Despite what you’ll see advertised in the financial media, there’s no such thing as a risk-free investment. While there are risk factors in mortgage investing, too, a professional mortgage investment company employs a number of strategies to protect against them.
- Risk #1: The biggest risk in the mortgage lending business is insufficient property equity. The reason is simple: If you don’t have enough equity in the property, and owner stops making payments and you have to foreclose, you won’t have enough coverage to get your money back plus the costs you’ve laid out. Make no mistake, properties go out of business, but capping a loan at 65% of the appraised value and requiring 35% owner equity serves as ample protection. It’s basic math, but it’s the most important math in this business and is the key to making a good loan.
- Risk #2: The second factor is market risk—in other words, the potential for real estate values to drop. (Chances are that you have personal experience with this if you owned any type of real estate in the late 2000s.) How does a drop in market value affect a mortgage investment loan? Say a property is worth $1 million, with a first mortgage for $600,000, and the market drops by 20%. You still have a $600,000 first lien against an $800,000 building—which ensures you’ll still get your money back. The key here, as above, is having a low loan-to-value (LTV) ratio. Beyond that, there are two other ways to mitigate this risk. 1) Verifying proper title insurance on the property, using a national title insurance firm to ensure that you have the first lien position. 2) As a mortgage investment company, there’s nothing we can do to keep prices from going down, but we can verify the valuation is accurate in the first place. That’s accomplished by using one of the third-party independent licensed appraisal countries across the country that do the appraisal work and give us the values. We can’t just take our borrower’s word for what they think a property is worth.
- Risk #3: Nonpayment risk. A credit check and background search are indicators of character and behavior, and therefore crucial steps when it comes to verifying that a borrower is going to make good on their payments. Again, though, property valuation, type, and income need to be right. It’s important to note that, because these are real estate equity-based loans only, they don’t depend on any business entity. If we loan on an assisted living facility and the assisted living business fails, it doesn’t matter. The building is worth what it’s worth, even without the business there.
Mortgage investing may not seem as thrilling as buying a high-flier tech stock, but the downsides are much less and much more easily managed. Add it all up, and the slow and steady approach to income of mortgage investing is much more likely to pay off over the long haul—and let you sleep every night.