A trust deed is a document that (when recorded) places a lien against the property described in the trust deed. The three parties to the trust deed are the trustor (owner of the property), the beneficiary (lender) and the trustee. A trust deed makes the property described in the trust deed as the security for a companion promissory note.
Trust deed investing involves purchasing short-term loans (promissory notes) that have real estate as the collateral. Trust deed investing offers attractive yields with the underlying security for the investment being real estate. The degree of safety in a trust deed investment is related to the loan to value ratio which is a comparison of the amount of the note to the value of the real estate collateral.
The return on a trust deed investment is generally in the range of 7-13% depending on the specifics of the loan scenario. For example, trust deed investments on 2nd trust deeds would yield a higher rate than 1st trust deeds due to the increased risk associated with 2nd trust deeds.
The type of property used as collateral for the trust deed will vary from loan to loan. The trust deed investor will be able to review the specific property and circumstances of the loan prior to deciding whether or not the loan meets the investor’s investment criteria.
The loan to value (LTV) ratio will vary based on the loan. A lower LTV provides a safer trust deed investment for the investor/lender and Twin River Capital generally limits the LTV to 75%.
If the borrower defaults on the loan, the trust deed investor is able to foreclose on the property in order to recover their investment. A lower loan to value ratio (LTV) allows the trust deed investor to sell the property quickly at a discounted price in order to recover their initial investment and possibly make a significant profit if a borrower defaults.
If the real estate market declines the borrower must still make the required payments and pay off the amount they initially borrowed. A conservative loan to value ratio (LTV) helps prevent the trust deed investor from losing money in a situation where the value of the property decreases.
When interest rates increase or decrease, the value of a trust deed investment would change slightly only if the holder of the note wanted to sell the investment prior to its maturity date. The terms and payment schedule in the note are unchanged. Because most trust deed investments are short-term investments of 6 months to 3 years, changes in interest rates have little or no impact on the value of the trust deed note.
The borrowers for hard money loans are typically real estate investors. Often they are purchasing a property, making improvements to the property and then selling the property for a profit. They do this in a relatively short amount of time to reduce their risk and holding costs. There are many other real estate related scenarios that require hard money loans.
The best way to get started with trust deed investing is by finding and working with a reputable hard money lender / broker. The broker will be able to present investment opportunities based on the new investor’s investment criteria.
Many people frequently invest in fractionalized trust deeds which means there are two or more lenders in the loan. In most circumstances there is little or no difference when investing in a fractionalized trust deed as long as the broker handles the origination of the loan properly. In the remote chance of a default by the borrower, the investors who own the majority of the note can direct the actions to be taken such as foreclosure.
Generally the minimum investment needed for a trust deed is $20,000 for a 2nd, $30,000 for a 1st. It may be difficult to find available trust deed investments for these investment amounts. With a larger amount available to invest, the investment opportunities increase.
Working with a professional and experienced broker ensures all of the constantly changing regulations will be met and numerous disclosures will be completed. Not properly completing any of the mandatory requirements of a trust deed investment could leave the investor susceptible to legal issues.
A broker will be able to guide the investor through the process of selecting an appropriate trust deed based on the investor’s investment criteria. When a broker is presenting an investment opportunity to an investor, the broker has already analyzed the investment and has obtained information on the borrower and property that a lender may not be able to do without the broker’s assistance.
Working with a licensed mortgage broker also exempts the loan from any usury laws.
In a trust deed fund, a pool of funds exists to which many different investors have contributed. A fund manager is responsible for investing these funds in various trust deeds. While the fund can provide some diversification for the investors, the individual investor gives up all abilities to make decisions on the loans that are purchased.
When an investor invests in individual trust deeds, the investor is given the opportunity to evaluate the specific loan scenario with the guidance of the hard money broker and decide if the loan meets their investing criteria.
Trust deed investors are able to invest in trust deeds with their self-directed IRA accounts. Since the interest from trust deed investments is treated as ordinary income, investing with an IRA is a great way to defer the payment of taxes.