What is a trust deed, you ask? Well a regular deed is the document that transfers ownership of real estate. In contrast, trust deeds are private mortgage loans secured by real estate. So the property is held as collateral. Then basically you become a private lender when you choose to invest in trust deeds. In essence, you are the bank and are lending to a qualified borrower. Eventually, when the loan is paid off, the trust deed is satisfied and title is returned to the borrower. You make money off the interest charged on the loan or trust deed, but more about that later.

Therefore we are talking about the buying of land or property and allowing the lender to keep temporary ownership of the title to the real estate until the conditions of the mortgage or loan are met. It is an investment device employed by 'hard money' lenders who are actually mortgage brokers, helping people to buy real estate, who can't go to a traditional bank for 'soft money.? This could be for a variety of reasons including the fact they have poor credit, a new job, other loans, a bad debt or any other factor the bank deems problematic. So they use one of these other lending businesses, but they will only typically lend up to 65% of the appraised value, (LTV or loan to value) and for a short term, say 1 to 3 years.

Let me paint a simple scenario. Fred wants to buy a piece of property in his town. It is worth $100,000. He only has a few weeks to close the deal and needs the money quickly. The local bank told him it could take a month to close and also, because of a recent divorce, his credit is questionable. Therefore he goes to ABC Funding who is a hard-money lender. They tell him they will do a fast appraisal, and background check. They next day they explain they can offer him $60,000 LTV for 18 months at 12% financing, plus 4% of the loan amount for points and closing costs. They also want a personal letter of guarantee to further secure the loan. In other words, if he fails to pay, they can sue him personally. In addition there are large fees for late payments and if he misses even one payment, they have the right to foreclose on the property and sell it at auction. Wow.

So why would Fred agree to these tough terms? Because he only needs the loan for a year before he can remodel the strip mall shopping center and then begin to make good money on the rents. Even paying back the $60,000 plus $2400 in fees (4%) and another $7200 for interest (12%) for the year, he's way ahead once the mall pays rent. He knows no bank will touch him so he says yes right away. He signs the paperwork, a trust deed goes to the lender and Fred gets the funding. Now this is where the investing comes in. Where do you think that ABC Funding gets their money to lend to Fred? Well, it comes from private lenders.

That could be you, me, a local businessperson, or any other investor that wants to make 12%. That's correct; the lender gets the whole interest payment from Fred, every month. ABC made its profit from the points or fees that are part of the 4% charged up front. So the private investor, say Harry, gets to hold the trust deed in exchange for the $60,000 they gave to ABC, which was passed on to Fred. It's a pretty nice deal for everyone, right? But I see you shaking your head. What if Fred doesn't make the payment, what then? Fine, let's take a look at that possibility.

First, Fred gets a warning he's 10 days late. Then he gets another warning at the 30 day mark. He is told that, if he doesn't make the payment due within 24 hours, the property goes into foreclosure and will be sold at auction. In this worst-case situation and Fred fails to pay, the property is now owned by the lender. That would be Harry, the private investor, who is now holding the trust deed. Harry has a commercial broker sell the property at a substantial discount, say 20% for a quick sale. Even at that, because the loan was only for 60% of the appraised value, there is room to spare. The property goes for $80,000, less commissions and Harry gets $75,000. Yet he only lent $60,000 for a year and now receives a $15,000 profit or 25% return on his investment. That's even better than the 12% Harry was getting to begin with.

While no one wants this to happen and it usually doesn't, this explains what can happen in a bad case. In the worst case, the property never sells and Harry, the investor loses everything. That is almost impossible because of the greed factor. Someone will snatch up a property that is severely undervalued every time. Under normal circumstances, all the payments are made, the loan repaid and the trust deed returned to the borrower. Then Harry gets to loan out his money all over again. Do you think you understand all that now? If not, please reread the aforementioned. And yes, this is a simplified example, but the concept is solid regardless of the amounts and percentages involved.

Finally, you may be wondering, why am I telling you all this? And no, I?m not a hard-money lender. Instead, I?m doing this as a public service because I realize that 12% with almost no risk is a better return than the stock market, bonds, and money market accounts. Many annuities promise only 6%. But if you have $50,000, their normal minimum, or more, you may want to consider trust deed investing. Remember it's secured by the property and you get a monthly check. You can even use your IRA money from a self-directed LLC account. And yes, at that rate (12%), your money will double every six years. It sure beats worrying about the market from day to day like I used to do. I say that because I recently became a trust deed investor after losing tens of thousands in the market. Sound familiar? And that's why this is the last thing your stockbroker will ever discuss.

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