Investors can purchase hard assets such as real estate, diamonds, gold, collectables, fancy automobiles, paintings, etc. All these items can be held physically or by an ownership certification. For example, an automobile pink slip, or a real estate ownership certificate called a grant deed. Recordation of grant deeds enable ones’ ownership of real property to be reflected in public records. Other investments such as stocks, bonds, mutual funds, US treasuries, bank savings accounts, pension plans, and IRA accounts are defined as securities. Under the Securities Act of 1933, and the Securities Exchange Act of 1934, the US government established the Securities and Exchange Commission, to oversee all securities transactions to prevent fraud and intentional deception. Language was included that “Any written evidence of indebtedness is defined as a security.”
A trust deed and a mortgage are written agreements between a borrower and a lender that reflect an evidence of indebtedness and security instruments once executed between the parties. They are recorded at a county or municipal public records office. This recorded agreement provides notice to the public that the subject property is pledged as security for a loan. When a property owner/borrower signs a trust deed, the lender takes a security interest in the property until the loan is repaid. The borrower also signs a promissory note, which is their promise to pay the lender and agree on amount of principal plus interest over a given period. Once the loan is repaid, the trust deed instrument is re-conveyed, thereby releasing the borrower’s lien and removing the lenders interest from public records.
Who are the lenders? Consumers usually assume that the lender is a bank, credit union, Wall Street based lender, or some quasi-government entity such as Fanny Mae, or Freddy Mac. That is not always the case. Private parties who have capital to invest may elect to invest their capital into a loan transaction as a designated lender/beneficiary. Private money lender/investors serve as an alternative source of financing to institutional banks or similar sources.
Licensed real estate brokers and mortgage brokers act as intermediaries soliciting real property loan transactions and private party lender/investors who may want to invest. This industry is known as private money lending.
Who can invest? Individuals, a family trust, corporations, LLC’s, self-directed IRA’s, 401k’s, and groups of investors may form securitized loan pools created specifically for investing in trust deeds or mortgages. In the case where a private party invests, they would become the designated beneficiary on the note and deed of trust. With investing in a loan pool, the investor will purchase shares in a limited liability company whose sole purpose was formed to make loans with investor capital LLC members.
Parties elect to invest into trust deeds because of reasonably high yields and monthly payments. Yields on first trust deeds may range from 7.5% per annum to 10% per annum. Yields on second trust deeds may range from 9% to 12%. The trust deed industry is regulated by multiple State and Federal agencies. A further discussion of the difference between a first and second trust deed can be found on danharkey.com, entitled “Liens and Encumbrances affecting Real Property Loan Transactions.”
The matching of trust deed investors with available funds to loan transactions is an ongoing process. Mortgage brokers must constantly solicit new loan transactions, and lender/investors, who may want to invest in the new loan transaction. Lender/investors have the choice of purchasing the entire trust deed or a fractional portion of the trust deed. If there are multiple investors, title will be held for each investor as tenants-in-common. For example, a $500,000 trust deed investment may have multiple owners: Party A owns $100,000 or a 20% undivided interest, Party B owns $50,000 or a 10% undivided interest, Party C owns $200,000 or an undivided 40%, and so on, all adding up to 100% ownership. The trust deed is recorded with each fractional investor’s name and their interest becomes a matter of public record.
How about an investor who has a total of $1,000,000 to invest? The investor could purchase one large trust deed or smaller portions thereby spreading the risk. Assuming a reasonably conservative portfolio of 5 to 10 trust deed investments, the investor could average monthly yield of 8% or 9%, with a monthly cash flow of $6,667 to $7,500 as part of their financial security and enhanced quality of life.
Each lender/investor receives a material disclosure package outlining the loan transaction, with a summary of a proposed loan investment, borrower application, credit report, financials, preliminary title review, borrower loan documents, and related investor disclosure documents. This information will allow an investor to make an informed decision to invest or not to invest.
Investors will expect full communication from the loan servicing broker, with interest payments processed from the borrower and forwarded to the investor, or communication about the disposition if payments are not received in a timely manner. The investor will also be in periodic contact with the servicing broker, forging an ongoing relationship for the future. If it dissatisfies the lender or investor, they can choose not to reinvest. Here lies, the pressure on the mortgage broker to perform in the most professional manner.