Investment Options

There are three main ways to get started investing in a private mortgage fund:

1. Make a direct investment into a professionally managed mortgage fund. This is the safest, and least time-consuming, option for investors as all of the day-to-day management responsibilities (including underwriting, originating, and servicing loans) as well as dealing with any defaults or foreclosures falls on the professional fund management rather than the investors.
2. Purchase a new private mortgage loan from a private mortgage fund or lender. This option involves the investor owning the mortgage outright and collecting monthly payments from the borrower, often through a loan servicing agency. Investors have to perform due diligence on each new mortgage they take on as well as deal with any defaults or foreclosures.
3. Underwrite private mortgages yourself. The third option is only recommended for experienced investors who are familiar with private mortgages and lenders. Investors have to perform due diligence as well as all the loan underwriting responsibilities: creating loan and underwriting documents; analyzing credit and environmental reports and appraisals; getting title reports and insurance; servicing the loans; processing payoffs and satisfaction of mortgages; and remedying any loan defaults.

Options 2 and 3 require special knowledge and experience as well as being more time-consuming. Option 1 allows investors to reap the benefits (and returns) of investing in private mortgages without any of hassle.

The Pros and Cons of Private Mortgage Funds

Private mortgage funds offer an alternative income producing investment option to fond funds or other types of income producing funds. Long-term bond funds are subject to significant risk if interest rates trend upwards.  Short term bond funds mitigate this risk but have much lower yields.  Private mortgage funds normally offer yields that equal or exceed those of almost all long-term bond funds but mitigate their risk with their policy of conservative loan principal amounts to appraised value of the real property. All of their loans are typically secured by first mortgages on real property. Most private mortgage funds are funding what are called “bridge loans.”  Bridge loans are normally made for a period not to exceed three years, thus mitigating the risk associated with funding loans with such long maturities where interest rate fluctuations will impact the resale value of the loan.

The main downside to this type of investment is the risk of losing principal in the event of a default. This risk is reduced by the underwriting practices employed by most private lenders by restricting private mortgages to no more than 65 percent of a property’s total value.

Private Mortgage Fund Management Teams

When choosing a private mortgage fund to invest in, it is important to consider the management team’s experience, competence, and culture. The key to a prosperous fund with good returns is scrupulous management that avoids underwriting risky loans. Investing in private mortgage funds only become truly risky when the management team does a poor job of underwriting and risk assessment, leading to a high loan-default rate and the risk of losing the principal investment.

These risks can be mitigated by investors who research their prospective management teams before electing to invest in a particular fund. Investors should seek out answers to the following questions:

1. How do they perform due diligence on all the loans they underwrite?
2. What is the maximum loan-to-value ratio allowed for a particular property?
3. How do they determine the value of an asset or property?
4. Do they have a proven track record of quality investments?
5. What percentage of their loans have resulted in foreclosures or defaults?

The answers to these questions will give you, as an investor, insight into how a fund’s management team handles risk as well as serving as an indicator of a fund’s future performance. Private mortgage funds can offer an interesting alternative investment choice for investors seeking income when managed properly. Doing appropriate due diligence on the management of private mortgage funds is key to making good decisions in this increasingly popular investment option.

This blog was written by Bob Amter, President of Montegra Capital Resources, LTD., a Colorado hard money lender.  [google_authorship] has been in the private capital lending business for 41 consecutive years.