• Make loans on a peer-to-peer basis, one investor at a time.
• Fund based on a fractional participation plan, with several investors.
• Finance the transaction using a mortgage pool.
The first option requires a lender to issue a trust deed that secures the investor’s interest in the loan. If the lender chooses and money it takes to structure the pool. However, if structured correctly, the pool becomes a benefit to your business. If done improperly, the pool could become a liability, bringing with it litigation, mistrust and lost relationships.
ORGANIZING A POOL
To start, a broker must contend with lending regulations as well as the intricacies of securities law surrounding the pooling of loans. We have all seen what happens when a mortgage pool goes wrong. Poorly planned mortgage pooling practices nearly crashed the whole system at the start of the housing crisis. A competent and experienced attorney can play a significant role in helping a private lender establish the structure needed to build and manage a robust investment to fund the loan via a “fractional interest” structure, with several investors putting their money held in a trust account, or using a fund or “mortgage pool,” the lender acts as the trustee and the servicer, offering additional benefits. There may be misconceptions about brokers looking to move from making individual loans to creating a mortgage pool, including the amount of time.
When structuring private loans, private lenders have various options at their disposal. They can have a private money mortgage pool. There are other options out there, such as using a mortgage pool consultant or CPA, but they may be able to provide only one or two pieces of the puzzle. On the other hand, a law firm that understands the complexities of raising capital, works in close collaboration with investors, creates bulletproof contracts and deals with the daily realities that accompany mortgage pooling and servicing, is a strong option.
HOW A TYPICAL MORTGAGE POOL WORKS
A common mortgage pool is established through a contract, with a pool manager acting on behalf of the pool of investors. The manager collects and manages the mortgage payments for the pool. In return, the manager receives a management fee from the first funds received. The fund investors are then paid a preferred return based on the terms of the pool. The return to the fund members is wholly dependent on the amount of payments received from the mortgages, with their investment secured by a lien. If there are fees collected in excess of the preferred fund payment, the profits are typically split among the members and the pool manager. Another option is for a mortgage pool to obtain a line of credit from a bank secured by the mortgages in the pool. If the credit is cheaper than the preferred return, the pool can increase profits by increasing the credit volume, closing more loans, and allowing the members to share in more significant returns.
While a credit line may provide more liquidity, there is a risk associated with this practice: Banks can decide to close the credit facility and demand payment. If this occurs, the mortgage pool must cope with repaying the loan within a one year close-down period.
SENIOR DEBT CLASS PRIVATE MONEY MORTGAGE POOL
In another mortgage pool scenario, the pool is established as a senior debt class at a lower coupon rate, but offering more security for investors who rely on their monthly investment cash flow.
Senior debt is borrowed funds that must be repaid first, regardless of the financial well-being of the company. Senior debt offers a lower rate of return but provides a safer environment for investor funds, especially those who are seeking a low-risk opportunity. Unlike a traditional mortgage pool, a private money senior debt class pool is offered at a set interest rate for a specified term.
Principal and interest payments are made to the investors on a regular schedule, regardless of the payments received from the borrowers. The amount of interest paid to investors is typically less than that of traditional mortgage pools, allowing the pool manager to retain the difference. The debt is less risky for the investor but offers a smaller financial return to the lender. The senior debt contract may also limit the amount of subordinated debt the company can hold, further reducing the risk to the investor of the firm becoming insolvent.
SENIOR DEBT BENEFITS FOR INVESTORS AND LENDERS
Different investors have different appetites. There will always be accredited investors who are willing to take a risk in exchange for the highest reward. However, for risk-averse investors, even those who are accredited, monthly cash-flow and stability can be the prudent alternative, albeit with a lower return on investment. A senior debt class presents options for both types of investors. Investors who may be nervous about placing a large portion of their investment allocation into the mortgage pool basket may reconsider that strategy if they are secured by senior debt. Accredited investors who feel comfortable investing into traditional mortgage pools may at first balk at the lower returns, but they will benefit in the long-term in the likely event of a future economic downturn.
Lenders also benefit with a senior debt class mortgage pool by providing investors with a safe investment for their funds, allowing the possibility to accrue more investors from clients more concerned with stable income from their investments than a higher rate of return.
GETTING STARTED WITH SYNDICATED CAPITAL
Pooling together funds from a group of investors and creating an entity for offering private loans can be an extraordinary opportunity. You won’t have to write individual contracts, and you will be able to provide a more diverse group of products to your borrowers. However, it is important to note that your success is tied directly to the mortgage pool. This statement may sound like a cliché, but your mortgage pool is only as good as your pool manager. The manager must manage the pool in a way that ensures stability and liquidity maximize returns and minimize risk.
If you are considering starting a mortgage pool, it is prudent to begin with assistance from competent legal counsel. A law firm experienced with drafting loan documents, structuring funds and pools, and conducting due diligence is important to starting your pool on the right footing. With the right amount of support and adequate structuring, your investors will have the confidence to support your endeavor with their capital.