# 9 Ways Investors Lose Money in Private Lending

> Nine specific failure modes, each with the control that prevents it. Written as a checklist you can run against any lender or fund, including this one.

Canonical: https://matadornotefund.com/blog/how-investors-lose-money-private-lending
Author: Apurva Sanghavi
Published: 2026-10-02T17:43:48.062Z
Tags: Debt Fund, Private Lending, Real Estate Investing

## 1. Lending in second position without pricing for it

A second lien is a claim on whatever is left after the first lender is made whole. At a foreclosure sale, "whatever is left" is frequently nothing.

Illustrative: a house worth $400,000, a first lien of $300,000, and your second of $60,000. Combined loan-to-value is 90%. The borrower stops paying, the first lender posts the property, and the sale brings $320,000 – a normal outcome for a distressed sale at roughly 80% of value. The first lender is owed $300,000 of principal plus accrued default interest, advanced taxes and foreclosure costs, which can easily total $325,000 by the time the gavel falls. You receive nothing, and your lien is extinguished by the sale.

Your only defense is to reinstate or pay off the first loan and take the property yourself. That requires $325,000 of cash available in about three weeks.

**The control.** Either lend in first position, or size your second position around the cash you can actually deploy to protect it. If you take a second, the specific items are: a written combined LTV ceiling well below the first lender's own, a recorded subordination and intercreditor agreement that gives you notice of the borrower's default and an express right to cure, a verified payoff statement on the first at closing, and a reserve you have set aside and not spent. We do not take second liens. Matador Note Fund 1 LLC holds first-lien loans on Texas real property only.

## 2. Trusting the borrower's valuation

Every borrower's property is worth more than the comparable sales suggest, for reasons specific to that property. Every one.

Overvaluation is the quiet failure mode, because nothing looks wrong until you sell the collateral. A loan at a stated 70% of value that was really 70% of an optimistic number is a loan at 85% of the real number, and 85% does not survive a foreclosure discount, six months of accrued interest and a sale commission.

**The control.** The valuation is ordered by the lender, from an appraiser on the lender's panel, and delivered to the lender. The borrower may pay for it; the borrower may not choose the appraiser or receive the report first. Underwrite the advance rate to as-is value, not to after-repair value, and treat ARV as a secondary test rather than the basis of the loan. Require comparable sales that are recent and close, and read them yourself. Then apply the cheapest sanity check in lending: if the borrower is buying the property today in an arm's-length transaction, the contract price is the value, whatever the appraisal says. A purchase at $300,000 with an as-is appraisal of $450,000 is not a bargain, it is a red flag.

## 3. Skipping title insurance

The lien you did not know about is the one that outranks you.

Private lenders skip title work under time pressure, usually on a deal with a borrower they know, and usually to save a few thousand dollars on a loan earning tens of thousands. What surfaces later: an unreleased deed of trust from a paid-off loan, a federal tax lien with its own redemption right, a mechanic's lien from work that started before your deed of trust was recorded, an HOA assessment lien, a divorce decree, or heirs who never signed anything. In Texas, mechanic's and materialman's lien priority can relate back to the start of work on the property, which means a lien recorded after your closing can still sit ahead of you.

**The control.** A lender's title policy in the amount of the loan, every time, with the endorsements your counsel asks for. Funds disbursed by the title company, never wired to the borrower. A current survey or a survey deletion. Tax certificates showing no delinquency. And the original recorded deed of trust returned to the lender or the fund's custodian, not left in a borrower's file. We do not fund a loan without a lender's policy.

## 4. Releasing rehab money without inspection

This is the most common way money disappears in a flip loan, and it almost never looks like fraud at the time. It looks like a borrower who needs Friday's draw to make payroll.

The pattern is consistent. A rehab holdback is advanced against work that is promised rather than completed. The borrower uses it to cover an overrun on a different project. The next draw covers the hole in this one. Four months later the property has $40,000 of work in it, $95,000 has been advanced, and the borrower has stopped answering. You now own a half-finished house and the completion cost exceeds what is left of your protective equity.

**The control.** Fund the purchase; hold back the rehab. Draws are paid in arrears, for work already in place, verified by a third-party inspector with date-stamped photographs, and the inspection fee is charged to the loan so nobody is tempted to skip it. Cap the number of draws. Hold retainage. Take conditional and unconditional lien waivers from the general contractor and any major subcontractor. Where the budget is large, pay the contractor directly. And never advance a draw because the borrower says the inspector is booked out.

## 5. Lending to inexperience on a complex project

A first fix-and-flip on a cosmetic rehab is a manageable risk. A first ground-up build is a different exercise, and the failure is rarely the borrower's honesty. It is the schedule.

Ground-up construction has a longer money-out period, a permitting process that does not care about your term sheet, a budget that is an estimate rather than a price, and no rentable or sellable asset until it is substantially finished. A borrower who has done three flips has never managed a framing crew, a utility connection or a municipal inspector. The loan does not default in month two. It defaults in month fourteen, when the interest reserve is exhausted and the house is at 70% complete, which is the least valuable state a house can be in.

**The control.** Tier your advance rate by verified experience, and verify it with addresses and closing statements rather than a résumé. On ground-up, require a licensed general contractor with a fixed-price contract, a line-item budget you can test against local cost per square foot, permits in hand before the first dollar, an interest reserve sized to the full term rather than the optimistic term, and more borrower equity than a comparable rehab would need. Our stated targets for ground-up construction are 75% of as-completed value, with an 85% maximum across the portfolio and 80% maximum on this product type.

The manager's own Texas lending record includes a new construction loan in Houston 77020, $176,400 on an 18-month term funded in January 2022, that went to foreclosure and returned principal in full. That is the outcome a control produces: a bad loan, not a lost loan. Those figures are the manager's lending record, not audited fund performance.

## 6. Concentrating in one loan or one borrower

Here is the two-loan portfolio problem in arithmetic.

Across 60 Texas loans funded since October 2019, the manager has had five workouts: four foreclosures and one deed in lieu. That is a workout rate of about 8.3%. Again, that is the manager's lending record and not audited fund performance.

Illustrative: if you personally held two loans of $125,000 each and they behaved like that book, there is roughly a 16% chance that at least one of them goes into a workout, and if the loss on that one is severe, it is 50% of your capital at risk in a single event. Spread the same $250,000 across a pool of sixty loans and the same 8.3% workout rate is an operating fact rather than a personal catastrophe. Diversification does not change the odds of a default. It changes what a default does to you.

**The control.** Written position limits, not intentions. A maximum per loan, a maximum per borrower across all loans, a maximum per product type, and a maximum per submarket. Our documents provide that no single loan will exceed 20% of fund capital once the fund holds $20 million or more. Ask any manager what their limits are, then ask to see the current loan tape and check whether the limits are being honored.

One honest complication: 20 of those 60 loans went to repeat borrowers. Repeat borrowers are better credit because you have watched them perform, and they are also concentration. Both statements are true, and a lender who only tells you the first one is selling.

## 7. No personal guarantee, no recourse

A personal guaranty is a recovery tool. It is not underwriting, and a lender who relies on it has already made the mistake.

A guaranty is worth the guarantor's collectible net worth, minus the homestead, minus retirement accounts, minus everything already pledged elsewhere, multiplied by your appetite for two years of litigation. In Texas it is worth less than many out-of-state lenders assume, because after a non-judicial foreclosure the borrower can ask a court to offset the deficiency by the property's fair market value, and the window to bring the claim is short. Against a guarantor who owns nothing in his own name, the document is a piece of paper with a signature on it.

**The control.** Take the guaranty anyway, from every principal, joint and several, plus a carve-out guaranty covering fraud, waste and misapplication of draws where the borrower is an entity. Then support it: a current personal financial statement backed by two months of statements rather than a self-reported form, a judgment, lien and litigation search, and confirmation of which assets are exempt. And size the loan as though the guaranty does not exist, because the collateral is the underwriting and everything else is a second way to get paid.

## 8. Manager commingling and weak controls

If you are investing through a fund rather than making loans yourself, this item and the next one are the only two that are fully within your power to check before you wire.

Commingling means investor money sits in the same account as the manager's money, or another fund's money, and no ledger separates them. It is the precondition for nearly every private-fund fraud, because it makes a shortfall in one place payable from another place, and it makes the whole thing look fine until it doesn't.

**The control.** Ask specific questions and expect specific answers. Are there separate bank accounts per entity, with the fund's name on them? Who is authorized to move money, and is a second signature required above a threshold? Who services the loans and collects the payments – the manager, or an independent servicer? Who holds the original notes and the recorded deeds of trust? Is there a third-party fund administrator, and is there an annual audit or review by a firm you can call? Do quarterly statements show loan-level detail you can reconcile? A manager who is offended by these questions has told you what you needed to know.

## 9. Not reading the documents

The Private Placement Memorandum, the Operating Agreement and the Subscription Agreement govern in all cases. The pitch deck governs nothing. Four things to find before you sign:

**Is the preferred return cumulative or non-cumulative?** This is the single most misread term in private funds. Ours is non-cumulative: the 8% preferred return is paid quarterly from available distributable cash before any manager profit share, and a quarter that is not paid is not owed later. Cumulative sounds better and is a different instrument. Know which one you are buying.

**How do fees layer?** Look for the asset management fee and its basis, the origination points on each loan and whether they accrue to the fund or to the manager, servicing fees, and any fee charged on committed rather than invested capital. Our asset management fee is 2% per year on invested capital. Above the 8% preferred, excess distributable cash splits 60% to investors and 40% to the manager.

**What are the exit mechanics?** Not the marketing summary, the actual clause. Ours: a 24-month lock-up, then a written request with 90 days' notice, processed quarterly, at up to 25% of your balance per quarter, subject to fund liquidity. Read the words "subject to fund liquidity" carefully, in ours and in everyone else's, because that is the gate.

**What may the manager do with affiliates and with borrowings?** Whether the fund may buy loans from the manager, on what terms, and who approves it. Whether the fund may borrow. Ours may use a note-on-note credit facility within the limits set in the PPM, and borrowing raises returns in good conditions and raises losses in bad ones.

## The checklist

Run this against any lender, any fund, or your own loan file. Every row is a control you can verify, not a principle you can agree with.

| **#** | **Failure mode** | **The control that prevents it** |
| --- | --- | --- |
| 1 | Second-position lending | First liens only, or a written CLTV ceiling plus an intercreditor cure right and cash set aside to reinstate the senior loan |
| 2 | Borrower's valuation | Lender-ordered appraisal from the lender's panel, advance rate set on as-is value, contract price treated as the value on a purchase |
| 3 | No title insurance | Lender's title policy in the loan amount, disbursement through title, tax certificates, survey, original recorded deed of trust held by the lender |
| 4 | Uninspected draws | Rehab held back, draws in arrears only, third-party inspection with dated photos, lien waivers, retainage, contractor paid directly on large budgets |
| 5 | Inexperience on complex projects | Advance rate tiered to verified completed projects, licensed GC with fixed-price contract, permits before funding, full-term interest reserve |
| 6 | Concentration | Written per-loan, per-borrower, per-type and per-market limits, and a loan tape you can check them against |
| 7 | Weak recourse | Joint and several guaranty from every principal, carve-out guaranty for fraud and waste, verified financial statement, lien and judgment search |
| 8 | Commingling | Separate accounts per entity, dual authorization on wires, independent servicer, third-party administrator, annual audit or review, reconcilable statements |
| 9 | Unread documents | Read the PPM, Operating Agreement and Subscription Agreement for pref definition, fee layering, redemption gates and affiliate transactions |

We keep this as a one-page PDF, formatted to print, with space to write the answer next to each control. It is the document we would want a prospective investor to bring to a meeting with us.

**\[Download the nine-point private lending checklist (PDF)\]** – enter your email and we will send it.

## Frequently asked questions

**Q: How do people lose money in hard money lending?**<br />A: Most losses trace to a short list of repeatable errors: lending behind another lien, accepting the borrower's own valuation, funding without a lender's title policy, releasing rehab draws without inspection, backing a first-time builder on a complex project, putting too much money into one loan or one borrower, taking recourse that cannot be collected, and not reading the fund documents. Each one has a specific control, and the controls are unglamorous.

**Q: Is second position lending worth it?**<br />A: Sometimes, if you are paid for it and you are able to act. A second lien is wiped out at the first lender's foreclosure sale unless there is real equity above the first balance plus costs, and defending it usually means reinstating or paying off the first loan with your own cash. If you cannot write that check on short notice, the position and the price are mismatched. We lend in first position only.

**Q: Do private lenders need title insurance?**<br />A: No rule requires it, and skipping it is how lenders find out about unreleased deeds of trust, mechanic's liens, tax liens and heirship problems after closing instead of before. A lender's policy in the amount of the loan, with funds disbursed through the title company rather than handed to the borrower, costs a few hundred to a few thousand dollars and removes a whole category of total loss.

**Q: What is commingling in a fund?**<br />A: Commingling is mixing investor money with the manager's own money, or with another entity's money, in one account, so that no one can say whose dollar is whose. It makes misappropriation easy and honest accounting hard. The controls are separate bank accounts per entity, third-party administration or independent servicing, dual authorization on outgoing wires, and statements an investor can actually reconcile.

Download the nine-point checklist as a printable PDF and run it against whoever you are considering, us included. Enter your email and we will send it over.

**Important disclosures.** This article is for informational purposes only and is not an offer to sell or a solicitation of an offer to buy any security. Any offer is made only through the Private Placement Memorandum, Operating Agreement and Subscription Agreement of Matador Note Fund 1 LLC, which govern in all cases and should be read in full, including the risk factors. Interests are offered only to accredited investors as defined in Rule 501 of Regulation D, pursuant to Rule 506(c); accredited status must be independently verified. Real estate debt investments involve significant risk, including possible loss of principal. The 8% preferred return is non-cumulative and is payable only from available distributable cash at the manager's discretion; it is not guaranteed. The 8–12% figure is a target objective, not a promise or projection of results. Targeted returns are not guarantees of future performance, and past performance is not indicative of future results. Figures describing prior lending are the manager's own lending record and are not audited fund performance. Nothing here is legal, tax or investment advice. Matador Lending LLC is not a registered investment adviser.

## What to read next
- [Risks of hard money lending](/insights/risks-of-hard-money-lending/)
- [Red flags](/insights/private-lending-fund-red-flags/)
- [27 questions to ask](/insights/questions-to-ask-before-investing-debt-fund/)
- [First-lien position](/insights/first-lien-position-explained/)