Investing in Private Mortgages
In the last few years, investors have been looking for alternatives to the stock market. One area that has seen tremendous growth is the private mortgage sector. Private mortgages have become popular because they offer investors a high yield that they cannot get from GICs or bonds. Yields of 8% to 11% are available for first mortgage investments while yields up to 18% are available for second mortgage investments. These investments are not without risk, but the fact that real property secures them has made investors more comfortable.
So what should a novice investor be aware of when considering an investment in a private mortgage?
The first thing you need to do is understand what a private mortgage is. Essentially, it is just a loan secured by real estate. In a private mortgage investment, you become the lender, and you decide whom you will lend your money to and under what terms and conditions. You can choose to invest in first or second mortgages. A first mortgage means that, in the event of default, your mortgage would have priority over other creditors. A second mortgage would be paid off only after the first mortgage was repaid in full. The risk in any mortgage investment is that the borrower will not be able to make their mortgage payments. The typical remedy for this is to sell the house under Power of Sale. Keep in mind that property taxes and expenses like real estate commissions and legal fees must be paid from the sale proceeds before any money is paid to creditors.
To minimize risk, most first mortgage lenders will only lend up to sixty-five or seventy-five percent of the value of the property. Second mortgage lenders are usually looking for a higher yield and are willing to take more risk. In this market, most second mortgage lenders will lend up to eighty-five percent of the value of a home. Private mortgages fill the gaps that institutional lenders, such as the banks, are unable or unwilling to fill. When a borrower has a unique situation or doesn’t fit institutional lenders standard lending criteria, a private mortgage is usually the only alternative for a borrower. The difficult part in the whole process is finding a willing investor to meet the needs of the borrower. This is where we come into play. Our office acts as intermediaries between investors and borrowers.
When a broker is presenting a potential mortgage investment to you, they will provide you with several pieces of information including a detailed application on the borrowers and an appraisal of the property involved. They will explain the pros and cons of the investment and recommend the terms and conditions for the mortgage. Ultimately, it is up to you to decide if this investment makes sense for your portfolio.
Private mortgages are illiquid, meaning that you cannot easily cash in your investment, so you have to be forward thinking. Most private mortgage investors will only agree to lend for a one-year term to help minimize the risks inherent to the real estate sector. Self-directed RRSPs are an ideal vehicle to invest in private mortgages. The interest that you earn is sheltered from tax within the RRSP, and the trustee for your RRSP will administer the mortgage for you. Private mortgage investments are not for everyone, but they can be a solid performer for many portfolios. After yield, one of the key attractions of these investments is that they are hands-on investment that can be easily understood. You can touch and feel your security (the real estate), and you can predict your risk much easier than you can with other investments like stocks and income trusts. If you enjoy choosing your investments, a private mortgage may be a good addition to your portfolio.