Mortgage Investing 101

For newer Investors in residential mortgages

Donald B. Wilson, BA MAOM
Mortgage Investment Consultant and Broker


First Word
Welcome to the world of profitable residential mortgage investing.

While some things may seem a little confusing, or even a little threatening, don’t be afraid to ask any questions you might have. And although you may have thought that you thought of everything before agreeing to fund a mortgage, you may suddenly discover you have a bunch of questions that never occurred to you previously.

Don’t be concerned, my job is to make sure that you understand exactly what is happening, and provide answers to any questions that might arise. So don’t feel bad if you have questions I haven’t yet answered.

Ask away!

Mortgage Investments – Questions to answer before you invest your money.

Mortgages represent one of most common investments in the world – by banks and institutional lenders. Banks like mortgage investing for the same reasons that you probably will. Good return on investment. Relatively lower risk than many alternatives.

Of course, there are many different types of mortgages but here I am only going to discuss residential first and second mortgages placed against property in the Province of BC.

When referring to a “first” or a “second” mortgage what we are referring to is the date of registration of the mortgage relative to any other mortgage placed on the property. Priority of a mortgage, at law, relates to the order in which mortgages are registered. So if I refer to a first mortgage, it means that no other mortgage is to be registered on title in priority to your mortgage. If I refer to a “second” mortgage I am referring to a mortgage that is to be registered behind a previously existing mortgage. Most private investments in mortgages are in “second” position and are called “Second” mortgages.

Second mortgages are generally considered to be riskier than first mortgages, which is why the interest charged to borrowers on second mortgages is generally higher than a first mortgage, and indeed, under certain circumstances, may be much higher.

The risk involved, however, is relative and varies considerably from one second mortgage to another.

Generally, most private residential mortgages are considered “equity” mortgages, which basically mean that they lean more on the value of the real estate than on the general credit worthiness of the borrower. However, the better the credit score of the borrower and the borrower’s cash flow position, the lower the interest rate will be, subject to the mortgage investment marketplace and the Loan to Value of the mortgage investment.

Typically second mortgage interest rates currently range from a low of 9% to a high of 18%, depending on a number of factors that are balanced by a mortgage broker when he quotes a rate to a borrower. The rate the mortgage broker will present will be a market-based rate based on the lowest rate likely to be acquired by an investor. In southwestern BC, at the current time, most second mortgages range from 12% to 14% subject to various factors including geographic location of the property, loan to value expressed as a percentage, use of the property either as a rental or homeowner occupied asset, etc.

For example, one of our lenders will place a second mortgage on property located in the Lower Mainland of BC, with a Loan To Value of 75%, to someone with good credit, at 10% to 12% per year. Another will place a mortgage on a property located in a declining marketplace outside of urban BC, to a loan to value of 75%, at an interest rate of 14% to someone with bruised credit.
So a significant part of the mortgage broker’s work is to determine what rate of interest will attract investment by an investor, and still be within the generally market rates otherwise available to the borrowers.

Before I propose a mortgage investment I will have priced the investment based on market conditions, taking into account various risk factors that affect the cost of the money to the borrower, and the rate of return to the investor.

More experienced investors may choose higher risk mortgages, as the investor has had more background in handling an occasional NSF cheque, or isn’t concerned about perhaps having to foreclose on the property to recover their investment. Their desire for a higher rate of return balances the higher risks involved.

The difference in the level of risk between most second mortgages does not mean that there is a significant risk of losing all your money. Rather, higher interest mortgages generally reflect the possibility that you will have to collect your payments actively, or even engage lawyers and extra expense to recover your investment dollars and/or your payments.

As long as the investment in a mortgage is made with reasonable parameters there is little or no risk of losing all your money, but you might have to wait to get paid at the higher risk levels.

Assessing Relative Risk and Reward

When investing your savings in a mortgage it is important to assess the risks involved.
If you put your money into a Canadian bank account, there is virtually no risk of total loss, but you will earn almost no interest income from it, either. At 2% your money is actually losing value every year against the Consumer Price Index and the underlying inflation rate. Government T-bills pay a little better, perhaps 3% or 4%, but using the Rule of 72 your money will double its value ever 24 years at 3% or every 18 years at 4%. Safe but not exactly sensible necessarily, since the value of your money will actually decline if your net rate of interest returns are the same as or close to inflation.

At the other end of the risk spectrum are investments in many different investments, including commodities like coal, corn or futures in metals. Those investments, when managed by skilful experts may result in being able to double your money in a few months or a year or two at the most. However, the risk of loss is extremely high. In other words you will likely lose some or all of your principle making these types of investments.

The same thing is true of investments in stocks and bonds, or even mutual funds based on stocks and bonds. The higher the rate of return published, the more likely the risk of losing some or all of your investment dollars. It doesn’t always have to happen. Sometimes investors do very well indeed investing in stocks on the various exchanges around the world. One might choose to have some exposure to this marketplace, but one should be cautious about exposing critical retirement money to the risks represented by equity markets where values are based on the volatile buying and selling of stocks.

The last type of investment really available to most investors is debt investments of one kind or another, where the risk of loss is lower, but the rate of returns is also lower. Mortgages are in this class of investments, however, their rate of return in substantially higher than most other equally “safe” or “less risky” investments.

Even within the mortgage investment world there are additional ways to reduce your risk of loss:

Mutualisation of mortgage risk – by investing in a mortgage pooling arrangement, (like a Mortgage Investment Corp.) decreases your risk by spreading it out over a large number of second mortgages. It also slightly reduces your net returns because typically MICs invest in a mixture of lower risk first mortgages and some higher risk seconds and charge the investors for the costs associated with administration.

Investing your money in a number of smaller mortgages instead of one large mortgage. This is the method preferred by most small mortgage investors, since the more mortgages represented in your portfolio, the less likely you are going to find yourself with more than more of them not performing at any given time.

Reliance on competent professionals all the way down the line. Seasoned investment professionals are more likely to successful with you than beginners. Check out some referrals. Ask lots of questions. If your mortgage broker balks at answering your questions at any time, be concerned, very concerned.

Make sure that the lawyers doing the work are always available to answer your concerns and question. Lawyers preparing mortgages for you, have a duty of care to you. Don’t hesitate to ask questions of the law firm preparing the documents and registering the mortgages for you. I use a number of different law firms to prepare documents for private mortgages I broker. The firms I use are all experienced lawyers, with skilful conveyancing staff. What they all share is that they always recognise their duty of care is to the lenders (the investors, you guys).

Review your documents when you receive them from the lawyers, and make sure that what you were told you were getting is exactly what you in fact have received. If there are any doubts or questions, call me (or the law firm) for clarification, or in the event of an error, rectification.
Mortgages are held in your own name, unless otherwise specified in writing. This is important, and the priority of your mortgage should always be consistent with what you have been presented by the broker. The Investor Disclosure sheet provided by me is your statement of intention by the broker. The actual mortgage should conform entirely to what has been disclosed. If there are changes to any of the material facts, the law firm will contact you directly confirm that you still wish to proceed with the investment. The lawyers provide you with assurances that the disclosure form accurately reflects the mortgage reality.

Ultimately, investing in mortgages can be relatively low risk, and mostly requires that you ask suitable questions to determine whether what you are investing in is a lower, medium or higher risk mortgage.

As your broker I’m most interested in maintaining your business, and reinvesting your money when it comes out of a mortgage at the end of the term of the mortgage. This will only happen if you are satisfied with the outcome of the processes.

The process of approving and then issuing a mortgage

I will send you a variety of documents that help describe and illustrate a potential investment opportunity in a mortgage. The documents I will send you will include:
Mortgage Investment Disclosure Statement
Mortgage Application from the proposed borrower
The Credit Report on the proposed borrower
Property appraisal, assessment or Agreement of Purchase and Sale with MLS listing.

Since the value of the property is the critical issue, the basis on which the value is given is important. Generally I order and provide an appraisal prior to funding, although it may not be available immediately. On lower Loan to Value loans a BC Property Assessment report may be sufficient. On a new purchase, if it is an MLS sale, then the Agreement of Purchase and Sale is usually sufficient to attest to fair market value. If it is a private sale, then I would require the borrower to provide an appraisal from an approved appraisals firm.

Once I send you the various information sources listed above I will generally request that you review and decided to fund or not to fund a specific mortgage. I will leave an investment opportunity in your hands for a relatively short period of time before sending it to the next potential investor, as I am expected to give the borrower an answer within 24 hours of a request for a loan. Clearly I have to make sure that I find a home for the mortgage quickly, or I will lose the mortgage opportunity to another lender or broker.

So if you are interested in a mortgage I have presented, it is really important to let me know right away, so that I can send a commitment to the borrower, and get the process of registering the mortgage underway at the lawyers’ offices.

I will let you know when the funds are expected to arrive at the lawyers office, and the method by which they can best be transmitted or deposited to the law firm. It is at this stage that many investors first have contact with the conveyancing staff of the law firm, or talk with the lawyer handling the conveyance (registration of the mortgage) to answer any questions they have.
Funds are deposited to the trust account of the law firm, the mortgage papers signed, and the funds issued to the borrower.

You then receive post-dated cheques and put the money in your account on a monthly basis.
After the end of the term of the mortgage, most commonly 12 months, you will receive your principle investment back, or you will ask me to arrange to renew the mortgage.

The law firm represents you in the preparation and registration of your mortgage investment.
The lawyers who draw up the mortgages and register them do all of the following in the course of doing a mortgage:

Title search prior to make sure that they have a comprehensive list of everything on title that needs to be removed before advancing the new mortgage.

Contacts the insurance provider of the mortgage borrower to make sure that valid general insurance is in place, and that a rider is attached to ensure payment of the mortgage in the event of a major claim.

Sees to it that any prior charges are paid out of the proceeds of the mortgage excepting for authorized mortgages.

Makes sure that property taxes are paid, if not, then they are paid out of the proceeds of the mortgage.

Collect post-dated cheques to your benefit from the borrowers for 12 months that they forward on to you for deposit.

Pay any charges or costs arising from the mortgage from the proceeds of the mortgage prior to paying out net proceeds.

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  Prepare a dispersements record for the borrower detailing any money deducted from the proceeds of the mortgage

Ensure that any statutory documents required by various levels of government are completed including BC Disclosure Statements
Collect payment from the borrower for all costs
After a week or so after all funds have been advanced the lawyer will send you a copy of the title showing your mortgage registered on title, a copy of the mortgage document actually registered, and post dated cheques for 12 month.
Last Word
Once you have invested in a few mortgages, much of what I’ve written above will seem self-evident and hardly worth mentioning. Most of my investors review the mortgage documents I send, decide to invest or not based on their own assessment of their risk comfort level, make the investment, and then simply collect the payments until the mortgage term expires, and then repeat the process as necessary.
One nice thing about mortgages is that they don’t take a lot of ongoing investor involvement. If there is any problem with a mortgage, call me (your broker) and it’s my job to figure how to collect the outstanding payment, or instruct council on your behalf to foreclose or otherwise act to the collect your money. Truthful, few of my investors have ever seen a missed payment or an NSF cheque. And few of the mortgages I’ve placed have ever going into foreclosure.
It is my job to make sure that you always have full disclosure of any relevant information about a potential investment in a mortgage. It’s also my job to make sure that your mortgage is set up properly through a qualified legal professional.