You have capital sitting in a savings account earning a fraction of what a local house flipper would gladly pay you for six months of it. Lending that money out at 10 to 12 percent interest plus two points sounds like the easiest business in the world — until you learn that one loan to the wrong borrower, documented the wrong way, in the wrong state, can cost you your license exemption, your interest, and in some states even your principal.
Private lending is a real business with real margins, but it is also one of the most regulated side hustles you can stumble into. Here is how to set up a hard money lending operation the right way: the licensing rules, the usury traps, the deal math, and the books that keep it all defensible.
What Hard Money Lending Actually Is
Hard money loans are short-term, asset-backed loans secured by real estate. Unlike a bank, which underwrites the borrower's creditworthiness, you underwrite the collateral — usually a residential investment property valued on its after-repair value (ARV).
Typical 2026 terms for first-position hard money loans look like this:
- Interest rate: 9.5 to 13 percent, interest-only with a balloon payment at maturity
- Origination points: 1.5 to 3 points paid upfront (each point equals 1 percent of the loan amount)
- Loan-to-value: up to 65 to 75 percent of ARV
- Term: 6 to 36 months
- Loan size: commonly $100,000 to a few million dollars
The borrower's exit strategy — a sale or a refinance into conventional financing — is what repays you. Your job as the lender is to make sure the collateral value, the paperwork, and the legal structure all hold up if that exit strategy fails.
Step 1: Figure Out Whether You Need a License
This is the question that trips up more new private lenders than any other, and the honest answer is that it depends on your state and the type of loans you make.
The business-purpose distinction
The single most important concept in private-lending compliance is the line between business-purpose loans and consumer-purpose loans. That line is drawn by what the borrowed funds will be used for — not by what property secures the loan. A loan to an investor who will renovate and resell a single-family home is a business-purpose loan even though the collateral is a house. A loan to someone who will live in the property is generally a consumer-purpose loan, which drags in the Truth in Lending Act (TILA), RESPA, Dodd-Frank ability-to-repay rules, and state mortgage originator licensing.
The private-lending industry's long-standing position is that business-purpose loans should not be subject to residential mortgage lender licensing at all. Many states agree in practice, but far from all of them — and several states license the activity of lending regardless of purpose once you cross a volume threshold.
State licensing: a patchwork with teeth
There is no federal hard money lending license. Instead, every state writes its own rules, and they fall roughly into three camps:
- License-friendly states allow individuals to make a small number of private loans per year without a license, and only require licensing once you are clearly "in the business" of lending.
- License-required states (California's finance lender license and Arizona's mortgage banker framework are commonly cited examples) require a license before you make even business-purpose loans secured by real estate, with narrow exemptions for one-off loans or loans you broker through a licensed party.
- Usury-first states focus less on licensing and more on capping what you can charge — which brings us to the next section.
Before you fund your first loan, do three things: read your state banking department's guidance on private and business-purpose lending, confirm whether your state's licensing exemptions cover the volume you plan to do, and talk to a local attorney who represents lenders rather than borrowers. A one-hour consultation is the cheapest insurance in this business.
The Dodd-Frank tripwire: never lend to an owner-occupant casually
If there is one compliance rule to tattoo on your forehead, it is this: do not make loans secured by a borrower's primary residence unless you fully comply with federal mortgage rules. Dodd-Frank's ability-to-repay provisions require creditors making covered residential mortgage loans to verify, in good faith, that the borrower can repay — using income, assets, employment status, and other documented criteria. Balloon payments, the bread and butter of hard money structures, are heavily restricted on covered loans.
Most private lenders solve this problem structurally: they lend only on non-owner-occupied investment property, document the business purpose in writing (a signed statement of occupancy and purpose at closing), and decline any deal where the borrower hints at moving in. If a deal smells like an owner-occupant trying to dress up as an investor, walk away. The penalties for getting this wrong include rescission rights and assignee liability that survive the sale of the note.
Step 2: Know Your State's Usury Ceiling
Usury law caps the interest a lender can charge, and the caps vary wildly — from single digits in strict states to no general cap at all in others. Two features of usury law matter most to new lenders.
Business-purpose loans often get an exemption — but not everywhere
Many states exempt commercial, agricultural, and investment-purpose loans from their usury ceilings entirely. Washington, for example, expressly provides that a borrower on a business-purpose loan cannot raise a usury defense. Other states set a higher ceiling for business loans (commonly in the teens) rather than removing the cap.
But the exemption is never automatic. It typically requires that the loan actually be business-purpose as documented at origination, and some states condition it on minimum loan amounts. If your paperwork is sloppy, a borrower in default will argue the loan was really consumer-purpose — and suddenly your 12 percent note is usurious.
Points and fees count as interest
In most states, "interest" for usury purposes includes origination points, discount fees, and other charges, not just the contract rate. Two points on a six-month loan add roughly four percentage points to the effective annualized rate. When you compute whether your all-in pricing fits under your state's cap, amortize every fee over the actual loan term. Short terms make this math brutal: the same two points that are harmless on a three-year note can push a six-month note over the line.
And take the penalties seriously. In strict states the consequence is not just forfeiting the excess interest — some jurisdictions void the interest entirely, and at least one famously allows the borrower to recover the principal too. Price every loan against a written usury worksheet for the state where the property sits, and keep that worksheet in the loan file.
Step 3: Structure the Business Before You Fund Loan One
Lending as an individual with a handshake and a wire transfer is how people lose money twice — once to a bad loan and once to taxes they did not plan for.
Choose an entity
Most serious private lenders operate through a limited liability company. The LLC shields your personal assets from borrower lawsuits and foreclosure-deficiency countersuits, gives you a clean separation between lending capital and household money, and lets you bring in capital partners later. Lenders who pool outside investor money typically graduate to a fund structure with securities counsel involved — taking other people's money to lend is a securities activity, not just a lending activity, and that is a separate compliance universe.
Set written lending criteria
Professionalize early by writing down your box: maximum LTV, minimum borrower experience or liquidity, acceptable property types and markets, rate and point schedule, and maximum term. Written criteria do three jobs at once — they keep you disciplined when a charismatic borrower pitches a thin deal, they demonstrate business purpose and commercial reasonableness if a loan is ever challenged, and they make your operation legible to the CPA and attorney you will need at tax time.
Document every loan like a bank would
At minimum, each loan file should contain a promissory note, a recorded deed of trust or mortgage, a signed business-purpose and non-owner-occupancy affidavit, proof of hazard insurance naming you as mortgagee, a title policy, and your usury worksheet. Interest-only payments with a balloon maturity are standard, but put the maturity date, default rate, late charges, and extension terms in writing. Verbal modifications are where private lenders go to lose foreclosure cases.
Step 4: Keep Books That Survive an Audit — and a Default
Your loan portfolio is a set of financial assets, and sloppy accounting will cost you in taxes, in workouts, and in court. Set up your chart of accounts for a lending business from day one.
Track principal, interest, and fees separately
The most common bookkeeping mistake new lenders make is recording every borrower payment as income. It is not. Each payment splits three ways:
- Principal reduces your loan receivable asset on the balance sheet — it is a return of your money, not a return on it, and it is not income.
- Interest is ordinary income when earned (or when received, if you are on the cash basis).
- Fees such as origination points, extension fees, and late charges are generally ordinary income too, though the timing of when you recognize them depends on your accounting method and the nature of the fee.
Maintain a separate receivable ledger per loan showing the beginning balance, each payment split, and the ending balance. When a borrower disputes what they owe — and in workouts they always do — that ledger is your evidence.
Know how the IRS treats a dead loan
Section 166 allows a deduction for debts that become worthless, but the character of the deduction turns on whether you are actually in the business of lending. If lending is your trade or business, a worthless loan generally produces an ordinary business bad debt deduction, available for partially as well as totally worthless debts. If you are an occasional lender and the debt is a nonbusiness bad debt, you get only a short-term capital loss, and only when the debt becomes totally worthless.
That distinction is worth real money: ordinary losses offset ordinary income dollar for dollar, while capital losses are capped against ordinary income at $3,000 per year. Operating through a dedicated entity, with written lending criteria and regular deal flow, is exactly the kind of evidence that supports business-debt treatment. And document worthlessness contemporaneously — collection letters, foreclosure filings, broker price opinions showing no equity — rather than reconstructing it at tax time.
Reserve for losses and watch concentration
Even good underwriting produces defaults. Sophisticated small lenders set aside a loan-loss mindset from the start: track days-past-due across the portfolio, move nonperforming loans to nonaccrual status (stop recognizing interest you are unlikely to collect), and avoid concentrating your entire capital in one borrower, one neighborhood, or one property type. A simple monthly portfolio report — outstanding principal by loan, weighted yield, delinquencies, and maturities coming due in the next 90 days — takes an hour to prepare and prevents almost every nasty surprise.
If your portfolio outgrows a spreadsheet, this is exactly the kind of multi-account, multi-loan tracking that plain-text accounting handles well: every loan as its own asset account, every payment split into principal and interest postings, and a full version-controlled history. The /docs/ walkthrough shows how to model receivables this way, and /fava/ gives you balance-sheet and income views over the same data.
Common Mistakes That Sink New Private Lenders
- Lending to friends and family on a handshake. Related-party loans get recharacterized as gifts or equity by the IRS, are nearly impossible to foreclose, and destroy holidays. If you must, document them exactly like arm's-length loans.
- Skipping the title search to "save money." A $300 search is what stands between you and a first-position lien that turns out to be third behind two liens you never knew about.
- Ignoring the borrower's exit. If the numbers only work at a sale price the neighborhood has never seen, you are not making a loan — you are buying a property through foreclosure at a premium.
- Commingling lending capital with personal funds. Every deposit and payment should flow through the business account. Commingling pierces entity protection and makes your books indefensible.
- Forgetting state tax nexus. Lending secured by property in another state can create filing obligations there. Ask your CPA before you fund your first out-of-state loan.
Keep Your Lending Business Audit-Ready from Day One
Running a private lending operation means living in your loan files: principal balances, interest accruals, fee income, and worthlessness documentation all have to tie out when the IRS or a borrower's attorney comes asking. Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data — no black boxes, no vendor lock-in. Get started for free and see why developers and finance professionals are switching to plain-text accounting.
