With home sales at a crawl and financial institutions cautious about lending, perhaps no one in real estate faces more significant challenges than Mortgage Brokers. The same people who've made significant profits off the housing and refinancing boom earlier in this decade are now thinking of retiring or finding some way to make supplemental income. They're also looking for alternatives to volatile investments such as real estate or stocks, whether it is in preparation for retirement or to acquire supplemental income to serve as a hedge against inevitable business cycles.
Many real estate-savvy investors are skeptical of riding the Wall Street rollercoaster and want greater consistency and higher yields than such traditional investments. If this is your situation, then trust deed investing is an alternative worth investigating.
Professionals in the mortgage industry should become familiar with the basics of trust deed investing. An informed Mortgage Broker is in an excellent position to find mortgage or trust deed investment opportunities! For example, many motivated sellers, especially in today's market, loan a portion of their equity to the potential purchaser of their homes as a concession to close the sale. These types of loans are often called 80-10-10 loans in the industry, because the borrower invests 10 percent downpayment, the seller invests 10 percent from their equity proceeds and the institutional lender loans the balance. After the close of the sale, many sellers want to sell their second trust deed or mortgage to an eager investor at a discount.
The business practices of conservative real estate lenders help an investor to reasonably estimate and minimize the risk of a trust deed transaction. For example, familiarity with the borrower's qualifications, such as credit, payment history and income, represents an important layer of risk protection against interruption of payments and the resultant loss of return on investment. The type of property offered as security and the equity equation of this property help secure the investor's risk capital. Risk capital is secured so that if the borrower defaults, the investor/lender can claim the real estate as security for the loan.
Real estate lenders require that borrowers sign not only the promissory note, but the borrower must also consent to either a trust deed or mortgage arrangement. Both trust deeds and mortgages are instruments that secure the loan by giving to the lender the right to foreclose on the borrower's property should the borrower default on the loan. However, two other fundamentals are likewise important.
First, the amount of equity in the borrower's property is very significant to loan security. Lenders equate larger equities with greater security for the loan. In view of the recent wave of foreclosures on low-equity houses, some lenders prefer to accept trust deeds on income-producing properties only, such as multi-family apartment buildings where foreclosures are much less common.
Second, it is also essential that the borrower is qualified to repay the loan. Well-qualified borrowers possess a good credit history, sufficient income to repay the debt and good equity in their real estate. Although underwriting standards can be flexible, lenders who maintain conservative guidelines will make safer, more profitable loans that produce regular monthly payments. However, sometimes even well-qualified borrowers default on their loan, thus endangering the lender's investment. What can a lender do?
Should the borrower default on the loan, the lender can instruct the third-party trustee to foreclose and sell the borrower's title to the property at a trustee's sale or sheriff's sale. In this manner, the lender may expect a return of the original principal investment; an anticipated return on investment, as represented by back payments with interest, late charges and other fees; and reimbursement of trustee and recording fees. The trust deed foreclosure process is mandated by state statute. The entire non-judicial process, from default of the loan to the actual foreclosure sale, can occur in less than four months, compared to as much as 12 months for a mortgage foreclosure! Use of prudent lending practices and the recourse of foreclosure help assure the profitability and security of the lender's investment.
There are three common methods used by individuals to make trust deed and mortgage investmentsthe investor who works alone, which is similar to the stock/bond day trader; the investor who works through a mortgage/trust deed pool fund, which is similar to a mutual fund; and the investor who regularly transacts with an established, institutional borrower.
Some investors single-handedly look for opportunities to purchase existing trust deeds, or become the lender or "bank" in a trust deed investment. These investors seek loans that are reasonably secure and produce regular, fixed payments that reflect exceptional yields. Working alone, this type of private trust deed investor is similar to the day trader of traditional stocks. If the day trader is knowledgeable and patient, good investment returns are likely. In comparison, the knowledgeable trust deed or mortgage investor often produces yields that easily surpass typical stocks, bonds or mutual funds, together with the consistency of regular, fixed payments. However, many investors choose not to participate directly in these types of investments.
Here is why: Acting as the bank is not always easy. Remember, the trust deed or mortgage investor is actually a lender and assumes all the risks of a debt collector. Borrowers may skip payments or may stop payments altogether, both of which interrupt the cash flow of an investment. Although foreclosure under a deed of trust is typically much faster and less expensive than a mortgage foreclosure, the foreclosure process still requires an additional investment of time and upfront trustee and recording fees. The foreclosure process can sometimes become timely and expensive. So, although the rewards of trust deed investments can be high, the risk for the individual investor can also be high. Fortunately, there are two other alternatives that allow the average investor to receive many of the benefits of trust deed investments, as well as reduce the risks.
One possible option would be involvement in a mortgage or trust deed pool with a professional trust deed investment company. These institutional investment companies maintain a large portfolio of trust deed and mortgage investments and invite participation from small, private investors. In this sense, investment in a pool of mortgages is similar to the traditional mutual fund investment. Diversification helps ensure both regular cash flow, as well as security of the investor's original capital involvement. Unfortunately, while mortgage pools help the investor to spread risk, this arrangement presents a disadvantage to the investor who wants to maximize income.
Although the yields on these investments are still very competitive with stocks, bonds and mutual funds, the returns can be significantly less profitable than individual trust deed investments. Another downside is the private investor's lack of up-to-date information about important issues such as payment collection and loan defaults on specific investments. Fortunately, there is a third investment strategy that provides the investor with both higher yields and close control over trust deed investments, as well as minimizing risk.
Transact with an established, institutional borrower. Remember the essential requisites for a profitable and secure trust deed investment mentioned earlier. An institutional borrower that satisfies these requirements presents very profitable opportunities to the private investor. The institutional borrower signs both a promissory note and trust deed in favor of the investor. The investor receives not only regular, fixed payments that reflect an excellent yield, but also the relative security of transacting with a company that has an excellent track record of payments and has pledged substantial equities in real estate as collateral. Very importantly, an institutional borrower can offer regular investment opportunities to trust deed and mortgage investors.
Trust deed investments, like all investments, represent a level of risk. However, the investor's ability to reasonably estimate and minimize the risk of a trust deed transaction is one of the more attractive aspects of this type of investment. This is especially true when the investor transacts with an institutional borrower.
Ultimately, the trust deed investor doesn't want ownership of pledged real estate in a foreclosure scenario; an investor wants regular payments that represent the expected rate of return and the timely repayment of its principal investment.
Although trust deed investments are not the typical, traditional investments found in Wall Street, these investments can be significantly more profitable and comparably secure. The high yields and regular, fixed payments of trust deed and mortgage investments can greatly enhance any investor's portfolio, but are especially attractive for mortgage professionals who know their way around the real estate market.