How to service a hard money loan

What loan servicing means for a private lender

Servicing is the ongoing administration of a loan: accruing interest, collecting and applying payments, funding draws, tracking insurance and taxes, enforcing late fees and default terms, handling extensions, and finally producing a payoff. Large lenders hand this to a dedicated servicer. Most private and hard money lenders do it themselves, often with one or two people and a spreadsheet.

Doing it yourself is fine as long as the process is consistent. Problems start when each loan is handled a little differently, when terms live in a document nobody re-reads, or when the numbers in your head don't match the numbers in your records.

Step 1: Set up the loan record correctly at funding

Everything downstream depends on the loan record. Before the first day of interest, make sure you have captured the terms exactly as the note states them.

• Principal and total commitment, including any construction holdback
• Note rate, default rate, and how interest is calculated (360 or 365 day year, full commitment or drawn balance)
• Payment schedule and due day, grace period, and late-fee terms
• Maturity date and any extension options and fees
• Points, doc prep, and other fees charged at closing
• Borrower, guarantors, entity, and property details
• Which capital source funded the loan

Step 2: Accrue interest every day

Hard money loans usually accrue interest daily even when payments are monthly. The daily amount — the per diem — is the outstanding balance multiplied by the annual rate, divided by the number of days in the year your note specifies. If the loan accrues on the drawn balance, the per diem changes each time a draw is funded or principal is paid down.

Keep a running record rather than recalculating from scratch each month. A daily accrual you can point to makes every later conversation — late notices, payoffs, disputes — simpler.

Step 3: Apply payments the same way every time

Your note should say how payments are applied. A common order is fees first, then accrued interest, then principal. Whatever the order, apply it consistently and record the date the funds actually arrived, not the date the borrower says they sent them. Partial payments, returned payments, and payments made outside the normal schedule all need the same discipline.

Step 4: Manage draws on construction loans

If the loan includes a rehab or construction holdback, servicing includes funding draws. Each draw should be tied to the budget, supported by photos, receipts, or an inspection, and approved for an amount the work actually supports. Record the remaining holdback after every draw. On drawn-balance loans, remember that each funded draw increases the balance that accrues interest.

Step 5: Enforce late fees and default terms

Late fees and default interest are only useful if they're applied consistently and according to the note. Track the due date, the grace period, and the date payment was received. If a loan goes into default, the default rate typically replaces the note rate from the default date forward; keep both rates visible so you can show the borrower exactly how a number was reached.

State law limits on fees and interest vary. Have your attorney confirm your note terms comply where the property is located.

Step 6: Watch maturities and extensions

Short-term loans mature quickly. Keep a list of upcoming maturities and contact borrowers well before the date. If you offer an extension, document the new maturity, any extension fee, and any change in rate, and update the loan record so interest continues to calculate correctly.

Step 7: Produce an accurate payoff

When the property sells or refinances, the title company will request a payoff statement good through a specific date. It should include outstanding principal, interest accrued through the good-through date, any default interest and unpaid late fees, and any fees for the payoff itself, such as a wire fee. Show the per diem so the title company can adjust if closing slips a day or two.

After the payoff funds arrive, confirm the amount, close the loan, and release the lien as your documents and state require.

Keep the books in step

Every one of these events has an accounting side: interest income, fee income, principal returned, and the cost of the capital that funded the loan. Lenders who record servicing in one place and accounting in another usually spend month-end reconciling the two. The fewer times a number is re-typed, the fewer chances it has to drift.