It’s traditionally believed that achieving higher returns on investments means taking on more risk. But that’s not necessarily the case. For attractive yields with a self-directed retirement account, investing in private mortgage loans backed by real estate could be a smart choice.
One of today’s most straightforward alternative investments is funding a private mortgage loan. An ever increasing number of real estate investors and business owners need access to capital but are unable to obtain funding through conventional banks for a variety of reasons. Some examples of what types of properties that can serve as collateral are income producing commercial properties, multi-family homes, new construction developments and renovation projects.
There are many opportunities present in today’s private lending market. Loans typically are approved at no more than 60 to 70 percent of the market value of the commercial or residential property. Loans made to real estate owners are typically one, five and ten year terms, allowing the borrower an opportunity to increase the income generated from the property and then qualify for a lower cost traditional mortgage.
Some of the investment advantages that private mortgage loans have to offer include:
- 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.
- Security. They are backed by a hard asset such as real estate, minimizing risk if the borrower defaults on the loan
- Short Term. They carry shorter terms on the investment notes, which is perfect for people approaching retirement.
While private loans provide a higher rate of return than traditional investing, there are also some risks associated with them. The main risks can be avoided by properly vetting the investment by following these tips:
- Consider the market for the property. Choose properties with resale value for the greatest pool of potential buyers. For example, properties that have very high values relative to the rest of the market have a smaller pool of potential buyers willing to purchase the property for the appraised price. In the case of default, you don’t want to end up with a property you can’t sell.
- Have a current appraisal report of the property. The goal of the private mortgage investor should be to confirm they have more than enough equity to justify the loan. An appraisal can go a long way towards that end.
- Complete a recent title search. Know that the property has a clean title before investing.
- Verify the lien position. Being in the first position on the title decreases collection risks should the borrower default.
- Require homeowners insurance for the property. Weather events, fire, or vandalism are risks to the property (and your investment) that can be mitigated by requiring proper insurance.
- Have an attorney review the documents. Having an experienced attorney review the loan closing documents and agreements will prevent exposure to otherwise avoidable risks.
For interested investors, often the main reason for not pursuing this type of alternative investments is experience. Underwriting or assessing the risk associated with a private mortgage loan is a bit different from other investments. Without firsthand knowledge of how to underwrite this type of alternative investment, many investors learn by trial and error with sometimes undesirable results.
One of the most prudent things you can do to reduce the risks related with private mortgage loan investing is to choose an expert service provider that can assist you in evaluating these opportunities. Proven and trusted professionals with an established network of resources are the best to help guide through the necessary steps to a successful investment.
About the author: Josh Manier is Managing Partner of Island View Private Loan Fund, LP which provides due diligence, loan underwriting, and loan servicing for private investors seeking to place private mortgage on real estate. The fund specializes in providing non-recourse financing to self-directed IRA holders looking to renovate, build new construction, or who need assistance structuring owner financing for their investment real estate transactions. He can be reached at 952-345-3445 or via email at email@example.com. Additional information can be found at www.ivplfund.com, or on Island View’s Facebook page.