Alternative investment: Private mortgage loans

[calmloki]

We've been doing rental real estate for the last 20+ years, buying, doing fixup, renting, plowing the income back in - wash - rinse - repeat. After the latest group of misjudgements on my part (giving someone a break and then dealing with the move-in boyfriend's mail theft & meth sales, destruction of our property by the tenant and the strong arm of the law; then entering the judicial zone, where the tenant's rights were vigorously protected by the judge; then dealing with the regulatory agency's new rules....) we're getting tired of being landlords.

We have bought individual stocks in the past and some stock options - made a little, lost a little, never felt that the market moved in accordance with my sense of logic. Feel uncomfortable being invested in something that I don't understand. Index funds make sense to me (which doesn't really make me feel secure!), but from my limited reading the returns are expected to be reduced in the next decade or so - maybe in the 7-9% range.

What we have been doing is funding individual mortgage loans through a local small loan company. We've done four loans so far, ranging from $37k to $94k, one has paid off. These loans have ranged from 8.5 to 10%, all have had a 5 year balloon, all have given us a note in trust and put us in the position of first mortgage holder. All loans have closed through title companies. I like these because we can go out and look at the investment - it's tangible. We loan at a 60% LTV ratio, and since we don't loan on anything we wouldn't mind owning, if a loan goes sour the worst that could happen is we lose 6-12 months interest earnings and maybe $3-5k in lawyer's fees to own the property. Monthly payments are sent to the loan company and forwarded to our bank of choice; they handle the paperwork and interest computations for $6/month. I like that the loans are short term - if interest rates go up we aren't stuck with a low interest rate loan for long. I'm thinking that by mixing these loans 1/2 and 1/2 with the current batch of 6+% CDs we have a real secure future with an average ~7.75% low volatility return.

One thing that strikes me is that all the interest income is taxed at regular rates - no long term capital gains - but I'm not sure how much that will affect us - we're firmly in the 28% tax bracket, with Oregon taking another 9%.

Please critique: interested in what other's see as the positives and the negatives in this scheme - maybe this is of interest or help to someone else.

 

[brewer12345]

Sounds Ok, I guess. I would say that you are pretty dependent on t he loan company to do a proper job of underwriting and collecting, which would be my principal worry. Another possible issue is taht you could get stuck with a significant environmental liability iff you foreclose on a contaminated property.

 

[OAG]

I do not know if this is viable at this time but back in the late 70's and early 80's I got involved in a few small second trusts. They were generally for 5K or a tad more but they went to people, usually military officers, that just needed the cash for a deck or other improvement to the home or for some other personal purpose. They were VERY good since the homes they were on generally were resold within 3 to 4 years and I never lost out on one of them. The interest rate worked out to about 21% on a discounted loan for 5K (note was for 6.250K) interest rate was 12% so actual cash moving to borrower was 5K but coming back to you was 6.2K plus interest for the term of the loan (5 years). I know this structure may not work in the present (12% and discounted to 21% may not fly) but these loans were small and you could do many of them with little capital (may have to raise the base to about 10K today) and you could afford for one to go bad and not lose too much. Also, it sure beat doing the Landlord thing.

 

[tryan]

I am trying to see what's in it for the the loan company - just fees? If they're paying you the interest (8.5-10%) ... could they possibly be charging a higher rate? Is there a link for these loan companies?

Last time I sold and carried the note (first position) I decided all the downside risk was mine (they mail me the keys if values drop; I lost potential equity if prices increase ). But I was carrying 90-95% of the house value. Getting a first position with only 60% LTV at 8.5-10% .... WHERE DO I SIGN?

I'ld keep doing what you're doing.

 

[justin]

"60% LTV at 8.5-10%"

The red flag around these deals in my mind is that the loan servicing company and the buyers might be running a scam. You'd have to sort of know real estate values to make sure you aren't getting shafted.

Say a slumlord rental house in the hood is listed at $50k. Buyer gets under contract at a $45k purchase price, then goes to you (the lender) with a cooked appraisal report showing a $100k FMV. Then you loan $60k (a 60% LTV), not knowing the true value or purchase price. Buyer walks from his $45k house with $15k in cash and the lender is S.O.L. Not saying this is the case in your situation calmloki, just a hypothetical.

Due diligence is obviously extremely important in these type deals.

What would motivate someone to go with a 60% LTV at 8.5% to 10%? I'm assuming the market rate for something like this would be lower?

 

[Peaceful_Warrior]

I've been investing in private mortgage loans for a couple of years now, and it has proven to be very profitable and very low risk.

However, I do not invest in individual mortgage loans. I invest in a business that invests in several mortgage loans to help spread the risk. So far it brings in 9-12% consistently, and I can compound my investments monthly through reinvesting the dividends.

 

[calmloki]

I am trying to see what's in it for the the loan company - just fees? If they're paying you the interest (8.5-10%) ... could they possibly be charging a higher rate? Is there a link for these loan companies?

Last time I sold and carried the note (first position) I decided all the downside risk was mine (they mail me the keys if values drop; I lost potential equity if prices increase ). But I was carrying 90-95% of the house value. Getting a first position with only 60% LTV at 8.5-10% .... WHERE DO I SIGN?

I'ld keep doing what you're doing.

I'm sure the loan company is scoring substantial fees. Met the (one man show) lender back in '94 when we bought the house we are in now from our deceased neighbor's son. We had bought the home from him at 1/3 down, he turned around and sold the loan at a substantial discount. No way on earth a bank would have lent money on this house in it's condition at that time. I hand carried payments to the loan company for years, getting to know the owner. Check your local yellow pages Tryan - call the little guys and tell them you're looking to fund loans.

Justin said "The red flag around these deals in my mind is that the loan servicing company and the buyers might be running a scam. You'd have to sort of know real estate values to make sure you aren't getting shafted."

Darn right. We go out and look at the potential properties. A property tax appraisal of Real Market Value is a good start, but if we wouldn't want to own it we don't fund the loan.

Justin said "What would motivate someone to go with a 60% LTV at 8.5% to 10%? I'm assuming the market rate for something like this would be lower?"

One guy was building a pizza parlor and had his place looking like hell - but had a good chunk of dirt under it. One had a major IRS bill, with penalties, house needed a roof, didn't have the money to bring up to bank lending standards to borrow at a lower rate. One was a divorce situation, was going to lose the house to the lender, we stepped in at a higher rate and paid the underlying debt. The rates are punitive enough that people are incented to seek other financing, which works for us as it keeps our money tracking interest rates up - I don't see them going down soon.

 

[justin]

calmloki - interesting. I might have to look into this at some point in the future. I'm just amazed that the traditional loan underwriting guys let these folks with a 40% down payment slip through the cracks. Maybe 8.5-10% was the best rate these folks could find.

 

[d]

how many individual loans do you hold? if only a few, i'd be concerned with the concentration of risk.

 

[Peaceful_Warrior]

I personally hold 0 individual loans, but the portfolio I invest in holds dozens.

how many individual loans do you hold? if only a few, i'd be concerned with the concentration of risk.

 

[calmloki]

calmloki - interesting. I might have to look into this at some point in the future. I'm just amazed that the traditional loan underwriting guys let these folks with a 40% down payment slip through the cracks. Maybe 8.5-10% was the best rate these folks could find.

I was unclear - all our loans have been refi's that put us in first position, or loans on a F&C property that gave the property owner some capital. On the initial loan, where we were paying, our seller sold his loan at a discount to someone who then took payments from us according to the terms of our original contract. Our latest loan we have lent at 10%, interest only, 3 year payoff - a real good looking redone set of offices.

 

[lloyds]

My parents did this very thing back in the 70's and 80's. Usually small loans at pretty high rates. It was all handled through the family attorney. He found the borrowers, set up the funding with friends and clients. If the borrower defaulted the attorney would foreclose, pay my folks the balance owed, and the attorney ended up owning the property. Then when the recession hit in 80 or 81 things started getting hinky. My dad died suddenly, leaving my mother to manage the portfolio. Attorney assures her he will take care of her and her investments. Pretty soon the borrowers start defaulting regularly, the attorney can't cover it all and turns the properties back to the clients. Mom ended up with a bunch of seconds, or worse, sometimes a second where the attorneys' wife had a first and a third. Stuff like that. Mom was distraught over her feelings of failing my dad and had a heart attack and died. Left it to me and my sister to sort out. We ended up suing the attorney after we found out that there were a lot of other investors left holding the bag, undervalued, uninsured. Lots of problems. We ended up settling with the bars' self-insuring arm for 10cents on the dollar, as did dozens of others. I still think it is a good investment strategy, you just have to be really careful.

 

[justin]

Another aspect of Due Diligence - making sure the properties are insured and the taxes are paid. Whether by escrow or by simply checking public tax records for on-time payment and being named as additional insured on the hazard policy. This is starting to sound more like a job...


I currently have a vehicle loan to my SIL secured by a lien on her vehicle title. In a sense the same deal as calmloki is talking about (secured lending), except I'm a dodo on this particular transaction - I have a 130% LTV!!! Long story as to how I got to this point. But if the SIL defaults, I view it as "charity". And the dollar amounts at risk aren't too high.

 

[haha]

calmloki - interesting. I might have to look into this at some point in the future. I'm just amazed that the traditional loan underwriting guys let these folks with a 40% down payment slip through the cracks. Maybe 8.5-10% was the best rate these folks could find.

If I have understood, they don't necessarily have a 40% cash DP. Just the LTV must be judged to be 60% or lower- in effect some of these are re-fis.

Ha

 

[al_bundy]

on some of the investor websites i've been on they call this hard money, or loans of last resort when the banks won't give them any money.

i would make sure to do a very good credit check to see why the banks don't give them a loan

 

[calmloki]

on some of the investor websites i've been on they call this hard money, or loans of last resort when the banks won't give them any money.

i would make sure to do a very good credit check to see why the banks don't give them a loan

The thing is - I don't fund the loan unless it doesn't really matter much to me if they pay or default.

 

[Peaceful_Warrior]

Sometimes it's just a matter of a borrower needing money quicker than a bank can fund a loan.

Not all hard-money loans are because there is a problem with the borrower's credit.

Ever been to Prosper.com? There's plenty of people looking for loans on there that have perfect credit, yet they still go to hard money lending (even for things like business expansion or investing in real estate).

on some of the investor websites i've been on they call this hard money, or loans of last resort when the banks won't give them any money.

i would make sure to do a very good credit check to see why the banks don't give them a loan

 

[tryan]

Another aspect of Due Diligence - making sure the properties are insured and the taxes are paid.

Yeah, the two things that can hurt (fire and taxes) ... so I escrowed taxes and ins then had the bills forwarded to me.

 

[Martha]

Some of these type of loan companies do not follow all the rules required by lending laws and securities laws. If they are selling you a loan, they are selling you a security. Depending on how many loans they sell, and whether the investors are accredited, they might be violating state or federal securities laws. If someone complains, it can be a problem for everyone.

Also, you want to be sure that the loan company is following state and federal lending laws. There may be limitations on the interest rate for the loan. There may be loan disclosures that have to be made.

If investing in these types of loans I would require an opinion from the lender's counsel that the loans are in compliance with state and federal lending laws, and that that the sale of the loan is not the sale of a security or if a security, it is exempt from registration.

 

[modhatter]

How long have you been doing this for? With re-fi rates so low and costs at a minimum now and for the past few years, there has to be some serious problem with the borrower or property, for someone to go for a higher rate like that.

Were you saying that the property looked so bad, that a normal lender did not want to lend on it? Often re-fi's are for new roofs or remodeling, and if the lender is concerned, they can ask to control the purse strings and pay the contractor directly themself after an inspection. Same as building a house. They want to make sure the money goes into the structure.

I am currently a landlord and sick to death of going in and having to re-do everything every few years. I would love to find another venue in real estate without tenants.

 

[Alex]

Seems like that 'after tax' return is awfully low for this amount of risk you are assuming.
8.5% - 34% = 5.61% AFTER TAX.
10% - 34% = 6.6 % AFTER TAX

 

[modhatter]

Calmioke: You said earlier:
One was a divorce situation, was going to lose the house to the lender, we stepped in at a higher rate and paid the underlying debt.

So what was the plan here? To get some money to pay a new mortgage at a higher rate until she sold the property?

Also, Road Warrior: Is that a mortgage Reit you are in?

 

[calmloki]

Martha said "Some of these type of loan companies do not follow all the rules required by lending laws and securities laws. If they are selling you a loan, they are selling you a security. Depending on how many loans they sell, and whether the investors are accredited, they might be violating state or federal securities laws."

- I'm not at all sure the lender is selling us loans - they facilitate them, but the loan is not made if an investor doesn't agree to take the borrower's note in trust. Shoot - I don't know - do the initials CMI, CCS, *** mean anything special?

How long have you been doing this for? With re-fi rates so low and costs at a minimum now and for the past few years, there has to be some serious problem with the borrower or property, for someone to go for a higher rate like that.

Were you saying that the property looked so bad, that a normal lender did not want to lend on it? Often re-fi's are for new roofs or remodeling, and if the lender is concerned, they can ask to control the purse strings and pay the contractor directly themself after an inspection. Same as building a house. They want to make sure the money goes into the structure.

I am currently a landlord and sick to death of going in and having to re-do everything every few years. I would love to find another venue in real estate without tenants.

We've been on the lending side since late '04. The guy that had a pizza parlor 'a building had a loan with us for less than a year before getting new financing. Our longest loan, the first one we made, was on a decent lot with an early 80's mobile home that the borrower was renting out - doing the OPM thing. The loan was for less than the lot was worth. About a year into the loan the mobile burned. The insurance on the mobile couldn't be cashed without us signing it. We could have been butts and ended up with the lot, instead we had the insurance money held in escrow and doled out to the borrower as they cleaned up the lot and moved in a much newer double wide, which then was part of their security. Monthly payments remained regular.

Calmioke: You said earlier:
One was a divorce situation, was going to lose the house to the lender, we stepped in at a higher rate and paid the underlying debt.

So what was the plan here? To get some money to pay a new mortgage at a higher rate until she sold the property?

Suspect that's just what the plan is. Her credit was pretty well savaged by hubby, but the 10 acres is in a great location, great view. Wouldn't bother me too much if we ended up with a great vacation location.... aside from the psychic trauma of the foreclosure. Doubt that will happen though - I've seen pictures of the inside of the house - as a fellow landlord you know there are some housekeeping styles that just do NOT scream failure.

Seems like that 'after tax' return is awfully low for this amount of risk you are assuming.
8.5% - 34% = 5.61% AFTER TAX.
10% - 34% = 6.6 % AFTER TAX

Yeah I know. Taxes suck. Figure in whatever rate of inflation you feel like and it's even worse. It does beat CD rates though, by 3-4%. Since we are used to real estate I'm just not feeling the risk. When I think individual stocks I tend to think ENRON - if I go for index funds I anticipate volatility and what? 9-10% return average? At 58 I'm trying to move us out of the apartment/house rental business and stop babysitting tenants. Can't do/don't have IRAs, so all our property sale ducats are going to get hit by the tax man. I figured that 6 or so loans totaling $500k and $500k in CDs would generate a very secure comfortable annual income. The remainder of our stash could go into index funds, hopefully some sort of tax advantaged funds that could grow undisturbed - but that's something I am NOT at all familiar or comfortable with. I am more than appreciative of any suggestions for maximizing after tax return and minimizing risk.

 

[Stuart]

You need to also make sure the loan is actually recorded in your name in the real estate records and not in the servicing company's name.

I've had a couple of clients who were in deals like this. It turned out the the servicing company told multiple people they had the first lien on the same property. The house of cards eventually fell apart and the clients lost a few bucks.

Trust but verify

 

[chinaco]

What happens if a the borrower defaults. Who pays for all of the legal bills, evictions, real estate agents fees, re taxes, etc...

And who takes care of the handling of the property if it defaults? The Bank?

If you have a 40% cushion on the value of the property you may be protected.

I like the idea of investing in a pool of loans for diversification.


Anybody have any info on this type of investment