Private Mortgage Lending – An investment vehicle no one knows about!

Mortgages represent one of most common investments in the world by banks and institutional lenders. The banks like mortgage investing for the same reasons that you probably will – good return on investment, and relatively lower risk than many alternatives. The Big 6 banks saw profits soar in 2021 thanks to strong mortgage growth and massive loan-loss provision reductions.

There are many different types of mortgages but here we are only going to discuss first and second mortgages placed against residential, commercial and/or agricultural real estate.

When referring to a “first” or a “second” mortgage what we are referring to is the date of registration of the mortgage relative to any other mortgage placed on the property. Priority of a mortgage, at law, relates to the order in which mortgages are registered.

If I refer to a first mortgage, it means that no other mortgage is to be registered on title in priority to your mortgage. If I refer to a “second” mortgage I am referring to a mortgage that is to be registered behind an already-existing mortgage.

Most private mortgages are considered “equity” mortgages, which mean that the lender`s decision to fund a new mortgage has more to do with the current value of the real estate than on the general credit worthiness of the borrower. However, the better the credit score of the borrower, employment history, and the borrower’s cash flow position, the lower the interest rate will be, subject to overall conditions of the mortgage marketplace and the loan-to-value (LTV) of the mortgage investment.

A significant part of the mortgage broker’s work is to determine what rate of interest will attract investment by an investor, and still be within the generally market rates otherwise available to the borrowers.

Typically, second mortgage interest rates currently range from a low of 8% to a high of 15%, depending on a number of factors that are balanced by a mortgage broker when he quotes a rate to a borrower. The rate the mortgage broker will quote will be a market-based rate based on the lowest rate likely to be acquired by an investor.

For example, one of our lenders will place a second mortgage on property located in Calgary, with a Loan-To-Value of 80%, to someone with good credit, at 9% per year. Another will place a mortgage on a property located in a declining marketplace outside of urban Alberta, to a loan to value of 75-80%, at an interest rate of 12% to someone with bruised credit.

Before I propose a mortgage investment, I will have priced the investment based on market conditions, taking into account various risk factors that affect the cost of the money to the borrower and the rate of return to the investor.

More experienced investors may choose higher risk mortgages, as the investor has had more background in handling an occasional NSF cheque or isn’t concerned about perhaps having to foreclose on the property to recover their investment. Their desire for a higher rate of return balances the higher risks involved.

The difference in the level of risk between most mortgages does not mean that there is a significant risk of losing all your money. Rather, higher interest mortgages generally reflect the possibility that you will have to collect your payments actively, or even engage lawyers and extra expense to recover your investment dollars and/or your payments. If the investment in a mortgage is made with reasonable parameters there is little or no risk of losing all your money, but you might have to wait to get paid at the higher risk levels.

Assessing Risk and Reward

When investing your savings in a mortgage it is important to assess the risks involved.

While your broker may recommend a given investment to you, the decision to invest in any given mortgage is entirely your decision. If you are not satisfied with any aspect of the mortgage prior to investing, don’t make the investment. The amount of risk you are willing to take is up to you, and while your broker will present mortgages to you that fit your stated preferences and situation, no person except you can have true appreciation of all the elements affecting your decision.

If you put your money into a bank account, there is virtually no risk of loss, but you will earn almost no interest income from it, either. At 2% your money is losing value every year against the Consumer Price Index and the underlying inflation rate. Government T-bills pay a little better, perhaps 3% or 4%, but using the Rule of 72 your money will double its value every 24 years at 3% or every 18 years at 4%. While safe, it’s not exactly necessarily sensible, since the value of your money will decline if your rate of interest return is the same, or close to, inflation.

At the other end of the risk spectrum are investments in many different investments, including commodities like coal, corn or futures in metals. Those investments, when managed by experts may result in being able to double your money in a few months or a year or two at the most. However, the risk of loss is extremely high.

The same thing is true of investments in stocks and bonds, or even mutual funds based on stocks and bonds. The higher the potential rate of return, the more likely the investor has the risk of losing some or all the invested capital. Investments in the private shares of small companies may also represent a far higher potential rate of return, while appearing to be low risk at the time of investment. In general, however, all these types of investments represent a fairly high level of risk, with various rates of return.

The last type of investment available to most investors is debt investments of one kind or another in major companies, governments, or municipalities, where the risk of loss is lower, but the rate of returns is much lower. Mortgages are in this class of investments; however, their rate of return is substantially higher than most other equally “safe” or “less risky” investments.

Even within the mortgage investment world there are additional ways to manage your risk of loss:

  • Investing your money in several smaller mortgages instead of one large mortgage. This is the method preferred by most small mortgage investors.
  • Mutualisation of mortgage risk – by investing in a mortgage pooling arrangement or mortgage syndications (Mortgage Investment Corporation, or, MIC) may decrease risk by spreading it out over many second mortgages or other lenders. It also slightly reduces your net returns because typically MICs invest in a mixture of lower risk first mortgages and some higher risk seconds.

Syndicated mortgages tend to be for larger amounts and are used most often in commercial applications.

Reliance on competent professionals all the way down the line is important. Seasoned investment professionals are more likely to be successful than beginners. Ask lots of questions. If your mortgage broker balks at answering your questions at any time, be very concerned.

Make sure that the lawyers doing the work are always available to answer your concerns and question. Lawyers preparing mortgages for you, have a duty of care to you. Don’t hesitate to ask questions of the law firm preparing the documents and registering the mortgages for you. Review your documents when you receive them from the lawyers, and make sure that what you were told you were getting is exactly what you in fact receive. If there are any doubts or questions, call me (or the law firm) for clarification, or in the event of an error, rectification.

Mortgages are held in your own name, unless otherwise specified in writing. This is important, and the priority of your mortgage should always be consistent with what you have been presented by the broker.

Ultimately, investing in mortgages is relatively low risk, and mostly requires that you ask suitable questions to determine whether a mortgage is a low, medium or high risk.

As your broker I’m most interested in maintaining your business and reinvesting your money when it comes out of a mortgage at the end of the term of the mortgage. This will only happen if you are satisfied with the outcome of the processes.

Reviewing & Assessing a Potential Mortgage Investment

It is my job to make sure that you always have full disclosure of any relevant information about a potential investment in a mortgage. I will send you a variety of documents that help describe and illustrate a potential investment opportunity in a mortgage. The documents I will send you will include:

  • Mortgage Application from the proposed borrower,
  • The Credit Report on the proposed borrower,
  • Property appraisal, assessment or Agreement of Purchase and Sale with MLS listing,
  • The `story` behind any past & current client issues, along with any potential future exit strategies.

Since the value of the property is the critical issue, the basis on which the value is given is important. Usually, I order and provide an appraisal prior to funding, so it may not be available on the outset of review. On lower Loan to Value loans (below 50% LTV) an AB Property Assessment report may be sufficient. If the transaction is a private home sale, the borrower is required to pay for an appraisal from an approved appraisals firm hired by us.

Once I send you information relating to a mortgage proposal, I will generally request that you review and decided to fund or not to fund a specific mortgage. I will leave an investment opportunity in your hands for a relatively short period of time before sending it to the next potential investor, as I am expected to give the borrower an answer within 24 hours of a request for a loan.

If you are interested in a mortgage I have presented, it is really important to let me know right away, so that I can send a commitment to the borrower and get the process of registering the mortgage underway at the lawyers’ offices. I will let you when the funds are expected at the lawyer’s office, and the method by which they can best be transmitted or deposited to the law firm. It is at this stage that many investors first have contact with the law firm or talk with the lawyer handling the conveyance (registration of the mortgage) to answer any questions they have. If you already have an experienced law firm or lawyer handling other mortgages for you, I work with your professional.

Funds are deposited to the trust account of the law firm, the mortgage papers signed, and the funds issued to the borrower. You then receive post-dated cheques made out to you so you can make monthly deposits. A pre-authorized debit arrangement is also possible.

Near the end of the term of the mortgage, I will review with you the prospect of offering a renewal for another term. There is no obligation to offer a renewal, even if the borrower pays on time every month.

The law firm represents you in the preparation and registration of your mortgage investment. The lawyers who draw up the mortgages and register them do all the following while doing a mortgage:

  • Title search prior to make sure that they have a comprehensive list of everything on title that needs to be removed before advancing the new mortgage.
  • Contacts the insurance provider of the mortgage borrower to make sure that valid general insurance is in place, and that a rider is attached to ensure payment of the mortgage in the event of a major claim.
  • Sees to it that any prior charges are paid out of the proceeds of the mortgage except for authorized mortgages.
  • Makes sure that property taxes are paid, if not, then they are paid out of the proceeds of the mortgage.
  • Collect post-dated cheques to your benefit from the borrowers for 12 months that they forward on to you for deposit.
  • Pay any charges or costs arising from the mortgage from the proceeds of the mortgage prior to paying out net proceeds.
  • Prepare a list of disbursements for the borrower detailing any money deducted from the proceeds of the mortgage.
  • Ensure that any statutory documents required by various levels of government are completed including AB Disclosure Statements.
  • Collect payment from the borrower for all costs.

After a week or so after all funds have been advanced the lawyer will send you a copy of the title showing your mortgage registered on title, a copy of the mortgage document registered, and post-dated cheques for 12 months.

Once you have invested in a few mortgages, much of the above will seem self-evident. Most of my investors review the mortgage documents I send, decide to invest or not based on their own risk assessment, move forward with funding, and then simply collect the payments until the mortgage term expires, and then repeat the process as necessary.

One nice thing about mortgages placed through our offices is that they don’t take a lot of ongoing investor involvement. I handle any renewals & collection activity – You just must let me know upon the rare occasions that payments do not clear.

If you are interested in reviewing any potential mortgages I may have at the moment, feel free to contact me!