Have you ever heard someone say something to the tune of “I’ve worked too hard building up my savings to lose even a little of it in this market, but I don’t know what I should invest in?” Sensible and cautious investors protect their principal by looking for low-risk investments with promise for worthwhile returns. This is the outlook of many investors these days, especially those with less than 10 years left before retirement.
Even so, people who aren’t close to retirement are looking for safety, too. With a more than 30 percent loss in values on the stock market during the past few years, keeping an investment straightforward and limiting exposure risk is a bigger priority than ever. This is why many have left Wall Street and are making use of self-directed retirement accounts to invest in private mortgage loans.
The difficulty with most traditional Wall Street investments is that dollars are allocated to various investments, like companies and mutual funds. In these scenarios, there is no limit to how much principal one individual could loose on any certain investment. That’s a risk most retirement-minded people can’t afford.
Some investments are guaranteed by insurance companies or even the U.S. government via a mortgage backed security from Fannie Mae or Freddie Mac. However, even in a situation where the investment income stream is guaranteed in this way, it is always based on the credit risk and means of the entity guaranteeing the loan, not directly secured by a tangible asset.
With this in mind, there are several reasons why a private mortgage loan is superior to a bond fund or other traditional fixed-income investment.
Less Volatility. Unlike typical investments like stocks or bonds, there are no real-time dynamic financial forces affecting the yield on a private mortgage loan. Either the installments and interest are paid by the borrower as agreed, or if a default occurs, there is generally more than enough value in the asset to recover the principal invested, as well as a margin of profit.
Asset Specificity. When you purchase shares in a mutual fund, your money is pooled with thousands of other investors and is then spread out into dozens of different companies. If there is a robust demand by investors for liquidity in the same investment, its value can fall drastically. By investing in private loans, the debt is secured to a specific asset, such as a commercial building or other investment property. While private mortgage loans are less liquid than other investments, you have greater control to protect the original principal invested.
Income Generation. Most traditional investments are primarily valued in relation to their liquidity, ability to provide an income stream, and for potential equity appreciation. With private lending for real estate, the amount of rent and expense of the property (asset) is known and taken into account with the loan underwriting. With the income from the property determined, it should easy to determine if it will make enough to cover the loan payment and expense for the property, as well as profitable interest.
Cushion of Equity Value. Unlike paying the value for a stock, bond or other investment, a private mortgage loan typically is not made above 65% of the property’s value. In the event of a default, the asset’s discounted value becomes the investment basis by the investor who made the private mortgage loan. This allows the private mortgage loan investor to acquire the asset at a fraction of its market value. The excess equity in the property could be realized as a gain through a resale of the property.
Shorter Term. Traditional mortgage backed securities offered by Fannie Mae and Freddie Mac offer low interest rates for up to thirty year notes at 3.50 to 4.5 percent. When you’re ten years from retirement, this doesn’t offer the security you need. In contrast, private mortgage loans are less than ten years in duration and carry a rate of interest in the mid- to high-single-digit range. Because there is no readily-available secondary market for private mortgage loans, investors should plan to hold the private mortgage loan without the need to liquidate the investment before the expected maturity date.
In many ways, a private mortgage loan is an exceptional investment compared to more traditional fixed-income investments. This is particularly true when it comes to people who may be nearing retirement. The greater control, less volatility, value cushion and short-term nature of private mortgage loans make them worth of consideration.