Investors who specialize in real estate will sometimes offer what is known as a trust deed. The investor acts in the same capacity as a bank. The borrower uses real estate as collateral to borrow money from the investor. The contract that contains the terms of this type of loan is known as a promissory note. The borrower makes monthly payments for a specified period until the loan is paid off. If the borrower defaults on the loan, the investor receives the deed to the land. Investors who take part in trust deed investments face several risks.
Lending to Borrowers Who Have Poor Credit
One of the significant risks is lending money to borrowers with poor credit histories. There is often a valid reason if they can’t borrow money from a bank. In most cases, it has to do with a poor credit history that involves a foreclosure, bankruptcy, or a series of late payments. This is the type of habit that stays the same over time.
Not Understanding Collateral
Know the basics of the collateral being used to secure the loan. If the land is undeveloped, it may not provide immediate cash flow if you need to sell it. Properties like commercial buildings, multi-unit apartments, and single-family homes are suitable investments because they offer a quick return in terms of cash flow. Make sure you are comfortable managing these types of property, though. A single-family home is much easier to manage than a multi-family property.
Construction Loans or Using Funds for Land Development
Remember that offering a loan on undeveloped land or for a construction project means the collateral will only reach total value once the construction and land development have been completed. If you are forced to foreclosure on the property, any unfinished construction will need to be completed by you for the property to reach its full potential.
Not Using a Third-Party Loan Servicing Company
If you don’t use a third-party lender to service the loan, it will be up to you to provide the borrower with monthly statements, year-end tax documents, and receipts when you collect the monthly payments. It will also be up to you to start the foreclosure process if the borrower goes into default.
Not Acting on a Non-Performing Trust Deed
If a borrower stops making payments, the investor must take immediate action. Please address the situation promptly to avoid late fees on property taxes or the loss of the property on a tax sale. It may make it more difficult for the investor to initiate foreclosure proceedings.
If you are an investor and want to avoid the common risks associated with trust deed investments, consider using a third-party lender to service the transaction. Contact us at Fidelity Mortgage Lenders today to learn more. We can help you through every step of the investment process and make sure things continue to run smoothly.