? You loan your money out. If you’re doing it on a handshake and hoping to get paid back, it’s a bad deal. The chances of those things working out are not good. You need a collateral-based loan, which means you’re going to loan your money and you’re going to get a lien position, hopefully, a first lien position on a piece of something that’s valuable that you can collect on or take from if you don’t get paid.

A collateral-based loan is the best. I personally like real estate. Why? You can loan on a car, but cars can drive away to God knows where. Cars can get wrecked into trees and bridges. Cars can be abused and have the engines blow up, and they’re not worth much. Cars are depreciating assets. It is worth less and less every year. These are the reasons why I prefer to borrow in real estate. Real estate is tangible. It’s not going anywhere physically and it’s not going anywhere trend-wise. Everyone needs real estate or a place to live or a place to run their business out of. I don’t think real estate is going out of style anytime soon. There’s only so much dirt and earth on this planet and they’re not making any more of it.

Real estate is tangible; it's not going anywhere physically. Share on X

There’s always that need to live and prosper. Almost everybody has a tie to some piece of real estate, be it their home or their business or the place they rent. It’s hard to survive on this planet without occupying a piece of real estate. I like the tangible aspect of it because when I loan on real estate, it can be documented and I can get a lien on it. If I don’t get paid as agreed, I can get that piece of real estate to make me whole and make up for the fact that I didn’t get paid the way I was promised on paper. All this has to be documented.

The biggest thing about loaning against real estate is you have to have an advantageous LTV or loan-to-value that is advantageous to you, the lender. If a house is worth $200,000, if you loan $250,000 on this house and it’s only worth $200,000, this is not a good deal. If you don’t get paid as agreed, whatever that agreement is, you’re supposed to get paid every month and you’re supposed to get X amount annual interest rate. This is what you’re supposed to collect every month for X amount of years. If you don’t get paid as agreed, you get that house instead of payments. You get to foreclose on the house.

If the person who borrowed the money from you got any ethics at all, if they can’t pay you and it starts getting out of hand, then they need to walk the deed over to you and deed the property to you as agreed. When you do a collateral-only loan, then you have the right to get paid as agreed or you need to be given that property to make up for the fact that you didn’t get paid as agreed to make up for the default on the payments. This works best. Not everybody is going to walk over and hand you the deed because they’re honest and come to the conclusion that they can’t pay. Most borrowers I know will think, “I’m going to hit it big here in a little bit if you’ll just hold off,” and 8, 9, 10, or a year later, they still haven’t hit it big.

They still haven’t made enough to pay you and in fact, they’re behind more and more the late charges, interest charges and payments. Everything’s getting out of hand. The past-due taxes and past-due insurance on the property are all mounting up on your side as the lender if you don’t get paid. We want to have a first lien position so that we can foreclose quickly. We want to be in a state that’s probably non-judicial, which means you don’t have to go in front of a judge necessarily to foreclose. You just send your certified letters and notices, and either you get made whole or you don’t.

There’s always the possibility that your borrower hires an attorney or files bankruptcy and then strings things out a little bit. This is why it’s super important to have a good spread when you start figuring out the loan-to-value or the LTV. Let’s say you take that same $200,000 house and you loan $75,000 in the first lien position. It’s worth $200,000 and you’re only loaning $75,000. You have a first lien, and if they don’t pay you back that $75,000 as agreed, then you get a $200,000 house to make up for that default. Now you’re talking.

Passive Income: The key to super passive income is to understand that most things you’re going to invest in are not that passive.

Make sure you’re in the right state and you’ve chosen a state where if you have to foreclose on your lender, it’s a reasonably short period of time. Texas, Georgia, and maybe Mississippi have the fastest foreclosure processes on the planet. I know Texas and Georgia, their foreclosure process and real estate lien law mimic each other. We like to say in Texas that Georgia copied us because we invent the wheel. If you’re in Georgia, they’ll tell you that Texas copied them because we invent the wheel.

We ran about 45 days. If your Johnny-on-the-spot hit the timing just right and don’t miss a 21-day notice. You have to give notice for 21 days. There are rules and if you missed that window, you’ve got to wait a whole other month so you can meet that 21-day requirement. Typically, in Texas and Georgia, it’s going to take about 60 to 90 days, depending on the timing of how things fall. The 60 to 90 days to take someone’s property away from them because they didn’t pay you is a reasonable length of time. I’ve been doing it for decades and it’s painful. Usually, by the time I get the property back, I have such good loan-to-value, that when I do resell that property to someone, whether I sell it on payments or I sell it outright, I’m going to get made whole plus.

You want to set up your loan so that the worst thing that can happen to you return-wise is that you get paid on time. They’ll say, “If you get paid on time, you’re going to make 10% on your money.” If you get that $200,000 house back because they didn’t pay you on time for that $75,000 loan, now you’re going to make some big money. That’s how you want your loans to be. It’s like, “You pay me, I’m happy. You don’t pay me, I’m ecstatic.” There’s going to be a little pain and a little dry spell there for a minute, 60, 70, 80, 90 days. They even had to go six months or a year because they filed for bankruptcy. Still, when that process is over, you’re going to get healed up well.

The key to super passive income is to understand that most things that you’re going to invest in are not that passive if you have control of them. Loaning money in the stock market is passive. You have no idea what’s going to happen tomorrow and you have no way to stop whatever it is that’s going to happen. You can’t defend yourself against the stock market hardly. I understand you can buy puts and pushes. I don’t even know all the lingo, but I know you can hedge your bets in certain ways. There’s not a lot to do. Loaning money is much simpler. I either get paid or I get that piece of collateral right over there. The key is to make sure that the piece of collateral is worth the pain and the effort you’re going to have to go through if your borrower doesn’t pay you as agreed. Make sure that piece of property suits you just fine.

Private Lenders

Who’s loaning their money out? I have lots of private lenders. My whole business functions off of private lenders for the most part. I am bankable. I have millions of dollars’ worth of bank loans. There’s a time and a place for a bank who will loan me money at a lower interest rate than my private lenders loan me money for. There’s a place and time for the private lender and there’s a place and time for the banks. Private lenders work best to start the ball rolling, to buy that rickety house that’s all dilapidated and leaning and not right for a song. We’re going to buy this property for a song, but a private lender is a person who bought all that money from. Trying to get a bank to loan you money on what that house could be, and what it will look like in 60 days is not fast.

The closer that timeline gets to the deadline, the more apt the seller is to sell at a major discount. Share on X

We need quickness when we’re in the real estate investing arena. We need to be quick. It’s hard to steal houses in slow motion. I use the word steal loosely. The point is that most deals that sell at major discounts have a lot of back pressure on them. There’s some clock ticking and when that clock ticks its final minute or second off, then the person that owns the property is going to get $0. They’re going to lose it and they’re going to get absolutely nothing for it. The closer that timeline gets to the deadline, the more apt the seller is to sell at a major discount, and that’s where private lenders come in.

Close your eyes and think of yourself. If you were to loan money, imagine someone like Mitch Stephen is calling you and going, “I’ve got four days before this foreclosure and I need X amount of dollars for this property.” The first question out of your mouth would be, “What is the property worth?” You can figure out what your LTV is, your loan-to-value. You’re loaning X and the property is worth Y. How much is Y? Is there’s a good enough spread? What’s a good enough spread? I don’t ever let my lenders into a deal over 65% of whatever I’m going to sell this property for. I have formulas on what these properties are worth. They’re based on the rents. I look back into the rents and we figure out exactly what I can owner finance this property for. I never borrow more than 65% of the market sales price. When I say market, I mean market for owner financed houses.

I average only borrowing 58%. If I’m going to owner finance a house for my buyer at $100,000, I average borrowing $58,000 from a private person and giving them the first lien. Imagine what that looks like from my private lenders’ point of view. He’s loaning $58,000 on average. At the most, he’s loaning $65,000 on a property that’s worth $100,000. That’s a calculated and low risk. It’d be difficult not to be made whole. Think about it. Even if you loan at 65% or $65,000 on $100,000 property, property values would have to drop 35% before the property was worth exactly what you loaned on it. You haven’t even got a loss yet.

Who Loans Their Money

Who are the people that are loaning money to people like Mitch Stephen? A lot of the people that loaned me money were enthusiastic about the idea of being a house flipper or being a real estate investor. They quickly learned after a deal or two that it’s a major endeavor. It’s become a science. Finding the houses and selling the houses, you have a lot of competition out there. You have to get into it to be competitive and to make money. You have to know your business. You have to become an expert or you have to have an expert on your side. You have to take a deep dive into this stuff. A lot of the people that loaned me money went in wanting to be the investors. They figured out that this is work and decided it was more work than they wanted to do, and then they decided to loan out their money at that point.

A lot of them were landlords that thought they were going to make 10%, 12%, 14% rate of return buying this house and renting it out, only to figure out that they lost money at the end of the year. They didn’t even make $0, they made negative. It’s the same thing. Being a landlord, you’ve got to know your game and you have to know who you’re up against and who’s in your house. Some of these people will tear your house to the ground and walk out. They know more about the law than you’ll know because they’ve been through it 100 times. You have to know about screening, income calculation, how to verify jobs, background and criminal history, and all this stuff. You then make an assessment whether you want to take a chance on this person that’s going to go to your house. It’s a science.

Passive Income: Make sure that that piece of collateral’s worth the pain and the effort you’re going to have to go through.

A lot of ex-landlords and landlords that were successful loans to me because they have all these properties. They go and they sell them all. They’ve got this big amount of money in the bank and then they’re used to cashflow. They understand that they don’t want to spend their principal because if you keep spending your principal or your retirement money, it’s going to disappear. It keeps getting lower and lower, and then you look up one day and you don’t have much of that left. They want to invest it and live off the interest income or the return on their money and keep that money the same or bigger every year. I have a theory. If your money’s not growing, it’s losing. There is no break-even. There is no standstill where I’m at. Your money is either making money or your money is losing money, but there is no neutral.

People think, “I could just go to sleep and I’ll be neutral.” You’re still breathing. As long as you’re breathing, you’re going to need to replace some energy somewhere sometime. There is no neutral. We’re either getting ahead or falling behind. The other kind of people that loaned me money are retired people who want to stay retired. Retired people that do want to have a minimal friction lifestyle. They just want to play golf and travel with their wife. They’ve got some people handling their books and writing their checks, or everything’s automatic withdrawal. They want money in and money out, and all systematized and ready to go. They don’t want a job. They’ve already had a job and they earn their freedom. They have enough retirement money that they don’t need to work and they’re not going to work anymore.

The other kind of people that loaned me money are professionals, doctors, lawyers, and professional athletes that do well financially at what they do, that it doesn’t pay them to get their focus broken into fragments or to take their eye off the ball. It doesn’t pay for them to do anything but what they do. They make outstanding money. It’s exhausting or intensive on them that when they do have some time, the last thing they want to do is get into another business that they have to learn and watch over and take the rest of their time. They need their spare time to recoup and to enjoy their life and money. Those are the people.

I have 36 people in my life who have been out on the street that have loaned me about $24 million. This didn’t happen overnight. Most of these people had been with me for decades and they have been loaning me money. There would be a whole bunch of them over two decades, but a lot of them have died. Unfortunately, that’s how I lose my private lenders is they pass away. It goes into the estate and then the kids get the estate. The kids need a new boat and a new car. They’re not interested at all in keeping those savings plans going. Usually, when someone passes away, that’s the end of it.

I take care of a lot of wills. I started doing business with the man of the family and then 15 to 20 years later, the man passes away and his widow decides, “Why should I fix something that’s been running well and is never broken for decades? Let’s just stay where we’re at.” It’s enough money for the widow to live off of. I take care of a lot of widows because my career has been many years long. There are a couple of hiatuses there, where I took a break and took some sabbaticals. For the most part, I’ve always been in the business for many years. Even when I wasn’t in the business, I had lots of real estates that I had to watch over.

If your money's not growing, it's losing. Share on X

CEOs, pro athletes, doctors, lawyers, and people that are at the top of their game making big money, those are the kind of people that have been lending me money. Also, people that are not business people but they inherited a lot of money where they won the lottery or they had some windfall, and they don’t trust themselves with the money. They’ve never been successful financially on their own. They have this windfall and they want to get it out of their hands and into professional’s hands so that they have a better chance of not losing it. I have seen that many times.

When people have windfall they do this. They’re like, “You’ve got $1 million windfall. Go ahead and spend $15,000, $20,000, $30,000 or maybe $100,000. I wouldn’t go much over 10%. Take 10% of your windfall and blow it out. Go and rent those jet skis or buy those jet skis. Go on that vacation and buy the car. Do a lot of things that you’ve seen everyone else doing that you’ve never been able to afford to do and do some of it.” I call it pent-up demand. Take some of that pent-up demand and get it out of your system, and then live off of what the $900,000 makes. If you’d have $900,000 at 10% annual interest, that’s an annual income that you never had before. You’ve survived all this time without it. Now you’re going to have this annual income of $90,000 or something coming in extra per year. Save it and grow. Take a little bit of it and add to your lifestyle, but also take some of it and keep letting that number get bigger and bigger. That’s your retirement plan.

I also borrow a lot of money from people who are sick and tired of 2% or less CD rates. They finally figured out that inflation is 3% per year. This income is not even keeping up with inflation. Their money is making less and less compared to what they need to buy every year. I’m also there for people who are sick and tired of living by the Wall Street ticker tape. I have a lot of people that have pulled out of the stock market saying, “I would rather take this more predictable income and this reliable collateral than gamble on hitting it a little bit bigger in the stock market.”

Here’s the thing. When you know what you’re going to make every month, you can plan. We’ve talked to a lot of people in the stock market, “I’m averaging 17% or 15% rate of return for the last three years.” It’s only that rate of return if you take your money out and sell. Until you sell, it’s what you could make if you sold, and then a lot of people hang on too long. There’s a crash and it takes them 7, 8, 9, 10 years to get back to where they were. That’s ten years of not making any money and trying to get back to what you could have made, especially psychologically. Most people I know agree. If you could make 8% and 10% steady on your money all the way, never lose, and keep compounding that 8% and 10% per year, they would have been better off than they ever were in the stock market. As a general rule, I hear that all the time.

Loaning out your money directly is another option that people try. Still, when you loan out your money directly to private lenders in your town, not anyone specific, just whoever has a good deal come to me and I’ll loan you the money if I like it. You’re going to need to know your laws, real estate values, paperwork, software and bookkeeping, and collection process. You’re going to have to know some attorneys and appraisers. You’re going to have to know what you’re doing. You have to get into it and all of a sudden, loaning the money out yourself at a premium rate isn’t passive anymore. I’m talking to people that want to be passive. Go to your mailbox on the first and pick up a check. Put it in the bank and then go about your golfing, your boating weekend, your trip to Europe or China, or wherever you’re going.

Passive Income: You have to really get into the business competitively to make money. You have to become an expert, or you have to have an expert on your side.

Loan Your Money To A Real Pro

Here’s the proposition. You can loan your money to a real pro. I want to put my hat in the ring. I’m a pro. I’ve been in the business for decades. I have many years’ worth of being in this business. I started in March of 1996 officially full-time. I have owned a property since I was 21 from the ‘80s. I have had a rent house or two or something going on. I wasn’t in it big until 1996. I was always in it from age 21 when I bought my first condo by myself. I learned why condos weren’t a good deal the hard way. A little word called special assessments and recessions. You can loan your money to a person like me. For the record, I’ve never filed bankruptcy ever. I’ve never filed Chapter 7 or Chapter 13. I’ve never been foreclosed on and I’ve never deeded back property to one of my private lenders.

I’ve never failed anyone. I’ve had a handful of deals go south but not many. The ones that did go south wasn’t my private lenders’ problem. I took care of it and handled it. I took my loss like a man. I took it on the chin and never said a word about it and paid as agreed. Some people have loaned me money wishing I would fail because sometimes, I only borrow 40% of what the property’s worth or sometimes, I only borrow 25% of what the property’s worth. Those people wish that I would default but I don’t default, and I have never defaulted. Not to say that it couldn’t happen, but that’s why you’ve got to look at the collateral. You have to say, “Even though Mitch Stephen has a great track record, if he defaults, what do I get?”

You’ve got to look at your collateral and say, “I have two rights.” With all my 36 lenders and all that $24 million, I have two rights every day in my life. I have the right to pay as agreed or I have the right to deed the property back to the person who loaned me the money if I can’t pay or don’t want to pay. I have those two rights every day. It’s a non-recourse collateral-only loan. If you don’t like the collateral, I always look at my potential lenders and say, “If you don’t like the collateral, don’t do the deal because I always have that right.”

Have I ever given a property back or deed it back? No, I haven’t ever. Somewhere around 2,000 deals, 100 deals a year, over two decades worth of deals. I haven’t ever given a property back. Even when I lost money, I didn’t give the property back to the lender because if I give properties back to my lenders, even though it might be a great deal for them financially, that’s not what they loaned me the money for. They loaned me the money because they want to be passive, get a check in the mail every month, make their deposit, and go about their life.

I know that if I start giving houses back to people, they’ll stop loaning you their money. Their money is the lifeblood of my business. It’s the reason why I do well in the recession because, in the recession, the banks closed. I cleaned up in the recession. I do extremely well in the recession. The house business buying and then selling with seller financing or owner financing, selling our house with that built-in loan from me to my buyer, that’s a boom time in a recession because the banks are closing.

When you know what you're going to make every month, then you can plan. Share on X

I have private lenders and I don’t need a bank to buy houses. My buyer doesn’t need a bank to buy a house for me because I’m making the loan to him. I don’t need a bank on either end in my business when there’s a recession and the banks closed. I’m the only guy open for business. I didn’t need them to buy my houses because I have used private lenders. I don’t need a bank or mortgage company to sell my houses because we’re not going out, putting applications for loans. I’m given the loan on the house. You just make me 30 years’ worth of payments.

What do I offer as a rate of return? It’s easy. If you give me a fifteen-year fully amortized loan, I pay 10%. You give me a ten-year fully amortized loan, I’ll pay 9%. If you give me a fifteen-year amortization with a seven-year balloon or a seven-year call, at the end of seven years, I’ve got to pay you whatever the balance is on that fifteen-year note. I’ve got to pay you off. I’ll pay you 8.5%. If you give me a 15-year amortization with a 5-year balloon, I’ll pay it 8%. Anything that’s fully amortized seven years or less, I pay 6%.

I occasionally come across properties and say, “I want to put this on a 5 or 6-year amortization. I want to pay it off. I want that property free and clear in a short period of time.” If I do that, anything seven years or less, I’ll pay 6%. Here’s what’s neat about that deal. The property might be worth $50,000 and I’m borrowing $20,000 in the first lien position, but I want to pay it off in seven years. Every month that goes by, you’re owed less and less. I didn’t borrow hardly any money against this collateral in the first place, so it’s strong.

A rate of return is usually based on risk. The higher the risk, the higher the return. If you see these people offering you a 20% or 25% rate of return, there’s probably a lot more risk associated with this. I do not pull my money. Everyone who loans me money, it’s me or my company as the borrower, you as the lender, and a piece of collateral that you get if this particular loan doesn’t get paid as agreed. One borrower, one lender, and usually one piece of collateral. Although there could be multiple pieces of collateral but usually, we only need one to satisfy that.

Never borrow over 60% so you never loan over 65%. The average is 58% and always a first lien position. Those are the kinds of loans that I make and those are the rates that I pay. I would love to have a private consultation with you even if you’re remotely interested in loaning your money out and having a truly passive source of income. If that sounds appealing to you, or you just like to meet or talk, we can talk over the phone. We can set up a Zoom meeting if you like to see each other when we talk or you can come to San Antonio or maybe I travel to you. It depends if you’re living someplace interesting I’d like to go.

We’re not traveling all that much because of the pandemic. Hopefully, this stuff we’re passing. Call me at (210) 669-4020. That is my direct cell phone number. I’m going to be the guy that answers it 99.999% of the time, so give me a call. My email is Mitch@1000Houses.com. If you ever want to learn about me and my story, I wrote a book called My Life & 1,000 Houses: Failing Forward to Financial Freedom. It will give you a lot of insight as to how I became an expert in this business and it had a lot to do with falling down, getting back up, and dusting yourself off.

If you’re interested in the passive rate of return with minimal risk, great collateral, something tangible that you’re going to get paid as agreed, and be it a tangible valuable piece of Texas real estate, then give me a call. I’ll be happy to talk to you and would love to meet you in person if you’re in San Antonio or near Canyon Lake, Texas, or New Braunfels. We can meet up somewhere. I’m not even opposed to traveling if you’re serious, especially if you live in an interesting place. I’d like to thank everyone for stopping by to get you some insight as to how to passively invest. I hope you’re meeting your goals. Hang in there through this pandemic. It’s going to pass. We’re in the United States of America and we will get it done.