While there are several options for funding real estate projects, understanding the finer points can make a big difference in returns for investors. Developers and property flippers are looking beyond traditional lending institutions and towards individual investors to fund their projects.
Relatively new approaches, like crowdfunding, as well as the tried and true private money loan, are opening up the market and increasing opportunities for project funding. One type of private money loan that can be a great option for investors is a first trust deed.
What is a first trust deed?
This is a legal document that gives the lender the right to foreclose on a property when the owner is unable to make the mortgage payments. The loan is secured by real property, reducing the level of risk.
How is it different from a traditional mortgage?
Every mortgage is actually made up of two parts: (1) the promissory note, which lists the details of a mortgage loan, including the principal amount, interest rate and repayment terms,and (2) the trust deed, which provides for foreclosure in the event that the terms of that promissory note are not met.
Don’t banks own these?
Actually, when a property is purchased with bank financing, an outside investor purchases a promissory note, funds the loan, and retains the legal title to the property. So in the event of default, that investor has the right to sell the property, or alternatively, may execute a loan buy-back agreement.
So trust deeds allow investors to participate in the real estate market without identifying, acquiring, fixing, maintaining, managing and eventually reselling actual real estate.
A bank cannot hold the title to a property so if there is no trustee, the borrower retains both the legal and physical title to the property. If the borrower defaults, this makes it very difficult to foreclose. However, if the legal title is held by a third party, that trustee can foreclose on behalf of the bank, making the process much less time-consuming.
What are the returns?
When the borrower makes a mortgage payment, the trust deed investor earns interest from the bank, often at rates higher than earnings on stocks and bonds. The initial investment is recovered when the property is sold or the mortgage term ends.
It’s important to understand that there can be second deed investors as well, and these are exposed to slightly more risk, since the first deed investor is the first in line to be paid back in the event of a default.
What are the benefits and risks of first trust deeds?
- Higher rates of return with reduced risk
- Loan secured by a hard asset
- Shorter terms on the investment notes –depending on the term of the note
- Not insured by the FDIC
- Second trust deeds carry more risk.
- Title problems can interfere with returns.
- An accurate appraisal is the responsibility of the investor
- Lengthy process to recover investment if the owner declares bankruptcy
Interested in learning more about First Trust Deeds and other alternative funding options for your next real estate project? Connect with our team at Patch of Land today!