At its most basic level, investing is the process by which a person trades risk for profit. Like any investment, underwriting trust deeds does carry some risk of the loss of your money, usually from an investor not making his loan payments or failing to refinance at the end of the trust deed's life. Done right, though, trust deed investments can be extremely safe, especially given the high returns that they generate. Here is a five-step process to making an investment that is profitable and as safe as possible:
- Lend on the right kind of properties. Do your due diligence to make sure that the underlying property is reasonably priced and, if possible, has room for the investor to easily create equity. A property with untapped equity excites investors and protects lenders.
- Make your loan expensive. If bank financing would be 5 percent with a 1 percent origination fee if the investor could get it, it's fine to charge 9 percent or more with an origination fee of at least 3 points. Trust deed investments with these kinds of numbers put more money in your pocket, but they also do something else. They force buyers to find good deals so that they can pay your financing and make a healthy profit. The better the deal is for them, the safer the loan is for you.
- Require a sizable down payment. If a buyer is looking for a zero down payment loan, she's really looking for the opportunity to buy a property and painlessly walk away from it if it doesn't work. If the buyer has a lot of her own money in the property she has a great deal of incentive to make her loan payments and protect your investment.
- Cap your loan-to-value ratio at 65 percent of the purchase price. A 65 percent LTV ratio doesn't only make the buyer put a lot of her own money in to protect you. It also ensures that there is a significant cushion just in case the buyer doesn't perform. If you know that the buyer got a good deal buying a property for $300,000, it's reasonable to assume that you could resell it for $195,000 to cover your loan.
- Focus on the borrower. While property due diligence is important, it's ultimately the buyer's payments that make your trust deed investments profitable. Make sure that they have the strength and the reserves to pay you back.
