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The safety of Trust Deed Notes investment

From time to time, we received solicitations from local mortgage brokerage companies to offer very high return (11% or 12%) on 1st or 2nd trust deed on local homes.  It looks great from the protective equity or from the percentage of loan to the value of the home.  Can we trust such arrangement of investment?

  • December 19 2008 - Excelsior
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Answers (3)

Crestlake, Since Rudi and Justin provided solid advice on their topics, I will address another aspect of your question.  You seem to be asking, "how can I get 11% or 12% on my money when other income-oriented investments are only yielding 1%-5%?" It seems too good to be true.

In fact, it is possible to earn 11% or 12% on trust deed investments today that have a solid margin of safety (which I would define, a little arbitrarily, as 30% or more equity cushion).

However,  it takes quite a bit of expertise to distinguish the solid investments from ones that have a flaw of some sort. Each trust deed investment is "made" individually, and if the people who made it don't know what they are doing, the investor could end up holding the bag.

As an example, one company made a series of loans here in Los Angeles to a borrower who fixed up homes and then resold them. The borrower also had their own escrow company, and the lender allowed the borrower to use their own escrow company to handle the loans. In the end, the borrower got into a bind and didn't arrange to have some loans properly recorded. As a result, some investors who thought they had a first trust deed really didn't have the security they thought they had.

This is not to scare anyone away from trust deed investing. It is an excellent market precisely because it is not for amateurs to take on by themselves, and it is not accessible to the major Wall Street firms. For this reason, it is a niche market that features very strong risk-adjusted returns. But make sure you are working closely with people who have done it before and who know the pitfalls.
  • June 18 2011
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Crestlake, Justin gave you some good tips. Hers's a few more. Be sure you receive:

1. A Promissory Note

2. Recorded Trust Deed of Trust ... You have a Secured Lein Against the Property

3. A Fire Insurance Policy of Endorsement insuring your investment in the property

4. Policy of Title Insurance and Endorsement insuring your position as Beneficiary.

Note: Trust Deed Investing is short term on every transaction. Your main concern is not the credit worthiness of the borrower. It's:

1. The ability to repay
2. The borrower's exit stategy
3. The LTV
4. The length of time to sell short to recapture your investment should you need to foreclose

Trust Deed investing is not for everyone. Most get more emotionally involved than if they were buying stocks. Stay with SFR or Small Commercial. No non-profits or bare land/lots. Do your homework on every property that you are contemplating to put your money into!

Good luck!
  • December 19 2008
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If you know what you are doing it can be lucrative.  A few rules of thumb for criteria to look for

1) Property is in an urban area and conforming (similar comps)
2) Minimum 150,000 net equity cushion
3) Loan to Value Max 60 on First Deed, Combined Max 50 on Second Deed
4) Don't go behind a large first deed
5) Hire a good servicer and don't be shy if payments fall behind
6) Walk the property before you invest
  • December 19 2008
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