When investing in private mortgage loans, you should rely on someone experienced in reviewing and analyzing these types of alternative investments. It is not rocket science and not a new idea going back to the 1930’s’s with insurance companies. There are a few items to keep in mind as you consider investing in private mortgage loans:
Collateral
We all enjoy purchasing items for a lower cost than average, especially big ticket items right? With a private mortgage loan investment, it is no different. If you lend 50% of the value of an investment property – with the intention of collecting a passive fixed income from the mortgage interest – even if the borrower were to default on the loan, you have inadvertently acquired the real estate asset half off through claiming the real estate title via foreclosure. Depending upon the property, you may be able to rent out the unit and potentially gain a 50%-100% higher annual return than what you were making on passive mortgage interest income. If of course, you wanted to recoup your principal invested and additional profit you could simply resell the property.
Repayment Ability
While how much equity or collateral the real estate contains most often comes to mind when discussing private mortgage loans, the repayment ability of the borrower is a crucial part of determining whether or not to make an investment. The issue of repayment ability addresses the level of certainty as to whether or not a borrower will make the regularly scheduled payments versus defaulting on the loan. If the rental income more than covers the mortgage payment and monthly property expenses, then there’s a higher likelihood of repayment. For a borrower purchasing and renovating a property to resell, if they’ve recently completed and resold previous projects similar to the subject property, then the new loan is being secured should present a higher likelihood of repayment. Requiring the borrower have a certain amount of their own cash into the property also lowers the default risk. Ultimately, most investors desire a passive fixed income investment and generally have an aversion to foreclosing on any property.
Exit Strategy (Loan Repayment)
In this day and age where banks aren’t even lending to well qualified buyers, knowing how your principal investment will be returned is crucial. For example, if you provide a two year interest only balloon loan on a rental property with the strategy for the borrower to refinance or resell, a few factors should be considered. What’s the borrower current credit history? Are there additional free and clear properties or other assets that could repay your loan via selling those assets? Do they have a history of repaying short term loans on other properties that can evidence they’d pay this new one off? What if the real estate market declines and they can’t obtain the resale price they want for the property?
No single answer to the questions listed above will provide a concrete or definitive conclusion, however, the overall experience level of the borrower should be weighed more heavily upon for balloon payments. Each private mortgage investor should be thoroughly aware of how the borrower is going to pay back the loan when it comes due. There are numerous examples of private lenders being forced to extend loan terms on ballooning loans because there’s no way to refinance the property. This can be problematic, especially if the mortgage holder needs to receive their principal investment back at a specific time or deadline. One way to overcome the obstacles present with a balloon mortgage, is to offer a fully amortizing loan on existing rental properties where the rental income can more than sufficiently repay the mortgage and property expenses. Not only are you being repaid your principal invested, but there is less debt owed on the property over time, ultimately reducing your exposure to a loan default because so much equity is built up in the property.
Experience Level
Lending to a borrower with a track record of successful real estate investing is always preferable for private mortgage investors that are seeking a passive fixed income. While you could loan to a first time investor with perhaps a larger down payment, a first time borrower without real estate experience often is required to put additional cash into an investment real estate transaction to compensate for this increased risk.
Credit and Character
Life happens and often bad things happen to good people. Some real estate investors who have owned properties and personally signed for loans have experienced foreclosures or loan modifications on properties they owned over the past few years. This does not in and of itself rule out making a private mortgage loan, however, often times a large cash down payment is required and/or a reduction of the loan to value is required to reduce the loan default risk.
In an age of global financial markets being so interdependent, hard earned dollars are put into investments with the risk of loss often obscured. Why not invest in what everyone on earth needs to live; a place called “home”. When facilitated in a thorough and conservative manner, private mortgage loans are a great source of passive income with the ability to preserve your principal investment even in the event of a loan default.
PRIVATE MORTGAGE LOANS ARE A GREAT WAY TO FIXED INCOME WITH GURANTEEING PRINCIPLE PRESERVATION