While there is less risk in trust deed investments than in other types of investments such as stocks, bonds and other volatile securities, it still has its risks. However, being aware of some potential pitfalls can help investors avoid the possibility of losing money on a bad loan.
Insufficient Equity
Insufficient equity is probably one of the most common potential pitfalls of trust deed investing. This is the very thing that brought down traditional lenders, but trust deed investors have several factors in their favor:
• Regulatory agencies are not breathing down their necks to approve all the loans
• There are no corporate conglomerates telling the lender how to work through each loan request
• Trust deed investing is not under the same guidelines that govern traditional lenders
Trust deed investing can be very profitable when the investor makes sure he properly assesses the value of the property in order to be certain there is sufficient equity in the property to cover not only borrower default/foreclosure but also declining real estate prices.
Bankruptcy of the Borrower
Most borrowers do not enter into a trust deed transaction expecting to file bankruptcy, but sometimes these things happen. This is one of the reasons that interest rates are higher on these types of loans and the investors require borrowers to have a substantial amount of equity in the property: to protect their investment. Bankruptcy is always a fear in any loan situation, but in a trust deed investment the investor only stands to lose if he fails to efficiently protect his investment with enough equity or doesn’t research the deed for the existence of other liens or trust deeds that may reduce the amount of available equity.
Litigation and Other Legal Issues
There are any number of issue that might come into the picture here including mortgage fraud. One thing that might occur there is the borrower applied for loans from several different lenders at around the same time. Since only one lender can be senior, the others have to maintain a junior position, something that could create a problem for those investors in the event the borrower defaults.
An adjacent landowner might file a lawsuit against the borrower claiming the property is not up to code. This could cause the property to lose value thus increasing the LTV (Loan to Value) ratio. It’s a good idea to remain at about 60 percent for trust deed investments in order to allow for decreases in property value. You want to cover yourself if the borrower should default during a real estate downturn.
Fortunately these situations do not occur frequently enough to cause concern for those interested in trust deed investments. In most cases borrowers are honest and straightforward with private investors because they know they will be unable to obtain the funds the need from any of the traditional sources.
Research Is the Key Element
Trust deed investing is an extremely profitable venture but does require potential investors to conduct some research. When you conduct research before you enter into any trust deed transaction you can expect to receive a healthy rate of return (ROI) on your investment.