To become a private lender, you choose a capital source, form a business entity, obtain any licenses your loan types require, draft enforceable loan documents, and follow the federal and state rules that govern underwriting, interest rates, and servicing. The regulatory load depends mostly on one choice: lending against homes pulls you into federal consumer-protection law, while lending for business or investment purposes largely stays out of it. The sections below walk through each decision in the order you’ll face it.
Where Your Capital Comes From
Most private lenders start with personal savings, liquid investments, or equity in assets they already own. A Self-Directed Individual Retirement Account (SDIRA) is another route, letting IRA funds back private loans, but it carries strict prohibited-transaction rules under 26 U.S.C. § 4975. You cannot lend SDIRA funds to yourself, your spouse, your parents, your children, or their spouses; the IRS classifies all of them as “disqualified persons.”1Internal Revenue Service. Retirement Topics – Prohibited Transactions A violation triggers an initial excise tax of 15% of the amount involved for each year the transaction remains uncorrected, and a follow-up tax of 100% if you still fail to fix it.2Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
Pooling money from other investors is a different animal. Once outside capital is involved, you are likely creating a securities offering. The SEC requires these offerings to comply with Regulation D, typically under Rule 506(b), which limits you to no more than 35 non-accredited investors and prohibits general advertising or solicitation.3U.S. Securities and Exchange Commission. Private Placements – Rule 506(b) You must file a Form D with the SEC within 15 days of the first sale of securities. A private placement memorandum is commonly used to disclose investment details, though it is not strictly required when the offering is limited to accredited investors.4U.S. Securities and Exchange Commission. Private Placements Under Regulation D – Updated Investor Bulletin
With capital settled, pick a lending niche. Common choices are short-term bridge loans for property acquisitions, rehabilitation loans for fix-and-flip investors, and longer-term financing for commercial properties. Hard money lending focuses on the collateral’s value rather than the borrower’s credit history. Your niche sets the risk profile, the typical loan terms, and much of which regulatory rules you’ll live under.
Forming the Business Entity
Lending through a formal entity separates your personal assets from the loans you make. A limited liability company is the most common choice because it combines liability protection with flexible tax treatment. If a borrower sues over a loan dispute, the entity structure generally limits your exposure to the assets inside the company rather than your personal savings or home.
Register the entity with your state’s secretary of state, obtain an Employer Identification Number from the IRS, and open a dedicated business bank account. Every loan funded and every payment received should flow through that account. Mixing personal and business funds can undermine the liability protection the entity was created to give you.
Licensing
Whether you need a license depends on what you lend against and how often you lend. Residential and commercial loans follow different paths, and federal law carves out exemptions for genuinely small-scale activity.
Residential Mortgage Lending
Loans secured by residential property generally require a mortgage loan originator license under the federal Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act), obtained through the Nationwide Multistate Licensing System (NMLS).5eCFR. 12 CFR Part 1008 – SAFE Mortgage Licensing Act Each state administers its own licensing under minimum federal standards. At a minimum, you must complete at least 20 hours of pre-licensing education covering federal law, ethics, and nontraditional mortgage products, pass a criminal background check that includes FBI fingerprinting, and submit to a credit report review.6Consumer Financial Protection Bureau. 12 CFR 1008.105 – Minimum Loan Originator License Requirements Operating without a required license can bring civil penalties, license revocation, and in severe cases criminal prosecution under state law.
Exemptions for Small-Scale Lenders
Federal law provides room for lenders operating at low volume. Under Regulation Z, you are not a “creditor” subject to Truth in Lending Act requirements unless you extend credit secured by a dwelling more than five times in a calendar year, or more than 25 times for general consumer credit.7Consumer Financial Protection Bureau. 12 CFR 1026.2 – Definitions and Rules of Construction Separately, if you sell a property you own and provide the financing yourself, you may be exempt from loan originator requirements when you finance three or fewer properties in any 12-month period, the loan is fully amortizing, the rate is fixed or reasonably adjustable, and you make a good-faith determination the buyer can repay.8Consumer Financial Protection Bureau. 12 CFR 1026.36 – Prohibited Acts or Practices and Certain Requirements for Credit Secured by a Dwelling
These federal thresholds are a floor. Your state can impose stricter rules, so check with your state’s financial regulatory agency before relying on any exemption.
Commercial Lending
Loans made for business or investment purposes rather than personal or household use generally fall outside the SAFE Act’s residential licensing framework. Most states do not require a special license for commercial lending, but some require a lending license for any type of loan regardless of purpose. Research your state’s rules before originating commercial loans.
Federal Consumer Lending Laws
If you cross the creditor threshold on residential loans, two federal requirements shape every deal you close.
Ability-to-Repay
Under 15 U.S.C. § 1639c, part of the Dodd-Frank Act, you cannot make a residential mortgage loan unless you make a reasonable, good-faith determination, based on verified and documented information, that the borrower can repay the loan according to its terms. You must weigh the borrower’s credit history, current and reasonably expected income, existing debts, debt-to-income ratio, and employment status. Income must be verified with W-2s, tax returns, payroll records, or bank statements. The borrower’s word alone is not enough.9Office of the Law Revision Counsel. 15 USC 1639c – Minimum Standards for Residential Mortgage Loans
Truth in Lending Act Disclosures
Once you meet the Regulation Z creditor threshold of more than five dwelling-secured extensions of credit per year, you must give borrowers disclosures spelling out the annual percentage rate, finance charges, total payment amounts, and other key terms.7Consumer Financial Protection Bureau. 12 CFR 1026.2 – Definitions and Rules of Construction These disclosures must be delivered before closing. Missing or incomplete disclosures can make loan terms unenforceable and open the door to borrower lawsuits.
State Interest Rate Limits
Every state caps the interest rates lenders can charge, and the caps vary widely by loan type and whether the borrower is a consumer or a business. Some states cap consumer loan rates in the single digits; others allow rates above 20% for licensed lenders. Commercial and business-purpose loans are often exempt from state usury caps or allowed significantly higher ceilings. Federal law also preempts state usury limits on most first-lien residential mortgage loans, though the specific application depends on the lender type and loan structure.
Penalties for usury are serious. Depending on the state, they can include forfeiture of all interest earned on the loan, liability for double or triple the interest charged, or criminal charges for extreme violations. Research the limits in every state where you plan to lend, and if you intend to charge rates near a statutory ceiling, run them past an attorney familiar with that state’s lending laws.
Core Loan Documents
Every private loan should be backed by three documents: a promissory note, a security instrument, and a loan agreement. An error in any one of them can leave your investment unprotected.
Promissory Note
The promissory note is the borrower’s written promise to repay. It states the principal amount, interest rate, payment schedule, and maturity date. It should include an acceleration clause, which lets you demand immediate repayment of the full remaining balance if the borrower defaults. Without that clause, you can pursue past-due installments but not call the entire loan due.
Security Instrument
A mortgage or deed of trust ties the loan to a specific property as collateral. It is recorded in the county’s public records, creating a lien that gives you a legal claim to the property if the borrower stops paying. Recording fees vary by jurisdiction, and a minority of states also impose a mortgage recording tax calculated as a percentage of the loan amount. Budget for these closing costs when structuring the deal.
Loan Agreement
The loan agreement covers terms the note and security instrument don’t fully address: late-fee provisions, prepayment terms, hazard insurance requirements, property maintenance obligations, and the specific conditions that trigger a default.
Accuracy across all three documents matters. An error in the property’s legal description, for instance, can weaken or invalidate your lien. Many private lenders hire a real estate attorney to draft or review these documents rather than relying on generic templates.
Underwriting and Closing
Before funding, verify the borrower’s financial claims. Review bank statements, tax returns, and pay stubs, and for residential loans document the ability to repay as federal law requires.9Office of the Law Revision Counsel. 15 USC 1639c – Minimum Standards for Residential Mortgage Loans Order a professional property appraisal to confirm the collateral’s value and calculate the loan-to-value (LTV) ratio. Most private lenders keep LTV at or below 65% to 75%, maintaining an equity cushion against market declines.
If you pull the borrower’s credit report, the Fair Credit Reporting Act requires a permissible purpose. Extending credit qualifies, but you must follow specific procedures, including notifying the borrower if you take adverse action based on the report.10FDIC. Fair Credit Reporting Act
At closing, work with a title or escrow company rather than sending funds directly to the borrower. The title company confirms existing liens are paid off and your new security instrument is properly recorded. Wire the loan proceeds to the escrow agent, who disburses them according to the settlement statement.
Insurance That Protects Your Loan
Two policies protect your position after funding.
A lender’s title insurance policy protects you if a previously unknown lien, ownership dispute, or title defect surfaces after closing. The coverage amount decreases as the borrower pays down the loan and expires when the loan is fully repaid. The borrower typically pays the premium at closing as a one-time cost.
Require the borrower to maintain hazard insurance on the collateral with your entity named as the mortgagee or loss payee. If the property is damaged or destroyed, the payout goes toward protecting your loan balance rather than solely to the borrower. Monitor renewals annually; a lapsed policy exposes your collateral. Your loan agreement should give you the right to force-place insurance at the borrower’s expense if coverage drops.11eCFR. 12 CFR Part 1024 Subpart C – Mortgage Servicing
Tax Obligations
Private lending income carries several federal tax requirements, and the treatment depends on whether the IRS views your lending as a trade or business or as occasional investment activity.
Reporting Interest Income
If you receive $600 or more of mortgage interest during the calendar year in the course of a trade or business, you must file Form 1098 (Mortgage Interest Statement) with the IRS. This applies even if lending is not your primary business.12Internal Revenue Service. Instructions for Form 1098
Self-Employment Tax
Interest received in the course of a trade or business, such as operating a lending company that regularly originates loans, is subject to self-employment tax. Interest from occasional or passive lending is generally treated as investment income, not subject to self-employment tax, but still subject to ordinary income tax.
Bad Debt Deductions
If a borrower defaults and the debt becomes worthless, tax treatment depends on whether the loan was made in your lending trade or business. A business bad debt can be deducted as an ordinary loss, and you can take a partial deduction if the debt is only partially worthless. A nonbusiness bad debt can only be deducted as a short-term capital loss once the debt becomes completely worthless, regardless of how long you held the loan.13Office of the Law Revision Counsel. 26 USC 166 – Bad Debts Short-term capital losses offset capital gains and up to $3,000 of ordinary income per year, with unused losses carried forward.
Servicing the Loan and Handling Default
After funding, you need a system to track payments, manage any escrow accounts, and send required notices. You can service loans yourself or hire a third-party servicer. Third-party servicers typically charge a percentage of the outstanding loan balance, often around 0.25% to 0.50% annually, with fees varying by loan type and servicer.
Keep detailed records of every payment received, every late notice sent, and every borrower communication. Those records matter for tax reporting, regulatory compliance, and your legal position if you ever need to foreclose.
When a borrower falls behind, send written notices promptly once any grace period expires. For residential mortgage loans, federal servicing rules generally prohibit beginning foreclosure proceedings until the borrower is more than 120 days delinquent.11eCFR. 12 CFR Part 1024 Subpart C – Mortgage Servicing The foreclosure itself follows the procedures in your security instrument and your state’s laws. Some states require judicial foreclosure through the courts; others allow faster non-judicial foreclosure through a trustee sale. Before pursuing foreclosure, consult a real estate attorney in the state where the property is located to make sure every required step is followed.