Get the scoop on private mortgage investing

January 10, 2014 | By | Add a Comment

private mortgages in Toronto and Mississauga | Ingrid Bjel McGaughey at CanadianMortgageCo.comWant to invest in private mortgages? Here’s how…

If you’ve ever wondered how you could invest in real estate without going to the effort of researching, purchasing and managing a property, you might like to check out real estate-related investing from a different angle: investing in private mortgages.

How do private mortgages work?

Lending private mortgage money, sometimes known as “hard money lending”, simply refers to private individuals or groups loaning money to a borrower. The borrower might be looking for a mortgage to purchase a property, wanting to re-finance an existing mortgage, or needing to add a second (or third) mortgage “behind” the first (or second).

Like an institutional lender, the private mortgage lender-investor holds the borrower’s property as collateral for the loan, and receives payments on the loan. The interest rate, fees, and terms are negotiated between the lender and the borrower, sometimes through an intermediary like a mortgage agent.

For more on how a private mortgage works from a borrower’s perspective, including some typical examples of borrowers who might need private financing, check out my article on private mortgages.

Who might want to invest in private mortgages?

So what about you, the potential investor? You might consider lending money out in this way if:

  • You are disappointed in the fluctuations of your investment portfolio, and you want to diversify by adding an investment backed by real estate
  • You would like to help someone get mortgage funds, someone who would not qualify at a mainstream mortgage lender, for various reasons (read about private mortgages)
  • You have money to invest and would like to receive a consistent monthly income while having a finite, relatively short-term, exit strategy
  • You have a substantial amount of money to invest, and you’d like to boost your investment performance by diversifying into another investment vehicle

How much can you make?

To start, you need to determine how much risk you’d like to take on. This is primarily defined by your maximum loan to value (Note: when calculating the total loan to value, you’re adding together all the mortgages on the property, including the one you’re being asked to provide, dividing that total into the property’s appraised value, and describing that as a percentage.) An industry professional can then educate you on the corresponding market rate, and connect you with borrowers who need private funds.

Suppose you want to max out your return. Why couldn’t you just charge whatever you want to? There are a few reasons. For one, an ethical mortgage agent will be trying to help their borrower obtain a fair mortgage for their circumstances, and will not recommend you if your rate is priced above that offered by competing private lenders.

For another, over-burdening your borrower with an exorbitant interest rate, in addition to being unethical or even illegal, also increases the risk that they will default. While your money is secured by the property, and you can take steps to recover both it and your legal costs, it is a pain in the neck to have to go that route. A good mortgage professional can give you guidance on the market rate, and how to structure the terms of the mortgage.

For example, a mortgage on a property where the total is 85% is going to be more risky (and therefore warrant a higher interest rate) than a property where the loan to value is 50%.

How do you start?

Ideally, you should find several trusted contacts such as a real estate lawyer and a mortgage professional that can help bring you, the investor, and potential borrowers together. Typically, you will need a minimum of $25,000 to invest, and you can use either non-registered funds, or registered funds such as those in an RRSP or self-directed TFSA (for some more details on this, check out Olympia Trust and Canadian Western Trust).

When a potential investment is brought to you, you can expect to see a package that includes a net worth statement for the borrowers, a summary of their financial situation, a property appraisal (conducted by an appraiser), and any other relevant financial information.

If you decide to proceed, you sign off, your borrower signs off, and the whole thing goes to your respective lawyers. All legal costs are paid for by your borrowers. Once everything is ready to be closed off, you prepare your funds and hand them off to the lawyer, who does the rest of the work.

What about alternatives?

You can also invest through a Mortgage Investment Corporation or MIC. While you don’t have the ability to know exactly who is borrowing the money and what the real estate collateral is, your money is pooled together with that of other investors and spread across multiple properties.

How exactly investing decisions are made will be outlined in the MIC’s prospectus. There are more details in articles like this one from the National Post. Just a note: there are some great companies out there, but as with any investment, make sure you do your due diligence before proceeding.

Any more questions? Please feel free to get in touch. I’d be interested in your thoughts on private mortgage investing. Can you see yourself doing it? Why or why not?

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About the Author (Author Profile)

I'm a Toronto Mortgage Broker. My focus is on saving people time and money in financing and re-financing their homes. Am passionate about helping people make informed choices, giving back, and helping to improve financial literacy in Canada.

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