Understanding the Workings of a Trust Deed Investment
It is no secret that banks in today’s market have tightened their lending policies and made getting approved for a loan a much longer process. In some cases this is a good thing; tighter lending policies are supposed to stop bad loans from taking place. However, even borrowers with strong credit history and financials, are currently finding it very difficult to get loans. Today’s real estate market is full of excellent opportunities to take advantage of low price property, but if banks are not lending in a timely manner then opportunities slip away.
This lending time paradox is actually not something new and there is a very profitable solution found with special types of real estate lending firms called “Trust Deed Lenders.” Qualified real estate investors can actually borrow money without going through a bank, and then pay back the interest to qualified, private investors. This type of transaction is called a “Trust Deed” investment.
A Trust Deed is a short term loan, usually 1 to 2 years, at a higher interest rate than offered from traditional banking institutions that is backed by real estate collateral. There are three main entities involved in a Trust Deed investment: the borrower, the lender, and the broker. Understanding each of these roles will help you understand the full concept of a Trust Deed.
First, the Borrower:
The borrower is the person that has found a real estate opportunity and is searching for capitol to fund the opportunity. Usually, these investment opportunities are for medium to large amounts ($200,000 to $5,000,000 or more.) However, we have seen Trust Deeds for as little as $30,000. The borrower tends to be a person that has a lot of experience dealing with real estate investments, has enough equity to back up the loan, but who doesn’t have the liquid capitol for it. That is why they are searching for funding. The role of the borrower is to borrow liquid funds from a lender or group of lenders and pay them back in a short period with interest.
Second, The lender:
The lender or lenders are those people who will ultimately lend money to the borrower. These people can be experienced or first time investors who can lend anywhere from $10,000 to $1,000,000. Some of these investors have non-qualified funds (i.e. cash, trust) but most of them use a special type of IRA called a “Self-Directed IRA.” This type of IRA allows the investor to pool together their funds with other Self-Directed IRAs from other people in order to collectively invest. In the case of a Trust Deed, they are collectively lending to the borrower and will be listed individually on the deed.
Third, The Broker:
The Broker, acts as the middleman for the transaction between the borrower and the lender. The borrower doesn’t seek out individual investors for his/her loan, instead he/she contracts a broker to do this for them. The broker typically has a client base of ready investors and is able to provide capitol for the investment when the borrower gains approval for their loan. The most important role of the broker is to screen the borrower and evaluate the property that they are requesting funding on. A broker will carry special, state approved, licenses in order to accomplish these things.
Connecting the Pieces
The last and very important piece to the Trust Deed puzzle is that every loan is backed by collateral. Borrowers and lenders enter the agreement with the common understanding that if, for whatever reason, the borrower is unable to pay the loan back with the agreed interest that the lenders can foreclose on the borrower and take ownership of the property. This means that Trust Deeds have a unique security surrounding them. Many investments do not allow the investors any type of security blanket if things should go south. For example, if you purchase stocks in a company and the company goes bankrupt, you do not get to sell their property to make back any money.
Finally, working with a reputable Broker is one of the keys to a successful Trust Deed. A Broker will be able to make sure that all the necessary paperwork is in place for the loan, that the borrower is a credible one, and that investors understand the workings of each opportunity. CapSource has an excellent reputation for doing all of those things. If you are considering investing in a Trust Deed, or if you are just interested in learning more about them then we encourage you to reach out to us.