Personal Finance For Dummies Three eBook Bundle by Eric Tyson

Author:Eric Tyson
Language: eng
Format: epub
Publisher: Wiley
Published: 2013-06-14T16:00:00+00:00

You know by now that a low-risk, high-yield investment doesn’t exist. Earning a relatively high interest rate goes hand in hand with accepting relatively high risk. The risk is that the borrower can default — which leaves you holding the bag. (In the mid- to late 2000s, mortgage defaults escalated significantly.) More specifically, you can get stuck with a property that you may need to foreclose on, and if you don’t hold the first mortgage, you’re not first in line with a claim on the property.

The fact that private mortgages are high risk should be obvious when you consider why the borrower elects to obtain needed funds privately rather than through a bank. Put yourself in the borrower’s shoes. As a property buyer or owner, if you can obtain a mortgage through a conventional lender, such as a bank, wouldn’t you do so? After all, banks generally give better interest rates. If a mortgage broker offers you a deal where you can, for example, borrow money at 11 percent when the going bank rate is, say, 7 percent, the deal must carry a fair amount of risk.

I would avoid private mortgages. If you really want to invest in such mortgages, you must do some time-consuming homework on the borrower’s financial situation. A banker doesn’t lend someone money without examining a borrower’s assets, liabilities, and monthly expenses, and you shouldn’t either. Be careful to check the borrower’s credit, and get a large down payment (at least 20 percent). The best circumstance in which to be a lender is if you sell some of your own real estate and you’re willing to act as the bank and provide the financing to the buyer in the form of a first mortgage.

Also recognize that your mortgage investment carries interest rate risk: If you need to “sell” it early, you’d have to discount it, perhaps substantially if interest rates have increased since you purchased it. Try not to lend so much money on one mortgage that it represents more than 5 percent of your total investments.

If you’re willing to lend your money to borrowers who carry a relatively high risk of defaulting, consider investing in high-yield (junk) bond mutual funds instead. With these funds, you can at least diversify your money across many borrowers, and you benefit from the professional review and due diligence of the fund management team. You can also consider lending money to family members.

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