On the investor side, putting money into private mortgages, either as an individual or as a larger entity, offers the promise of higher interest rates – often in the double digits – making the return much higher than what banks and credit unions get on the mortgages they extend. The fact that people will almost always let all their other bills lapse before they put their primary residence at risk means that this is the loan that they are least likely to let go into default. Before you sink a lot of your money into a private mortgage, though, there are some risks that you should bear in mind.
- Investing in any mortgage brings risk. Obviously, widespread default on mortgages is an extremely rare event, and when it happens, it can cause major problems for those holding the mortgages – as we saw in 2007 and 2008. The higher interest rates that you receive on the investment do reflect the higher risk you are accepting with the loan.
- Higher risk brings higher return. There’s a reason why government-backed securities pay almost nothing in terms of return, even with interest rates a bit higher over the last year or so, and that’s the lack of risk associated with those investments. If you want a bigger bang for your buck, some risk is part of the bargain.
- Always read the Disclosure Statement and the supporting documentation before agreeing to fund a private mortgage. Borrowers are required by law to disclose their financial state, which includes credit score, employment history and income history, as well as other factors that could influence their ability to pay off the mortgage. Read these carefully so you understand the risk you are taking on.
- Amansad Financial requires all investors to secure independent legal advice before signing an investment contract. The purpose of this is to make sure that you go into a private mortgage investment with your eyes open, fully aware of the risks involved. You will spend some money on this, but the savings you receive in terms of eliminating avoidable losses will make up for it.
- No mortgage brokerage guarantees a mortgage investment. Remember – the higher returns you make on this investment come with a risk. Amansad Financial does not guarantee the private mortgages that we represent – and no private mortgage broker does. If you don’t have the funds available to make an investment that involves risk, you should consider government-backed options instead.
- Make sure that you can carry the payments on the priority mortgage if you are not investing in a first position loan. If a borrower in priority position is in default, assume the payments yourself. You will reduce the risk of a total loss, and your willingness to make the payments will permit your attorney to guide the process of the power of sale or foreclosure.
- Read the terms of a development, commercial project, or construction mortgage carefully. With these kinds of mortgages, repayment may depend on the project’s successful completion and subsequent sale or leasing. This means that you could wait months, or even years, before seeing a return on your investment.
- Just because you fund a mortgage for a construction project does not mean that the project will be completed. Setbacks can happen at any number of points along the timeline of a construction project, which can lead to empty buildings without tenants – and no payments to mortgage holders. It is also possible that the project will cost more than the original budget, which could make additional financing necessary, either adding to your loan or adding another loan to the situation.
- Evaluate the Disclosure Statement to make sure you are comfortable with the documentation surrounding the property valuation. Private mortgage funding decisions often depend heavily on the loan-to-value ratio, so you will want to make sure the borrower has not inflated the value artificially to get a bigger loan. Comparable transactions (“comps”) are a helpful starting point.
- Remember that property values may drop over time, including the time between the last appraisal and the closing of the mortgage. This is why getting a new appraisal in the period between application and closing is crucial.
- Remember that decreases in property value can influence an investment’s value, making it more problematic to sell a property after default. In a time when interest rates are on the rise, property values will drop, and when values drop at the wrong time, it can be harder for an investor to unload a foreclosed property at a value that makes the investment worthwhile.
- When the mortgage term expires, the options can be just as daunting for the investor as they are for the borrower. Private mortgages generally have terms that max out at a year, although sometimes they run 18-24 months. When the term is up, if the client doesn’t have the full amount due on hand, you can renew it, but if you want your money out, the borrower must get financing elsewhere or sell the property – or you must find someone to buy your investment.
The other risks are not associated with products that Amansad Financial represents but have to do with the syndicated mortgage investment process, which is also a popular destination for funds that individuals and entities place in the real estate market. Here are 9 additional Risk to be mindful of.
- Any time multiple investors put money into a mortgage, this results in a syndicated mortgage investment (SMI). When these are associated with developers, there are increased risks in terms of default and in taking part in a syndicate. It is worth noting as well that you will need an Exempt Market Dealer Representative working for you if you want to take part in SMI deals.
- We do not recommend that new real estate investors join SMI investments related to development project mortgages. The risk factors are too complex, and it is easy for new investors to end up on the wrong end of the deal, even after having an attorney review the paperwork first.
- With SMI deals, investors should inspect the project or property and secure a recent appraisal from the CRA, or an appraiser designated by the AACI. The borrowing entity has every incentive to make the project or property appear as high in value as possible, so due diligence here is in order.
- SMI projects are not insured by the federal or provincial governments in Canada, nor by any other fund set up for investor protection. Again, when you take advantage of high rates of return, you can expect the risk to be higher as well. Government-backed securities pay significantly lower interest rates because of the lower risk that accompanies them.
- SMI investors may not be able to enforce repayment in the event of default without the agreement of the other investors. In other words, the entire syndicate must agree that it is time to pursue foreclosure or a forced sale, instead of giving the borrower(s) more time.
- Check the position of the SMI mortgage before entering into a contractual agreement. In the case of default, the first-position debt must be paid first, and as the mortgage(s) ahead of yours get satisfied, that means less remaining for your investment.
- If your SMI project is a construction deal, remember that the projected value of the project after completion will differ significantly from the current property value before development. You want to make sure that your loan-to-value ratio on the deal accurately reflects the potential value should default occur and you need to sell the property.
- Read the contract’s terms for loan extension. If the contract permits extension, you might not be able to opt out individually if you need your money out sooner, so you will want to check these provisions carefully.
- You may not be able to withdraw your money out before the loan’s term is up. Therefore, it is important to invest only money that you will not need for other purposes. If you must get your money out early, you may have to find someone to buy your share and given the period that you need someone to do this, you may end up having to sell at a discount.
DISCLAIMER: This article is not intended as legal advice. Instead, it just contains general insights about investing in private mortgages and syndicated mortgage investments. Every deal is different, which means that you should secure legal advice specific to your own potential investment before entering into any binding agreements. You should also take the application through a comprehensive underwriting process before agreeing to provide an investment.
If you have questions about the private mortgage process and your own situation, or if you need a referral to an attorney who can help you with questions about a potential deal, please reach out today.