# Direct mortgages



## axelis (Jan 13, 2015)

At Guban's request, I am opening a thread on direct mortgages. Basically we invested last year in a direct mortgage (our first), i.e. we play the role of the bank and lend our money to someone who needs it. Of course it's not "low risk" since the borrowers are usually people/businesses with credit history that are not accepted by banks or other standard lending institutions. In our case we passed on a few opportunities that did not fit us (commercial, etc...) and ended up going for a 2nd position on a residential single family house, where the borrower was doing debt consolidation. After about 8 months (the term was 1y) they sold their house and paid back the principal (it was an interests only payment), which we just got back. All in all it went well, but of course it could have gone (as all investments) in a completely different direction.


----------



## gt_23 (Jan 18, 2014)

I started doing these a couple years ago, mostly 2nd, although have done one 1st balloon. Most have been debt refis, CRA liens, or consumer proposals.

The key is in the underwriting, the asset quality, equity, and borrower. All else being equal I like younger, two-earner borrowers since these loans are recourse. I also look at the property and whether I might like to own/operate it in the event I have to take it back. You also need to be comfortable with inconsistent cash flow, as NSF cheques are quite common in this line of business.

The biggest challenge I've started to encounter is deal flow, specifically quality deals. As the principal comes back on maturing loans, it needs to be reinvested (ideally at similar terms for rate and credit quality) in new loans. Therefore, deal flow is very important over the long-term. How did you source your deal? I work with a number of mortgage brokers, however, I find that the majority of brokers have preferred go-to private clients where they send their best deals. IMO, there is more capital than deals available and this tends to distort the risk/return profile in some cases. As a result, I find I have to look at at least 10 files before finding 1 with an acceptable risk/reward.


----------



## Guban (Jul 5, 2011)

What sort of return does one expect with a direct mortgage? Sounds like there is definitely a risk premium that has to taken into account. What are the chances that there will be a default, and you'll end up owning another house?


----------



## axelis (Jan 13, 2015)

Agreed with gt_23, finding the right fit is not easy, takes a long time and some research. And I typically won't do commercial so it restricts my options - I'm also in favor of residential with a (young) couple in it.

Re. returns, I'm seen somewhere between 7% and 13% depending on risk level, etc...


----------



## gt_23 (Jan 18, 2014)

Guban said:


> What sort of return does one expect with a direct mortgage? Sounds like there is definitely a risk premium that has to taken into account. What are the chances that there will be a default, and you'll end up owning another house?


There's two (well three) ways to make money on these:

1) Interest
2) Fees - Lender fees, "administration fees", NSF fees
3) Somehow you end up with the property and sell if for more then is owed. This happens, but rarely in a hot market.

The Interest rates are similar to what axelis said and are really dependent on whether your in 1st or 2nd position and the total LTV. A second mortgage up to 80-85% LTV goes for about 12-14%. If you include lender fees, your return can go much higher, although if you renew the client, your average return will go down since they only pay that once. NSF fees can be quite lucrative too, we charge $250. I once had a lady bounce two months in a row. The fees $500 were almost as much as her payments, $560 combined. However, due probably to the excess supply of investment capital I referred to above, there are lots of lenders competing for these deals now that are willing to not charge fees and I can't really blame a borrower for going with them if they have the choice.

I know this might give the impression that private lenders prey on the less well off. However, many clients that I funded were on the verge of bankruptcy or losing their home and were subsequently able to turn it around and show good borrowing behaviors with me so they didn't pay any more than they had to.


----------



## axelis (Jan 13, 2015)

Thanks for the clarification, I usually don't think of the fees since I deal with a third party who manages the day to day operations (more like month to month really once the mortgage is setup) so they collect the fees and I only get the interest (minus a mgt fee). So in my case it's only #1 and possibly #3 if it were to happen (which I would not want not)


----------



## Just a Guy (Mar 27, 2012)

It's even more rare if your a second mortgage, as the bank gets the first seat at the table.

Now would not be a good time to be in a second mortgage situation, if the bubble bursts, there's a good chance you could lose your investment.


----------



## Rusty O'Toole (Feb 1, 2012)

You won't end up with the property. If the mortgage defaults you have the right to sell it under Power of Sale. You have to get an appraisal and list it with a RE broker, you are responsible to sell it for fair market value, because once you get back your money plus expenses, the change goes to the borrower. It is a fairly straight forward thing to do, it may take a few months but you will get your money, IF the property is worth it, which you should have made sure of before you made the loan. Also make sure the property is insured.

I have done a few of these loans and only one went sour. That was a loan to an out and out con man and crook, arranged by a crooked mortgage broker who later went bankrupt. Recommended to me by a clueless lawyer who is no longer my lawyer.

In that particular case I would have been better off to foreclose because the property was worth $200,000 and I only loaned $50,000 on it. BUT the borrower could force a judicial sale and otherwise tie up the property so I played it safe and did a power of sale.

It turned out, while this was going on, the borrower got arrested for $5,000,000 worth of mortgage fraud then disappeared. So I could have foreclosed and the borrower would not have done anything about it, but did not know that until it was too late.

So that was about as bad as they get. BUT you MUST be sure the loan is secured by good property and your lawyer covers everything properly.


----------



## gt_23 (Jan 18, 2014)

Rusty O'Toole said:


> You won't end up with the property. If the mortgage defaults you have the right to sell it under Power of Sale. You have to get an appraisal and list it with a RE broker, you are responsible to sell it for fair market value, because once you get back your money plus expenses, the change goes to the borrower. It is a fairly straight forward thing to do, it may take a few months but you will get your money, IF the property is worth it, which you should have made sure of before you made the loan. Also make sure the property is insured.
> 
> I have done a few of these loans and only one went sour. That was a loan to an out and out con man and crook, arranged by a crooked mortgage broker who later went bankrupt. Recommended to me by a clueless lawyer who is no longer my lawyer.
> 
> ...


Actually you're wrong. I didn't say you will end up with the property, I said you can in a rare case and make a lot of money.

I know two private lenders and a mortgage broker who this happened to. The borrowers got into trouble and they gave them the option to walk away and avoid foreclosure or pos. I don't know whether the borrowers got independent legal advice or not, but nonetheless chose not to fight. The investors stepped in to assume the 1st mortgage and gained from the equity on top of the loans.

Finally, foreclosure is not a forgone conclusion. Most of these proceed via pos unless the owner wants to fight. You can also usually find a lawyer to do the work on contingency if there is equity.


----------



## gt_23 (Jan 18, 2014)

Just a Guy said:


> It's even more rare if your a second mortgage, as the bank gets the first seat at the table.


I'm not sure what your implying, but borrowers typically stop paying the 2nd before the 1st, which is why it is usually the 2nd lender that initiates proceedings. The bank doesn't care as long as they're up to date, so its typical for the 2nd mortgagor to begin paying the bank once the legal process starts. If this is the case, they will have little to do with the process.



Just a Guy said:


> Now would not be a good time to be in a second mortgage situation, if the bubble bursts, there's a good chance you could lose your investment.


There's always risk of loss in any investment, its up to the investor to manage his own risk. The advantage is that mortgages are recourse (where I am).


----------



## Just a Guy (Mar 27, 2012)

I was saying that the chances of you winding up with the property is rarer as a 2nd position as the first position people get their money out first. If values drop, the first position may wind up getting the house, or at least it's value, even if you start the proceedings.

In a bubble, I wouldn't want a second position. As for recourse mortgages, if they lose their house, bankruptcy isn't that big a step, so you're no better off, nor are you protected. 

In a different environment, I don't think this is a bad way to invest...as I believe the bubble needs to burst soon, I wouldn't be exposed today (of course, it all depends on the actual deal I'm speaking generally).


----------



## birdman (Feb 12, 2013)

Been there done that and it wasn't good. Years ago myself and some buddies invested in high rate 2nd mtges and sure didn't make any money. In one case in particular the owners took on additional unsecured debt and just stopped making payments to everyone. About 6 mos later they made an assignment in bankruptcy. We of course had either to keep the 1st mtge up to date or press for an Order for Sale. Unfortunately, the house and yard were not in good shape with things like pen engravings of phone numbers, etc on kitchen cupboards where the phone was, ruined carpets, needed painted throughout, and overgrown gardens with grass 2 ft tall. 10 months later the property sold and we were out a fair amount of cash due to lost interest, interest on the first mtge, repairs (much of which we did ourselves-yuk!), legal fees, and real estate commission. We opposed the owners Discharge from Bankruptcy and in order to receive their discharge they were required to pay us 300. pm for 24 mos which they did. 
In my previous life I was in the lending business and rest assured that if you are not very, very careful in your underwriting things can go sideways in a hurry. Legal fees, delays in selling the property, keeping the first mtge up to date if required, damage to the property, etc, etc. are all significant risks. MIC's are perhaps a little better but I am into a couple of these and am working to get out of them. Be cautious and its certainly not easy money and one wrong move can be costly.


----------



## gt_23 (Jan 18, 2014)

frase said:


> . MIC's are perhaps a little better but I am into a couple of these and am working to get out of them. Be cautious and its certainly not easy money and one wrong move can be costly.


It comes down to preference. I avoid MICs because I don't want exposure to development loans, I'm much more comfortable with lending 2nds to two-income household homeowners. 

With private mortgages, the bigger the portfolio the better. If you're only doing 1 or 2 loans a year, and you happen to get a bad one, it can really hurt you. The key is closing the 10% of deals with good risk/reward profiles and avoiding the rest (i.e. underwriting) and being patient until the right deals come along, which can be particularly hard for undisciplined investors with cash burning a hole in their pocket.


----------



## axelis (Jan 13, 2015)

frase said:


> MIC's are perhaps a little better but I am into a couple of these and am working to get out of them. Be cautious and its certainly not easy money and one wrong move can be costly.


These would be private MICs I'm guessing (i.e. not publicly traded MIC)... can you share the reason(s) causing you to try to get out of them?


----------



## birdman (Feb 12, 2013)

Yes Axelis I can explain. Firstly, the low interest rate environment have reduced their returns to myself as an investor. They probably generate a 10% return but after bad debt expense and overhead the amount back to myself is 4.5%. Also, one of them has done some poor underwriting and got way in over their head. Advanced way too much money for "work out situations" and were quite frankly over their head. In my opinion the Credit Committee errored and of course management should be held accountable. The dividend was cut to 0% this year but are hopeful of reinstating it next year. I have no confidence in management or the credit committee who happen to I be all (or close to) realtors. In both cases the MIC has restricted withdrawals to 10%. This 10% is based on the total assets of the mic so if some investors do not withdraw their portion but gets passed on to other investors. Overal the longer term both investments should be okay but quite frankly in my opinion the 5% or so return is not worth the risk. Lots of people think they are lenders but really don't understand all the risks involved, particularly in development projects which may seem good on paper but if things start to go sideways it can become very messy. In summary, no confidence in the investments.


----------



## axelis (Jan 13, 2015)

Thank you *frase* for sharing your experience(s) with both MICs and direct mortgages (earlier in the thread).


----------



## Fain (Oct 11, 2009)

Can you structure to loan to be at say 6% but if the borrower misses say 3-4 payments then it shoots up to 20%?


----------



## gt_23 (Jan 18, 2014)

Fain said:


> Can you structure to loan to be at say 6% but if the borrower misses say 3-4 payments then it shoots up to 20%?


As the lender, you can do whatever you want provided the total cost of borrowing is below the statutory limits.


----------



## CharlesF.Donahue (Jan 7, 2015)

There are lots of benefits of investing in direct mortages. There are many lenders both banks and non-banks that offer superior home loan deals but you may have never heard of. A difference of even 0.1% on your home loan can save you thousands of dollars over the term of the loan.


----------



## axelis (Jan 13, 2015)

CharlesF.Donahue said:


> There are lots of benefits of investing in direct mortages. There are many lenders both banks and non-banks that offer superior home loan deals but you may have never heard of. A difference of even 0.1% on your home loan can save you thousands of dollars over the term of the loan.


I'm not sure I understand, my apologies... can you clarify / expand ?


----------



## Rusty O'Toole (Feb 1, 2012)

Fain said:


> Can you structure to loan to be at say 6% but if the borrower misses say 3-4 payments then it shoots up to 20%?


If they can't pay 6% how can they pay 20%?


----------



## Fain (Oct 11, 2009)

Rusty O'Toole said:


> If they can't pay 6% how can they pay 20%?


They probably can't pay 20% after missing payments on 6% but maybe they have equity built up in the property though.


----------



## CharlesF.Donahue (Jan 7, 2015)

You don't be in a second mortgage situation because after certain time period you will loose your investment. So there be arise a great risk in any investment and you have to plan about how you will manage the risk while investment.


----------

