Banks make money on mortgage loans. Lots of money. As a result, some smart money managers realized that creating opportunities for regular Joe’s and Jane’s to make money off of mortgage debt might be a great option. But are these investment products and strategies worth it? Here’s a general overview, as well as the pros and cons, of the four different ways a person can become a mortgage lender as either a generous family member or as an investor who wants to earn money on the debt.
1. The Bank of Mom & Dad
Receiving a cash gift from parents to put towards a down payment is a big help for first-time homebuyers. Even if the Bank of Mom & Dad can’t stretch to a cash gift then a no-interest or low-interest loan can be another effective option.
Even if you trust your son or daughter to make repayments to you, it’s best to put repayment terms in writing so everyone’s on the same page. Just keep in mind that any “formal” loan will count as debt that other loan lenders will use as part of their debt ratio calculations.
Electing to be the Bank of Mom & Dad means you run the risk of not having the loan paid back if other life events happen to take priority.
2. Becoming a Private Lender
If you’ve paid off the mortgage on your home or you have a sizeable unregistered savings nest egg then you could consider becoming a private lender. You could either hand over your nest egg or take out a mortgage on your home, at a low rate, and then give that money to a mortgage broker. That broker will lend out that money to a borrower, at a higher interest rate. Quite often, these borrowers have been turned down for a loan by a traditional bank.
Banks make money on mortgage loans. Lots of money.
The benefits of being a private lender are that you’ll typically make a higher rate of return than from stocks or bonds. The downside is the risk associated with non-payment of the loan if the borrower defaults. For more investors, this is a very sophisticated and not very transparent way to make money on an investment. The key is to really understand what the underlying asset is, how the funds are to be used and the how risky the investment may be. Bottom line: Do your homework.
3. Investing in Mortgage Corporations (MICs)
Investing in a mortgage corporation (known as MICs) is another way to become a mortgage lender, albeit not in a personal capacity. The way it works is a group of investors pool their money and the account is managed by a professional investment manager. The newly formed mortgage corporation is then in a position to lend out funds to qualified borrowers at higher interest rates than conventional mortgages.
Just like a managed fund, the investors receive dividends and the account manager takes out management fees as reimbursement for their services. A mortgage corporation can be a good investment vehicle if you’re looking to invest a sum of money and receive decent stable returns.
There is a certain element of risk when investing in MICs, especially after the 2008/2009 housing crisis. You can also be thumped with an early exit fee if you want to withdraw your money before a certain period of time.
4. Buy Shares in Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts, or REITs, are companies that have a portfolio of residential and commercial properties, as well as mortgages. Investors buy shares in the REIT and receive a steady income stream in the form of dividends.
REITS are required to distribute 90% of their income to shareholders, so the returns are usually higher than investing in the stock market. In saying that, because REITs focus purely on a narrow category of assets they’re less diversified and be vulnerable to market downturns. When choosing a REIT, be sure to understand what is being held and how funds are distributed.