Trust deed back refinancing: is this a legitimate form of investment?
Question: I was approached with an investment opportunity and I’m wondering if there are downsides to it that I am not appreciating.
The person I would be giving my money to is a loan agent for what seems to be a legit mortgage company.
What he does is give people 1-2 year loans at around 15%, typically to refinance their homes when they are having problems paying their bank mortgages. He takes a couple of % as a fee on top, and also is a partial lender himself. I would get around a 12% return.
The loans are supposed to be backed by trust deeds, and the underlying property is always worth substantially more than the loan amount. Also I believe he insures the properties against disaster.
So this kind of looks like a risk free 12% or so per annum.
The reason banks do not do these loans, I am told, is a combination of regulation prohibiting them from lending to people with weak credit records, and also the fact that the borrowers typically need the money very soon and banks operate too slowly for that.
So what do you guys think? See any holes in this story?
Answer: Trust Deed Investing is a legitmate field and people invest profitable in it. It has it’s large share of risks. The kind of people who pay 15% on loans are very poor credit risks and likely to default. You leave out an enormous number of details. Are these first or second trust deeds? The protective equity is much different. The foreclosure rules are much different. Whose name is on the promissory note and trust deed? Do you directly have a lien against the property or are you just an investor in group that has a lien against the property? The only recourse you have in the likely event of non-payment of the loan is foreclusure. Can your force foreclosure? What if the group wants to give the borrower more time and you want to foreclose, what happens? If a property is likely to default what stops your fellow inestors from switching your money into the bad deal and their money out? Would an Enron executive dump his stock while telling his employees to buy more?
It costs a lot of money to foreclose. It takes many months. If the borrower declares bankruptcy, a bankruptcy judge can stall things. He can even undue done deals (e.g. yours), if he feels there were unfair to some creditors. All that time your money is tied up earning nothing and you could lose principal. You had better hope nothing happens to the colateral e.g. flood, fire or earthquake. Insurance companies may not pay off on floods if you don’t have flood insurance, fire damage is often way underinsured and earthquakes are not covered, or covered for far less than replacment value.
Education: Always in search of a good metaphor: Let’s say you got together with some nice fellows and decided to lend money to poker players using their cars as collateral. What could go wrong? The car could get stolen or smashed into a tree or run somebody over in a DUI or about a million other things. Even if that doesn’t happen the wholesale value of a car is much less than the retail value and unless you run a car lot with no overhead, you aren’t going to walk away with full retail and no expeneses.
Each state is different and you didn’t mention which states these trust deeds will be in. Judicial foreclosure states are different from trust deed states. Purchase money mortgages can be different than refi’s when it comes to recourse to default. It all matters. Have a very, very specific plan for when the borrower doesn’t pay. A blurb about how things work in California:
http://www.dre.ca.gov/trust.htm
Do thank Arnold the next time you share a cigar.
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