How to Invest in a Private First Deed

Private loans require careful due diligence.

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Private mortgages, sometimes also referred to as private first deeds of trust, are loans that investors make to home buyers who choose not to use banks. Private mortgages are frequently used by investors or by people that can't otherwise qualify for a bank loan. While private mortgages can be risky, they can also offer healthy rates of return.

Finding Deed Investments

The first step in investing in private first deeds of trust is to find one to invest in. You can do this by lending directly to a buyer or by purchasing a loan that someone else made and wants to sell. Private mortgages usually aren't listed in the newspaper like stocks and bonds, so you may have to do some digging to find options. Companies that arrange private loans maintain websites that you can find. You may also want to affiliate with the industry's trade group -- the American Association of Private Lenders.

Doing Due Diligence

Just because your loans might not go through the same process as a traditional lender doesn't mean that you don't want to carefully look at the person to whom you're lending money. You can set whatever conditions you want; however, you probably would like to get an appraisal of the property to see its value. You may also want to get a sense of the borrower's strength. In addition to looking at his income and credit, you can consider looking into his total net worth so that you can see how many assets he has to tap to pay your loan.

Down Payments

For many private first trust deed lenders, the down payment is their key form of protection. If you can, get 35 or (even better) 45 percent down on a property that is already selling at a discount price, the chance of you losing money is relatively slim. If the borrower pays you back, you make money. On the other hand, if you have to foreclose, there should be more than enough equity to pay off the loan and any foreclosure charges that accrue. Either way, you get your return.

What to Charge

Interest rates for private mortgages vary depending on the borrower, the market and the type of property. Generally, though, they're higher than the prevailing rate on traditional mortgages. For instance, while a bank might make a mortgage between 4 and 5 percent, as a private lender, you could charge three percentage points more. Private trust deeds also frequently have higher origination fees.

Making the Loan

Making a private loan is similar to when a traditional lender makes one. The buyer will sign a promissory note in which she promises to pay back the money you lent her. She will also sign a trust deed that gives you a security interest in the property. You can require title insurance and require that the owner names you as a beneficiary on her property insurance as well.

Make vs. Buy

One choice that you may have to make is whether to make a new loan or to buy an existing one. When you make a new loan, you have the benefit of being able to do your own analysis on the property and the borrower, but you're taking the risk that it won't work out the way you expect. With an existing loan that is performing well, you have some payment history to analyze, but you also run the risk of buying a loan that turns out to be a problem that the other investor is trying to dump.