Those who have gotten into mortgage investing find this method of wealth-building attractive for several reasons. One is that risks, while they do exist, can be managed and more predictably assessed because of the basic nature of these types of investments.
A mortgage, by definition, is a loan that is secured by collateral, usually in the form of real estate property. By contrast, stocks and mutual funds don’t offer this type of protection. Stock prices can fluctuate based on an unpredictable market, and investors have little to no control over what happens in the stock exchange.
When an individual has managed to significantly build up a nest egg big enough that they can afford to take some risks in the pursuit of capitalizing on their assets and growing their wealth, the next question is usually “Where do I take my money?” Should they discover the upsides to mortgage investments, the same question becomes a lot more specific.
Mortgage notes—which are documents stating the amount and duration of a loan, the interest rate, and the payment terms—state who is liable for the loan. These can be bought and sold in a “mortgage market” much like the stock exchange. Lenders may have a variety of reasons for selling mortgage notes. For example, they would much rather want to focus on their core business, which is lending and financing, rather than profit off foreclosures. Buyers, who are then able to purchase the notes at a discount, are more than happy to take over and find a way to make the loan profitable.
But before getting into sourcing the mortgage notes, an investor must decide on one of three strategies.
- Investing in a fund managed by professionals. The least onerous way of getting into mortgage investments is by letting the experts do the heavy lifting. In this scenario, investments are pooled into a mutual fund that a company uses to then reinvest in other ventures, like real estate equity, mortgages, or a mix of both. Here, the fund managers take care of finding and processing loans, dealing with defaults, and managing the portfolio. All an investor has to do is find a mortgage fund with a structure that’s aligned to his/her financial objectives.
- Working with professionals. An investor who wants to have a more hands-on approach can buy mortgage notes from a professional mortgage fund, thus owning the mortgage lien itself. They can then use a loan servicing company to collect the borrowers’ payments. With this strategy, investors have more control but also have to carry more risk in that they must assess loans themselves and be prepared to deal with defaults.
- Going it alone. One should only choose this option if one is prepared to take on all the risks and responsibilities along with the benefits. Making a mortgage investment completely independently means sourcing and assessing every loan, creating and handling all the necessary documents, processing permits and appraisals, and making sure that everything is compliant with government regulations. Of course, since there are no other players to share the pie with, the risk of default also rests on the shoulders of a single investor, and he/she would then have to rectify and amend that situation him/herself.
Whatever course an investor decides to take in terms of mortgage investment opportunities, it is wise to understand where the loans come from to get a better picture of the marketplace.
A mortgage investor can acquire mortgage notes from a variety of sources.
- Credit unions or banks. These lending institutions know that not all loans are going to be paid off and that they will need to cut their losses on some deals. An interested investor will be able to purchase such a loan by working with a bank’s loss mitigation department.
- Hedge or private equity funds. These entities purchase mortgages from banks at a wholesale price and then resell them to interested investors.
- Private note holders. These are individuals or private entities who have somehow gotten their hands on mortgage notes. They can be private lenders who hold loans for properties they themselves financed, or simply note resellers. It would be wise to be more cautious with these sources and make sure that they are not merely brokers whose notes actually belong to someone else.
- Real estate investment bodies. Investors on the prowl for great deals on notes may also want to attend REIT (real estate investment trust) or real estate investment club meetings. As in most businesses, networking can yield surprising and lucrative results.
- Online exchanges. Nowadays, there are online platforms that not only list mortgage notes up for sale but also facilitate the investment process itself. Each platform may offer different apps and tools to help both buyers and investors make well-informed decisions.
Property management can be time-consuming and risky. With all of the eggs in one basket, there is little room for mistakes. On the other hand, investing in mortgages diversifies risks and may be less arduous.
There’s a moral upside to it, too. In the last quarter of 2018, the Debt Service Ratio (DSR) of Canadian households reached 14.87%—the highest it’s been since 2007. DSR is the percentage of disposable income spent on loan payments. Interest rates may be low, but that doesn’t mean that no one is feeling the burden of debt. By purchasing mortgages and working with the borrowers, investors can even help people keep their homes—and make a good profit while they’re at it.