Investing today can be a challenge. Given the low interest rates offered by banks and the volatility of the stock market, many people, as a result, are turning to real estate as a source of opportunity, serving as private lenders. Instead of putting their money into a bank account to yield returns, they are BECOMING the bank; lending to people who need money for home purchases, renovations or refinancing.
If you are interested in investment alternatives, The Wilson Team of Mortgage Experts is your one-stop shop for opportunities. We at The Wilson Team can guide you through the ins and outs of private real estate lending, either as an individual lender or a member of a mortgage investment company. As with any investment, there is always risk, but The Wilson Team works to find you the safest possible channels for your money.
Private Lending Explained
As a private lender, you essentially become the bank – the direct lender — for an individual or a company seeking funds to finance a home purchase or property development. You loan an applicant a specific sum of money at an agreed-upon rate of return for a specific time frame. Often, direct lending is a short-term proposition, tiding over the borrower until he or she can obtain a loan from a traditional institution.
Anyone can become a private lender, as long as they can access the necessary cash to loan. There are no courses required and no license necessary.
Private lenders charge higher repayment rates than banks, because they generally deal in loans for properties or applicants that banks find unacceptable. Given the stringent bank loan requirements today, this leaves many potential borrowers out in the cold, so private lenders fill the gap. This means you’ll get a higher return on investment than you would from a savings account, bond or many stocks.
Direct lending is very flexible. You determine how much money you want to loan and what timeframe for repayment you require. You can request monthly payments or a lump sum at the end of the loan’s term. You also get to decide whether or not to lend funds to a particular applicant.
If you prefer not to take the risk alone, you can become part of a Mortgage Investment Corporation (MIC); investors that form a group to invest in residential mortgages.
Another option is the Real Estate Investment Trust (REIT). A REIT is a company that owns or finances income-producing real estate properties. Investors buy shares in publicly traded REITS and their funds are used to buy or manage properties. REITS can own or invest in a variety of income-producing properties; most of their purchases are commercial.
How to Do a Private Mortgage Correctly
If you’re considering a private mortgage, think like a “traditional” lender (although you can still offer better rates and a more consumer-friendly product). Imagine what could go wrong, and structure the deal so that you are not dependent on good luck, good memories, or good intentions.
For documentation (loan agreements and filing liens, for example), work with qualified experts. Talk to local attorneys, your tax preparer, and others who can help guide you through the process. If you’re working with large sums of money, this isn’t a DIY project. Several online services can handle everything for you, and local service providers can also do the job. Ask exactly which services are provided, including:
- Will you get written mortgage agreements?
- Can payments be handled by somebody else (and automated)?
- Will documents be filed with local governments (to secure the loan, for example)?
- Will payments be reported to credit bureaus (which helps borrowers build credit)?
Finding Investment Opportunities
If you are interested in private lending options, you’ll probably want to work through a mortgage broker, like The Wilson Team. There are online networks for finding loan applicants, but it is advisable to work with a group that understands mortgage details and can administer it for you.
You’ll also need a good lawyer to put the contracts together, and The Wilson Team has access to a number of skilled professionals.
Who Are Private Lenders?
Anyone can become a private lender. The common thread linking them is that they have the extra cash available to invest.
- Physicians, dentists, lawyers or other professionals;
- Retirees seeking passive investment income; or
- Owners of an estate or trust fund.
Private Mortgage Agreements
Any loan should be well-documented. A good loan agreement puts everything in writing so that everybody’s expectations are clear and there are fewer possible surprises. After several years, you (or the other person) may forget what you discussed and what you had in mind, but a written document has a much better memory.
Documentation does more than just keep your relationship intact — it protects both parties to a private mortgage. Again, you don’t know what you don’t know about the future, and it’s best to avoid any legal loose ends from the get-go. What’s more, a written agreement might make the deal work better from a tax perspective.
As you review your agreement, make sure every conceivable detail is spelled out, starting with:
- When are payments due? Monthly, quarterly, on the first of the month, etc.
- What if payments aren’t received? Can the lender charge a fee, and is there a grace period?
- How/where should payments be made? Electronic payments are best.
- Can the borrower prepay, and is there any penalty for doing so?
- Is the loan secured with any collateral? It better be.
What can the lender do if the borrower misses payments? Can the lender charge fees, report to credit reporting agencies, or foreclose on the home?
Who Are Potential Borrowers?
As previously discussed, potential borrowers are people who do not qualify or present too high of a risk for a traditional lender. With the application of the Stress Test and with the addition of more stringent requirements required by traditional lenders, more and more people find themselves unable to obtain a traditional mortgage.
As a direct or private lender, you’ll encounter borrowers who want money for a variety of purposes, including:
- Purchase/Live – A buyer may want to own a home but has a poor credit rating or a job whose income fluctuates, making traditional lenders reluctant to loan them money.
- Reno/Sell – The investor wants to buy a property with the intent of renovating it and selling it.
- Reno/Rent – The investor wants to purchase a property to renovate and then rent in order to have a regular cash flow.
- Builders/Developers – These investors buy vacant properties to develop and speculate that their finished product will sell/rent easily.
Understand the Risks
Life is full of surprises, and any loan can go bad. Of course, everybody has good intentions, and these deals often seem like a great idea when they first come to mind. But pause long enough to consider the following issues before you get too deep into something that will be difficult to unwind.
Relationships: Existing relationships between the borrower and seller may change. Especially if things get difficult for the borrower, borrowers may feel extra stress and guilt. Lenders also face complications — they may need to decide whether to sternly enforce agreements or take a loss.
Lender risk tolerance: The idea may be to make a loan (with the expectation of getting repaid), but surprises happen. Evaluate the lender’s ability to take risk (becoming unable to retire, risk of bankruptcy, etc.) before moving forward. This is especially important if others are dependent on the lender (dependent children or spouses, for example).
Property value: Real estate is expensive. Fluctuations in value can amount to tens (or hundreds) of thousands of dollars. Lenders need to be comfortable with the property condition and location — especially with all of those eggs in one basket.
Maintenance: It takes time, money, and attention to maintain property. Even with a good inspector, issues come up. Lenders need to be sure that the resident or owner will address problems before they get out of hand and be able to pay for maintenance.
Title issues and order of payments: The lender should insist on securing the loan with a lien (see below). In case the borrower adds any additional mortgages (or somebody puts a lien on the house), you’ll want to be sure that the lender gets paid first. However, you’ll also want to check for any issues before buying the property. Traditional mortgage lenders insist on a title search, and the borrower or lender should ensure that the property has a clear title. Title insurance provides extra protection, and would be a wise purchase.
Tax complications: Tax laws are tricky, and moving large sums of money around can create problems.
Before you do anything, speak with a local tax advisor so that you’re not caught by surprise.
Secure the Loan
It’s wise to secure the lender’s interest — even if the lender and borrower are close friends or family members. A secured loan allows the lender to take the property (through foreclosure) and get their money back in a worst-case-scenario.
Is that really necessary? Again, you don’t know what you don’t know about the future.
A borrower (who has the ability and every intention to repay) may die or get sued unexpectedly. If the property is held in the borrower’s name only — without a properly filed lien — creditors can go after their home or pressure the borrower to use the home’s value to satisfy a debt. A secured mortgage helps protect the lender’s interest, assuming everything is structured correctly. In fact, the term “mortgage” technically means “security” — not “loan.”
Securing a loan with property may also help with taxes. For example, the borrower might be able to deduct interest costs on the loan, but only if the loan is properly secured. Talk with a local tax preparer or CPA for more details and ideas.
While you can technically lend money to borrowers across Canada, it is advisable to first start with local applicants. You probably know and understand your own market best and you will have the opportunity to meet with applicants directly. This brings a certain amount of personal reassurance as you begin your lending career.
The Wilson Team can help you find potential borrowers in your area.
Take the Plunge
If you’re interested in diversifying your investments, are interested in real estate or want to escape the ups and downs of the stock market, then private real estate lending could be perfect for you. Contact The Wilson Team of Mortgage Experts to get started. We’ll steer you in the right direction!