Investing in mortgages is a lot like investing in real estate, except without the headaches and capital required to actually purchase a property. Corwin Mortgage Capital vice president Jason Geall recently told Investor’s Digest of Canada readers that, as a mortgage investor, you are lending against an asset, an asset you can touch and feel and that has verifiable value.
When you think of mortgages, typically banks, 25-year amortizations, fixed rates and variable rates come to mind. What people don’t think of is investing in mortgages.
Investing in mortgages is nothing new. However, investors have recently discovered the high returns, low risk and strong cash flow they provide.
Investing in mortgages is a lot like investing in real estate, except without the headaches and capital required to purchase a property. When Warren Buffett takes notice of an industry, it’s usually a strong indicator that the sector is strong. You may or may not have heard that the Oracle of Omaha purchased 38.39 per cent of Home Capital Group Inc. (TSX—HCG), one of Canada’s largest alternative mortgages lenders, which recently faced some negative press.
As a mortgage investor, you are lending against an asset, an asset you can touch and feel that has undeniable and verifiable value.
Private mortgages are much shorter than traditional mortgages. Usually these mortgages are on a one-year term and require borrowers to pay interest only.
Due to their short terms, borrowers pay a much higher rate, usually ranging between seven per cent and 10 per cent on first mortgages and 10 per cent to 15 per cent on second mortgages. These rates depend on a variety of factors like location, loan-to-value ratio, borrowers’ credit and the state of the market. Many borrowers could have great credit, but perhaps own multiple properties, are self-employed, or show little income.
Using a mortgage corporation or a syndicate?
There are a few different options when it comes to investing in mortgages.
Firstly, there are mortgage investment corporations or MICs. Mortgage investment corporations act like a fund. Investors put money into the MIC, which then places the money into mortgages at their discretion.
On average, MICs pay investors a five per cent to eight per cent return. Starting investment is usually in the $50,000-to-$150,000 range and depending on the MIC, interest is paid monthly. When looking at a MIC, it is important to look at a few things. Check its appetite for risk. What is the maximum LTV (loan-to-value) it lends at? How much of its portfolio are first mortgages compared to second? Is it mainly residential or commercial? Where does it lend?
One of the negatives to investing in a MIC is that as an investor, you have no say about the deals your money is being put into. It is entirely at the MIC’s discretion. Another thing to consider is that mortgage investments are also taxed as interest income, regardless of the way you decided to invest.
Another avenue into the world of mortgage investing is syndicated mortgages. Syndicated mortgages are comprised of multiple investors who invest into a mortgage. Brokerages that provide syndicated mortgages are licensed by the Financial Services Commission of Ontario (FSCO).
Whether you are interested in investing with a mortgage syndicate or MIC, make sure that it is a licensed brokerage. You can do so by searching the brokerage name on the FSCO website.
Unlike MICs, you are in full control of the mortgages you choose to invest in, and you hold onto your funds.
Typically a brokerage will send out emails on deals it is funding to see if investors are interested in putting money into the deal. This allows you as an investor to invest in mortgages that make sense to you.
For example, perhaps you like the downtown Toronto market. If that is the case, you can choose to only invest in mortgages that are in downtown Toronto.
An example of a deal might look something like this:
Say we are lending $650,000 as a first mortgage to a property located at 1234 Toronto Rd., Toronto, Ont. The property was appraised last week at $1 million, giving us a 65 per cent LTV. The mortgage is a one-year loan at 9.25 per cent interest.
As an investor, you’ll be able to examine the appraisal on the property to get a real look at the appraised value based on comparables and a variety of other factors. You can also invest as much or as little as you’d like, depending on the brokerage.
Investors generally receive payments either as post-dated cheques or by direct deposit. Again, this depends on the brokerage you are investing with.
Using the example above, a $200,000 investment at 9.25 per cent would equal a return of $1,541.67 per month, or $18,500 for the one-year term.
Syndicated mortgage investments are a great way to control your investment portfolio and diversify among first and second mortgages, residential and commercial.
What if the borrower defaults?
A common question that comes up is: “Well, what if the borrower stops paying?” Actually, this is quite rare. For example, our brokerage, Corwin Mortgage Capital, which offers syndicated mortgages, has more than $100 million worth of currently-funded mortgages on our book and our default rate is just over one per cent.
The fact is, single-family homeowners do not want to lose their homes to private lenders. They will often list their home for sale before we, as lenders, take possession. That being said, every brokerage has its own way of dealing with mortgages that go into default.
There are multiple ways to rectify this issue. Unlike being a landlord where a tenant has most of the power, as a lender, you are in control.
Usually, the lender’s lawyer will first send a demand letter to a delinquent borrower demanding payment. If a borrower is willing to work with the lender, often by paying an interest penalty or some fees, he will get back on track with payments.
If a borrower simply refuses to make payment, then there are two ways to rectify the situation. Exercising the power of sale (that is, the lender’s right to sell a property when its mortgage is in bad standing) is the most common option. A power of sale notice can be issued after 15 days of a loan being in default.
From there, a lender must wait 35 days before the property can be sold. Once the property is sold, lenders are able to reclaim the mortgage (their original investment), interest penalties and any resulting fees, including legal fees. The borrower is then left with whatever remains from the proceeds of the sale.
The second option is foreclosure. Foreclosure in Canada is a much harder and longer process than in the United States, so most Canadian lenders tend to avoid this option.
If a lender happens to go through with a foreclosure, the lender keeps all proceeds from the sale of the property.
This is why as lenders we mitigate our risk by lending at conservative loan-to-value ratios. These typically never exceed 75 per cent of a property’s value. The lower the LTV, the more secure we are against market changes, defaults and property sales.
Corwin Mortgage Capital is a licensed mortgage brokerage dealing in private mortgages. Jason Geall is a vice-president of private lending at Corwin and licensed mortgage agent in Toronto. Anyone interested in more information about investing in mortgages can reach him at Jason@corwincapital.ca or 416-804-0534.
This is an edited version of an article that was originally published for subscribers in the August 11, 2017, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
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