Becoming a private mortgage lender is a dream for many investors, but surprisingly, it’s so much more attainable than people think.
Investing in a mortgage is a simple process. It can even be done through your RRSP, RRIF or TFSA!
In essence, a mortgage is very much like a bond you can you buy, however, this one is secured by Real Estate.
Like any investment it has the potential for risks, but done correctly it can be hugely profitable and rewarding for both the lender and the borrower.
One question I get asked all the time is,
“What kind of person would need a private mortgage?”
Credit Issues? Not Always…
First, let’s address the elephant in the room: Not all private borrowers have credit issues, thus making them a bad risk.
While some clients do have credit issues, it’s important to look at the full picture.
Some common examples of clients in need of a private mortgage are:
- Credit issues caused by divorce
- Real Estate investors who are purchasing properties that need extensive repair
- Self-employed clients that may not show traditional income
Increased Returns, Lower Risk
As a private mortgage lender, your return on investment will vary on several factors, including:
- geographical location
- property type, and
- the overall risk
It is truly a free market, and the old saying stays true: “the lower the risk the lower the return”.
In some areas such as Quebec, there are less private mortgage lenders so the average rate is higher. In areas such as Toronto, there is a great supply of lenders, so consequently there are lower rates.
If you can find a niche Real Estate market, geographical or otherwise, it can greatly increase your return. Not to mention specialization helps in reducing risk as well.
Deals Come To You
One of the best aspects of becoming the private mortgage lender is that deals come to you!
You are in effect the pretty girl at the dance. It is your job to separate the boys that look so great (but you know are bad for you), the rebels that you can’t fix, and the keepers.
The returns can be substantial if done correctly. Rates of return vary greatly but can range from 6% on the low-end, up to 18-20% on the high end. The large range is primarily due to the risk level of a mortgage.
Most mortgages pay as agreed and are successful. If done correctly, default is very low and risk of capital is also very low.
Not surprisingly, if lending to family or friends, that actually poses the greatest risk.
Equity Is Key
The equity in the property is the greatest security a private mortgage lender has to protect their investment. The question then becomes:
“How quickly can you collect the equity if the borrower stops paying?”
Some questions you need to ask yourself:
- How quickly could I sell this property?
- Is the real estate market in this area (or for that property type) increasing in demand or decreasing?
- What are vacancy rates doing?
- If you are doing a 2nd mortgage, how large is the 1st mortgage and can you afford to make the 1st mortgage payments if needed?
- Is the property in good repair?
- What is the character of the borrower? Are they hard working or always blame others for their problems?
- Most importantly what is the exit strategy?
- How will the borrower repay this mortgage at the end of the term? Or are you signing onto the “never never” plan?
These are some very important questions that many lenders and brokers don’t think about.
Getting Paid Back
If you’re lending a borrower a 2nd mortgage with 85% loan to value, with interest-only payments, it may take 5 years or more until the total financing has fallen below 80% loan to value.
The 80% threshold is very important to having your mortgage paid back in full, as any new financing above that requires the mortgage to be insured by CMHC or Genworth. These rules are very strict and many clients will not qualify.
Below the 80% threshold, the rules vary greatly between lenders allowing borrowers greater flexibility.
If Things Go Wrong…
Once you’ve answered the above, you should have a really good feeling if this investment is worthy or not.
Occasionally even when you follow all the rules and choose the best borrowers, bad things happen and you have to collect on your mortgage. This normally involves forcing the sale of the property through Power of Sale or Foreclosure.
Every province has a different set of rules on how to do this. It is very important you obtain proper legal advice and hire a lawyer that specializes in this, as the procedures must be followed exactly.
So where do you start?
If really want to become the bank, the first step is determining how much you want to invest and from what source. Both registered investments vs non-registered funds have their pro and cons.
Next, interview your team of professionals and choose who you want to work with.
Finally, find a borrower, set up the mortgage, and collect your payments.