Private Mortgages/Real Estate

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Feb 27, 2006 10:34 am

I am dealing with alot of clients that are pulling money out because "I can get 12-15% in a riskless environment in mortages".  I tell them the risk should be as apperent as credit lines are at 8% and you are getting almost double that, there is obviously risk involved in what you are doing.  Any insight?

Feb 27, 2006 12:05 pm

The only risk is if they lend more money than the underlying property is worth.  Most mortgage investors avoid those scenarios and use a ratio of 3:1.  Lend $50,000 on $150,000 in equity, for example. If the borrower defaults, they foreclose.  The majority of the time, the loans are 5 year terms with 2 or 3 years prepayment penalties. Since default rates are very, very, low (most people prefer not to live under a bridge), it is pretty tough to talk someone out of this type of investment. 


I've encountered this plenty.  I suggest you don't waste much time and effort on converting them, but rather keep looking for folks that can use your services.   

Feb 27, 2006 2:10 pm

Actually there are some risks that are more intangible.....like what happens if a borrower defaults?  Yeah you have a lien on the property (hopefully in 1st position), but do you know how long it takes to actually foreclose on someone?  I know plenty of people who have lost money in private mortgages and sometimes it can take YEARS to get any of their money back if a deal goes south. 


I used to be a mortgage broker and here is the typical structure of these deals:


1) will lend up to 60% of underlying value of property


2) 5 to 10 year terms (and everything in between)


3) Very high rates (10 to 15%)


Skee:  I don't have the industry data on default rates, but from personal experience I have seen quite a few folks who have lost money on defaulted private mortgages. 


Think about it,  if the borrower was a "prime" borrower they could a get great rate on a LTV of < 60%, the reason why the rate is so high is because the borrower has major financial blemishes and is relying on equity in his/her home as the redeeming factor.  If I were to make an uninformed (as to the default rates) bet, I'd bet that default rates are actually quite high.  


Definitely not riskless and if it does go south, it can be a MAJOR pain in the a*s to get their money back.

Feb 27, 2006 2:28 pm

Ditto what Dude said.


I am in a complex with a R/E broker who does short term (generally less than 1 year) lending for construction to contractors/borrowers who can't get a bank loan or don't want to wait.  So far they have only had one default on a loan, but it was a biggie.  Fortunately they were able to flip the property within a few weeks and the investors got their money back. 


The R/E market is still pretty hot so far in my area, but the danger that I see is when the market slows, and property that was at a 50% loan to value is now defaulted at maybe 80% ltv. Then the property, an unfinished house or apartment building, will be on the market much longer, negating the advantage of the high interest rate on the, now defaulted, loan.


I agree, don't waste time trying to convert them.  Greedy people will take risks no matter what we tell them.  On the upside, if you have warned them, when the bottom falls out you can remind them that you are here to give them sound advice and look out for their best interests.  Can they say the same for the R/E broker, who is making money hand over fist?   Not!

Feb 27, 2006 2:44 pm

According to Foreclosure.com, "...the number of 2005 foreclosures needed to be kept in context. “Even with almost 850,000 properties entering some stage of foreclosure across the country over the course of the year, this represents less than 1 percent of all U.S. households. And the increase in U.S. foreclosures from Q3 to Q4 was just below 5 percent.”


“Over the past few years, we’ve seen historically low mortgage rates, consistently escalating home prices and steady, strong employment,” Saccacio said. “This has translated into relatively low levels of foreclosure properties — particularly bank-owned properties. With interest rates rising and an apparent slowing of property valuations in most markets, we’ll be watching closely to see if there’s a material effect on the number of foreclosures in 2006.”


Dude, what you say is valid, but I guess the local economy plays a big role in default rates. I haven't seen any mortgage investors jumping out of windows lately....


Feb 27, 2006 3:58 pm

...but I am ready to push the next one out of a freakin' window...

Feb 27, 2006 4:56 pm
skeedaddy2:

According to Foreclosure.com, "...the number of 2005 foreclosures needed to be kept in context. “Even with almost 850,000 properties entering some stage of foreclosure across the country over the course of the year, this represents less than 1 percent of all U.S. households. And the increase in U.S. foreclosures from Q3 to Q4 was just below 5 percent.”


“Over the past few years, we’ve seen historically low mortgage rates, consistently escalating home prices and steady, strong employment,” Saccacio said. “This has translated into relatively low levels of foreclosure properties — particularly bank-owned properties. With interest rates rising and an apparent slowing of property valuations in most markets, we’ll be watching closely to see if there’s a material effect on the number of foreclosures in 2006.”


Dude, what you say is valid, but I guess the local economy plays a big role in default rates. I haven't seen any mortgage investors jumping out of windows lately....




We're also talking apples and oranges here.  You cannot compare default rates on bank loans and A paper mortgages to the "subprime" default rates.  Your #'s are probably an aggregate, whereas I was speaking to the private "subprime" mortgage market.  I'd bet that default rates are much higher in the "subprime" mortgage market.

Feb 27, 2006 5:16 pm
babbling looney:

Ditto what Dude said.


I am in a complex with a R/E broker who does short term (generally less than 1 year) lending for construction to contractors/borrowers who can't get a bank loan or don't want to wait.  So far they have only had one default on a loan, but it was a biggie.  Fortunately they were able to flip the property within a few weeks and the investors got their money back. 


The R/E market is still pretty hot so far in my area, but the danger that I see is when the market slows, and property that was at a 50% loan to value is now defaulted at maybe 80% ltv. Then the property, an unfinished house or apartment building, will be on the market much longer, negating the advantage of the high interest rate on the, now defaulted, loan.


I agree, don't waste time trying to convert them.  Greedy people will take risks no matter what we tell them.  On the upside, if you have warned them, when the bottom falls out you can remind them that you are here to give them sound advice and look out for their best interests.  Can they say the same for the R/E broker, who is making money hand over fist?   Not!



The loans Bl are referring to are a little different flavor than the ones I was detailing, although both versions are being prmoted as "riskless".  Essentially these loans are short term "bridge" loans that allow a developer to finance a project until more conventional "later stage" financing options open up.  Just like the private mortgages, the "riskless" illusion comes from a very high equity to debt ratio which leaves the "lender" (your prospects) with the idea that if there is a default the property can be sold with a large margin to discount the property and recover the original investment.  The problem is that if there is a default the foreclosure process can be very expensive and time consuming, all the while your clients are not getting interest.


Frumhere, here's how I handle these poor delusional souls:


"Mr. Jones, let me ask you a question.....why do you think these homeowners are having to borrow money from you?  Why not the bank?"


Him "Because the banks won't lend 'em money (or something like that)?"


"Exactly, and do you know why that is?"


Blank stare


"Because these types of loans are too risky for banks to lend on.  Even with the high equity in the property, banks have determined that the default risk is too high for them to lend on these properties.  Don't you think that if the bank could earn 15% risk free return, they'd be all over it?"


"In addition, if you we're the borrower in this circumstance and you had great credit or "low default risk" and were only going to borrow 50% of your homes value, don't you think you could get a better rate than 15%?  Try 6.25%.  So why would these borrowers pay 15%?"


"There's a couple most likely answers.  1st is that they have "high default risk" / bad credit or the property is a very odd property that conventional lenders won't touch because it may be hard to liquidate in a foreclosure.  Under which of those situations would you like to lend your money?"


Hope that helps

Feb 28, 2006 3:49 pm

Dude:



Just curious why you left the mortgage broker business? It seems like an

easier way to make a good living. I'm a little frustrated today with this

market's action, so I will sound a bit blasphemus.



The mortgage brokers I know are printing money: They work for 800-900

basis points versus our 75-90 basis points, their target audience is 90%

of the population versus our 5% of population, and payouts are double

what we get and even higher after 1 year in the business.



Granted, a typical mortgage broker is not in the company of Harvard

MBAs and probably doesn't know the difference between Herpes and

Hermes, but that and $.35 will get you a call on a public phone.   

Feb 28, 2006 4:44 pm
skeedaddy:

Dude:

Just curious why you left the mortgage broker business? It seems like an
easier way to make a good living. I'm a little frustrated today with this
market's action, so I will sound a bit blasphemus.

The mortgage brokers I know are printing money: They work for 800-900
basis points versus our 75-90 basis points, their target audience is 90%
of the population versus our 5% of population, and payouts are double
what we get and even higher after 1 year in the business.

Granted, a typical mortgage broker is not in the company of Harvard
MBAs and probably doesn't know the difference between Herpes and
Hermes, but that and $.35 will get you a call on a public phone.   


Skee:


90% of the population own homes?  That figure seems a little high to me. 


The reason I'm no longer a mortgage broker has to do with my horrid timing.  I was a mortgage broker in early 2000, when interest rates were around 9%.  Needless to say, I was starving so on to bigger and better things?  Yeesh....I missed an opportunity!  Now I'm still starving (not really that bad) and working harder with less time on my hands. 


As far as what mortgage brokers get paid, I think you've got it wrong (or I'm not understanding your figures)......It usually breaks down like this:


1 point charged to borrower (origination fee) and 1 point in rebate or Yeild spread from the lender for a total of 2 points/ 200 basis points.


The payout is usually around 50% (depending on the brokerage).


Sounds a lot like the typical stockbrokers' transaction/payout to me.


A lot of mortgage brokers charge only 1 to 1.5% points, the problem is NO recurring revenue. 


Also, mortgage brokers' compensation is much more linked to market swings.  It's thrive or starve for most.  As a Financial Consultant the recurring revenues our clients generate, in addition to financial products that span multiple markets contributes to the possibility of a more stable income.

Feb 28, 2006 4:47 pm

Also, it is nice to work with folks that come from a deeper gene pool.  I like to associate with smart people. 

Feb 28, 2006 4:58 pm

You obviously don't work in the same field I do!