What to Expect When Investing in Private Mortgages
For individuals seeking to add to their investment portfolio, a mortgage might seem like the last thing they want to consider. From the individual perspective, a mortgage is something to pay off over multiple decades after going through several loan renewals. However, the mortgage is one of the most common investment vehicles in the world — just not as a part of individual portfolios. From the perspective of banks, of course, or other lending institutions, the mortgage is one of the most popular moneymakers. It brings in a decent return on the initial investment, and it also has a lower financial risk than many of the other alternatives out there.
If you’re an individual or you own a company that is looking to diversify its investment holdings, then it’s time to consider the private mortgage field. There are many different sorts of mortgages, but the most common targets for private mortgage investors are first and second mortgages taken out against property. A first mortgage is the initial lien on a property and must be satisfied from proceeds of the sale of the property before any other claim can be honored. A second mortgage also has value but the holder must wait until the first mortgage has been satisfied in full. The difference between the first and second has to do with the date of registration. If a property already has a first mortgage, the next one to be taken out is the second mortgage. If you are financing a second mortgage, you can ask for a higher interest rate, because there is a higher risk that you will go unpaid at renewal or the point of sale, because the first one has to be paid first.
You might be wondering why you would want to invest in a market that, if you’re looking in the financial papers, only returns between 3 and 5 percent — the rates of existing mortgages offered by banks. The good news is that you’re not offering those mortgages — you’re not competing with banks. Instead, you are lending to people who can’t qualify for bank financing — but still have the means to pay a mortgage off. The private mortgage market is aimed at people who have some significant credit issues in their past keeping their scores too low for the banks to approve financing, or at people who lack the documented income history to justify a bank extending a loan to them.
Here are two examples of typical private mortgage clients. One is a surgeon who, four years ago, went into private practice with two partners. While his salary before that was paid by the hospital that employed him, his practice has paid his salary the past four years. The first year things were somewhat irregular as the business was building, but the three years since then have been much more lucrative. However, the fact that the surgeon owns his own business raises a red flag with many lenders. Self-employed professionals don’t have the same oversight in their payroll departments — at least according to the calculations that banks use to determine creditworthiness — and so the banks aren’t approving the surgeon’s mortgage, even though he has 30 percent to put down.
Another would be an English professor at a local university. Her salary is modest but more than adequate to fund the mortgage payments that she wants to take out. She also has 25 percent of the purchase price saved up. Unfortunately, five years ago, her now ex-husband ruined the family finances, letting not one but two different cars go into repossession, and he maxed out their credit cards before running off with a girlfriend, leaving her to pick up the pieces — financially as well as emotionally. A lot of those joint credit issues are still on her profile, even though she has been divorced for four years. She has found a home she wants to purchase, and she has the means to pay for it, but her credit score is still so low — and the house puts her close to the highest debt-to-income parameters that the bank permits — that she can’t get approval.
Both of these potential borrowers have hefty down payments to put down, but they can’t qualify for bank financing. This makes them ideal borrowers in a private mortgage. As a private mortgage lender, you’re more interested in the property under consideration than the creditworthiness of the borrower anyway. You know that you’re taking on a higher level of risk because you’re dealing with people that the banks won’t work with. So your primary concern is the property itself. Let’s say that a borrower wants to purchase a house listed at $600,000 and has $150,000 to put down, leaving $450,000 for the lender to fund. An appraisal reports that the house is actually worth $615,000 — so the purchase price is actually a good deal. You don’t have any problem extending this loan, because you know that if you had to foreclose on the house and sell it, you’d be almost assured of making your money back and then some, because the likelihood of the real estate market tanking to that degree over the course of a private loan is fairly small.
Of course, you still will want to look at the borrower’s financial profile — you’re just not giving it as much weight as the banks do. You’re looking at things like the credit score, the borrower’s work profile and the cash flow that the borrower has in place. Those details help you decide where to set the interest rate — and the ideal loan-to-value ratio of the investment overall. If your private mortgage is a second lien, you can currently ask between 9 and 18 percent as an interest rate. On a first note, you can ask between 7 and 12 percent — both significantly higher than what the banks would ask.
When you first slide your foot into the private mortgage investing pool, you might be looking for the safest private mortgage possible. So your ideal client might be the professor who has built up a solid work history but just has that messy divorce and financial chaos in her reasonably distant past. Because the surgeon doesn’t have any other employer than himself, you could likely get away with asking for a higher interest rate for his loan. Either way, though, be prepared to take a more active role in collecting your payments than you would if you were a bank. You might need to send out a reminder a week or so before the due date. In some cases, the client can turn out to be an unpleasant surprise — if it turns out that the professor has a nasty cocaine habit and has been using a trust fund to pay a meager rent until she can qualify for your loan, and now the trust fund is dry and she isn’t making her payments to you, you may need to hire an attorney and go through foreclosure proceedings.
In most cases, though, even private mortgage borrowers pay off their notes with little or no fuss on your part. After all, the typical term of a private loan is short — no more than one to two years in most cases — and people who take out private mortgages are often motivated to build a credit history and/or repair a poor credit score from the past. Also, people are least likely to run into default on their mortgage payments because their home is their greatest source of security. As long as you are mentally prepared for the fact that some irregularity may ensue with the payments, then you’re ready to consider the private mortgage investment market.
So how do you determine the balance between risk and reward as a private mortgage investor? You may have a mortgage broker suggesting a particular rate to you. However, the broker is not putting his own money at hazard — he’s suggesting that you do it with yours. This means that it is your job to carry out the due diligence that is necessary to eliminate as much risk as possible. This means that you’ll want to peruse the potential borrower’s credit history, employment history and all of the other documentation that he has submitted to the broker for consideration. If you do this research well, you’ll end up with an investment that has a little more risk than government-backed securities but less risk that the stock or commodities market. If anything looks fishy on the client application, though, feel free to say no — and to ask for the next application. A good broker will perform an assessment of your investment wants and needs to match you with risk profiles that are compatible, but the final answer is yours to give. You’re the one who will be drawing the profits — and bearing the loss should things go south.
You might believe that bank-based investments are enough to guarantee your solvency during retirement. If you go by the Rule of 72, you know that an investment returning 3 percent will take 24 years (3 x 24 = 72) to double in value. The risk is nil, but the rate of return is hard to distinguish from annual inflation — which makes it a poor use of your money. The other end of the spectrum of investment risk can be enticing, as commodities and stocks can double your money as quickly as a year — or even faster. However, that extremely high level of reward comes with an extremely high level of risk. If you have a savings account in a bank and the bank collapses, the government insures your account, ensuring that you retain your money. However, if you are investing in commodities, stocks, bonds or futures, there is no such protection in place for you. If the value plummets, so do your holdings.
If you have $100,000 to invest in a private mortgage, though, it’s natural that you’d be concerned about putting that money in just one loan. If you choose the wrong borrower, even after you perform all of that due diligence, you could end up out a lot of that money, particularly if attorneys’ fees eat up a lot of your proceeds and you have to accept a short sale (a sale of the house for less than the amount still owed on it).
The good news is that there are several ways to manage your risk. You can have your money invested in several mortgages instead of one. So instead of funding one (or part of one) mortgage with your $100,000, you could ask the broker to invest $25,000 each in four different mortgages. That way, even if one mortgage goes into default, the other three should continue to pay reliably. Most people who are entering the private mortgage market as smaller investors prefer this approach. Some investors — even the larger ones — take part in a mortgage pooling arrangement or a syndicate. This spreads your money out over a wide group of mortgages — or even across multiple lenders, depending on how much you invest. While this is likely to lower your return a bit, as you’ll have a mix of lower-risk private mortgages along with the higher-risk ones, you’re also securing your return to a greater degree.
Another important step involves choosing the right broker. There are many different companies in the mortgage brokerage industry, and as one might expect, there is a wide variety of quality and reliability. Before you agree to take a look at any applications, make a list of questions to pose to your broker, and ask all of them. If your broker gets impatient or hedges on any of the answers, it’s time to move onto the next broker. You’re about to invest a lot of your money, and you have the right to have all of your questions asked and your concerns addressed before you even think about getting your cheque book out.
So here’s how the process works with Amansad Financial Services once you set up as a lender.
1. You will be sent documents about a potential investment opportunity. This will include the borrower’s mortgage application and credit report as well as the appraisal on the property, a sales agreement (if a purchase), mortgage statements (if a refinance or cash take out), other applicable supporting documents. Use these documents to determine whether or not the mortgage is right for you. Once again, feel free to contact the us with any questions you have about the deal. Amansad Generally attempts to have all the questions answered within the submission package.
2. You’ll want to move quickly with your review of the application, because brokers want to be able to respond to the borrower within 24 to 48 hours. Homes for sale can disappear as soon as an owner accepts an offer, and we don’t want to lose business because a borrower is waiting for an approval. Also, some borrowers need money quickly in order to refinance existing mortgage or take out equity from existing property.This is why you should be able to expect the broker to answer your questions quickly — and completely.
3. Let us know whether you are approving or denying the loan. If approving the loan, indicate how you plan to bring the funds to your chosen solicitor. Amansad Financial Services will prepare the commitment and appropriate disclosures to be signed by both the lender and the borrowers. Once all parties have signed the appropriate paperwork, we will prepare the mortgage for instruction to your chosen Solicitor. (Note: If you do not have a chosen legal representative; Amansad Financial has relationships with various solicitors that understand our process so that the transaction is handled quickly and efficiently.)
4. The attorneys will handle all of the administrative tasks related to the title of the property — and will send you your money, if your broker offers a service of post-dated cheques. Once you’ve invested in one private mortgage, others will be less stressful and go more smoothly.It is our task to make sure that all of your questions are answered and to ensure that the loan follows all of the legal requirements in Canada.
Amansad Financial Services is registered under DLC Brokers For Life Inc., which is an Intermediary Mortgage Brokerage. We do not representing the lender or the borrower. Neither are considered clients. Both are CUSTOMERS. We will facilitate the mortgage deal by gathering information, explaining the options, completing the necessary documents and keeping both sides apprised of the deal’s progress.
Call 780-756-1119 or 1-877-756-1119 to discuss.