As we’ve shown in previous Insight articles, property has an important role to play in your investment strategy. While no investment is risk-free, property investment is a lower risk investment than stocks and bonds, for example, which can be negatively affected by the market. What makes it inherently less risky, is that if you choose to invest in a physical property, its value rarely drops to zero, and you should typically be able to recover at least a portion of your investment.
Buying a physical property however — either to flip, or as a rental investment — does come with a fair amount of challenges, so you need to carefully consider whether or not you want to take them on. We created our Private Mortgage Lending investment opportunity to assist investors who prefer a more passive approach to investing in property, saving them the potential headaches of managing any physical assets.
What is Private Mortgage Lending?
Private Mortgage Lending is a passive, cash-flow generating business that can offer you a consistent, sustainable income stream. It occurs when a private individual, or organisation, lends money to a borrower most commonly so they can purchase and/or renovate a property to sell on (commonly referred to as property flipping). This lower-risk investment can help you to diversify your investment portfolio, and — in the case of our opportunity, where the returns are in US Dollars — it can also act as a hedge against the Rand.
To mitigate mortgage investment risk, the private investor determines what qualification and underwriting guidelines to impose on the borrower, and typically only lends money on first lien mortgages. A first lien mortgage is a legal agreement that conveys the conditional right of ownership of an asset or property by its owner (the mortgagor) to a lender (the mortgagee) as security for the loan. This means that should the borrower default on the loan – as long as you’ve lent on a first lien mortgage – you will be the first debtor settled through the sale of the property. Typically, a private money lender will also lend no more than 65% – 70% of the after repair appraised value of the property in order to further protect their investment.
If you are considering this type of investment, then it’s important to make sure you properly vet potential borrowers, performing a thorough due diligence before committing to the loan. You also need to keep up to date with lending laws in the country in which you’ll offer the mortgage loans. Experience plays a huge factor in the success of private mortgage lending investments. The more experience you have to draw on, the greater your opportunity to mitigate risk.
For these reasons it is highly recommended that investors who are interested in becoming private money lenders partner with a knowledgeable, experienced, and honest private broker/lender who has real estate experience, and a knowledge of the country in which they wish to invest.
If you’re considering investing in off-shore property, particularly within the mortgage finance space, then it’s critical to have an understanding of the potential appetite borrowers might have. One of the ways to assess whether there are opportunities is to gain a better understanding of the mortgage origination climate in the country in which you’re considering investing.
An overview of the mortgage loan origination market in the United States
The Urban Institute’s ‘Housing Finance at a Glance’ Monthly Chartbook May 2019,’ states that the U.S.’s total mortgage debt outstanding at year-end 2018 held steady at $10.9 trillion. Household equity ticked up from $16.2 trillion in Q3 2018 to 16.4 trillion in Q4 2018, which brought the total value of the housing market to $27.2 trillion at year end, 13 percent higher than the pre-crisis peak in 2006.
Agency Mortgage-backed Securities (AMBS) — securities issued by government-sponsored enterprises such as Ginnie Mae, Fannie Mae or Freddie Mac — accounted for 61.0 percent of the total mortgage debt outstanding; private label securities (PLS) — securitized mortgages that are not backed by the government as they do not conform to the criteria set by the Government Sponsored Enterprises Freddie Mac, Fannie Mae and Ginnie Mae — made up 4.3 percent; and un-securitized first liens made up 29.8 percent. The remaining 4.9 percent of the total comprised second liens.
By March 2019, debt in the PLS market totalled $409 billion and was split among prime (17.7 percent), Alt A (34.4 percent), and subprime (47.9 percent) loans. In April 2019, outstanding securities in the AMBS market totalled $6.7 trillion.
With regards origination volume and composition, the Chartbook revealed that in 2018, first lien originations totalled $1.63 trillion, down from $1.81 trillion in 2017, as higher interest rates curtailed refinance activity. The GSE share was flat, at just above 45 percent, while the Federal Housing Administration (FHA) / Veterans Affairs (VA) share was down slightly: 22.6 percent in 2018 versus 23 percent in 2017. PLS finished at just under 2 percent share in 2018, the highest since 2007, but a small fraction of its share in the pre-bubble years.
The Urban Institute’s Housing Credit Availability Index (HCAI) which assesses lenders’ tolerance for both borrower risk and product risk, shows that mortgage credit availability increased to 5.85 percent in Q4 2018, up from the previous quarter (5.75 percent) and slightly higher than the fourth quarter of 2017 (5.83 percent) a result of an increase in risk taken by the portfolio, and private label securities channels. Credit also expanded in both the GSE and government channels, but very marginally. The Institute believes that significant space remains to safely expand the credit box, stating that if the current default risk was doubled across all channels, risk would still be well within the pre-crisis standard of 12.5 percent from 2001 to 2003 for the whole mortgage market.
Delinquencies and loss mitigation activity continued to decline nationally in 2018. Loans that are 90 days delinquent or in foreclosure fell to 1.96 percent in the first quarter of 2019.
(Note: The HCAI measures the percentage of owner-occupied home purchase loans that are likely to default — that is, go unpaid for more than 90 days past their due date. A lower HCAI indicates that lenders are unwilling to tolerate defaults and are imposing tighter lending standards, making it harder to get a loan. A higher HCAI indicates that lenders are willing to tolerate defaults and are taking more risks, making it easier to get a loan.)
Access to credit still remains tight in the U.S., with the median FICO for current purchase loans sitting about 32 points higher than the pre-crises level of around 700. (A FICO score is a type of credit score created by the Fair Isaac Corporation. Lenders use borrowers’ FICO scores along with other details on borrowers’ credit reports to assess credit risk and determine whether to extend credit.) Borrowers will need a minimum of 643 points to qualify for a mortgage. Lenders require a median 40 percent debt-to-income (DTI) ratio in addition to higher FICO scores. A reflection of the increase in FHA and VA lending sees the median Loan-to-value (LTV) at origination of 95 percent, which is relatively high. The median LTV for nonbank and bank originations are comparable, while the median DTIs for nonbank loans are higher, indicating that nonbanks are more accommodating in this dimension as well as in the FICO dimension.
With the drop in interest rates over the past few months, Fannie Mae, Freddie Mac and the Mortgage Bankers Association (MBA) all estimate the 2019 mortgage origination volume to be slightly higher than the $1.64 trillion in 2018. This increased origination estimate follows drops in origination volumes, due to drops in refinancing activity, over the past few years: 2018 was down from $1.76 –$1.83 trillion in 2017, and 2017 was down from $1.89 2.05 trillion in 2016.
Credit has been tight for all borrowers especially in Metropolitan Statistical Areas (MSAs) with high housing prices. In the Atlanta MSA, where we focus our private mortgage lending opportunities, potential borrowers’ mean origination FICO scores are above 700, and mean origination LTVs are just above 90 percent. (See graph below)
When it comes to mortgage affordability, as of April 2019, with a 20 percent down payment, the share of median income needed for the monthly mortgage payment stood at 22.7 percent; with 3.5 down, it is 26.1 percent. In the Atlanta MSA, home buyers can expect to spend roughly 20 percent of their income on their mortgage payments.
Nationally, house prices are now 11.8 percent higher than the pre-crisis peak levels. At the Metropolitan Statistical Area (MSA) level, Black Knight’s HPI for Top MSAs reveals that ten of the top 15 MSAs have exceeded their pre-crisis peak HPI: New York, NY; Los Angeles, CA; Atlanta, GA (13 percent higher); Houston, TX; Dallas, TX; Minneapolis, MN; Seattle, WA; Denver, CO, San Diego, CA, and Anaheim, CA.
Is it the right time to become a private mortgage investor in Atlanta?
The short answer is yes. The Atlanta Metropolitan Statistical Area (MSA) is one of the fastest growing metros in the U.S. and has the 10th largest metro economy in the U.S. as measured by Gross Metro Product (GMP). As we discussed in our 2019 Insight focus on Atlanta, the MSA remains one of the healthier real estate markets in the United States. The metropole was ranked 11th in PwC’s 2019 ‘Emerging Trends in Real Estate® United States and Canada’ report due to its continuing ability to attract new residents; a labour force participation rate that is well above the comparable U.S. rate; projected 2019 employment growth rates that are expected to be well above the national growth rate; the need for more affordable housing to meet demand; and a the fact that it has a higher percentage of its population falling under the age of 44.
There is an ongoing imbalance between housing supply and demand in Atlanta. There is in a strong seller’s market for properties below $500,000. Inventory is low, and demand is high. That translates into opportunities to assist borrowers who are intent on purchasing, and rehabilitating properties in this price bracket before selling them on.
In order to secure good deals in this metropole, buyers are having to move quickly, which can prove challenging when a bank mortgage loan can take anywhere from one month to three months to secure. As private mortgage lenders can often approve a loan, and supply the funding faster than traditional banks, it’s proving an appealing option for borrowers, who are willing to pay higher interest rates to speed up the deal so they can buy the ideal property. They are also attracted by the potential to borrow larger amounts than they might get through traditional lenders. Stricter guidelines instituted since the 2008 recession has also seen a reduction in loans granted by traditional sources, and this vacuum is being filled by private money lenders.
When you take the property market, the business climate, the cost of living and the lifestyle into account, it’s clear that Atlanta is a strong market in which to invest. YDL has a number of investment opportunities ranging from active to passive income options.
To learn more about buying-to-let, or buying-to-renovate-and-sell or our private mortgage lending investment opportunities, visit our website at www.ydlpropertyinvestments.com or contact us today to arrange a one-on-one appointment.
Glossary / Definitions
A government-sponsored enterprise is a quasi-governmental entity established to enhance the flow of credit to specific sectors of the American economy. Created by acts of Congress, these privately held agencies that provide public financial services, were introduced to improve the flow of credit in the housing market, while also reducing the cost of that credit. GSEs help to facilitate borrowing for all sorts of individuals, from students to farmers to homeowners.
Federal Home Loan Mortgage Corporation (Freddie Mac)
Federal Home Loan Mortgage Corp (FHLMC) is a stockholder-owned, government-sponsored enterprise (GSE) chartered by Congress in 1970. The mortgage GSE was originally created to encourage homeownership among the middle class and rental housing for middle-income Americans. It purchases, guarantees and securitizes mortgages to form mortgage-backed securities.
Federal National Mortgage Association (Fannie Mae)
Established in 1938, Fannie Mae was established to stimulate the housing market by making more mortgages available to moderate- to low-income borrowers by creating a secondary market for the purchase and sale of mortgages. In 1968, Fannie Mae ceased to exist as a government entity and became a quasi-governmental, federally chartered corporation in order to buy mortgages other than those insured by the Federal Housing Administration (FHA).
Government National Mortgage Association (Ginnie Mae)
The Government National Mortgage Association (commonly referred to as Ginnie Mae and abbreviated to GNMA) is a U.S. government corporation that guarantees the timely payment of principal and interest on mortgage-backed securities (MBSs) issued by approved Ginnie Mae lenders. Its purpose is to encourage homeownership among the middle class and working class.
Federal Housing Administration (FHA)
The Federal Housing Administration (FHA) is a U.S. agency offering mortgage insurance to FHA-approved lenders that meet specific qualifications. Mortgage insurance protects lenders against losses from mortgage defaults. If a borrower defaults on a loan, the FHA pays the lender a specified claim amount.
An FHA loan is a mortgage issued by an FHA-approved lender, and insured by the Federal Housing Administration (FHA). Designed for low-to-moderate income borrowers, FHA loans require a lower minimum down payments and credit scores than many conventional loans.
A VA loan is a mortgage loan available through a program established by the United States Department of Veterans Affairs. VA loans assist service members, veterans and eligible surviving spouses to become homeowners. The VA sets the qualifying standards, dictates the terms of the mortgages offered and guarantees a portion of the loan. VA home loans are provided by private lenders, such as banks and mortgage companies.
The Fair Isaac Corporation (FICO) score is a credit score used by mortgage lenders to predict the borrower’s ability and willingness to pay debts.
Loan-to-Value (LTV) Ratio
Loan-to-value (LTV) ratio is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are higher risk and, therefore, if the mortgage is approved, the loan costs the borrower more, and may require the borrower to purchase mortgage insurance to offset the lender’s risk.
Debt-to-Income (DTI) Ratio
The debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments. It is a metric that lenders, including mortgage lenders, use to measure an individual’s ability to manage monthly payments and repay debts.
Purchase vs refinance loans
A purchase loan is the classic type of mortgage which describes the process by which a home buyer borrows money from a mortgage lender. A refinance loan is obtained by homeowners to replace their existing mortgage with a new loan, which usually reduces the monthly payments, the interest rate or changes it to a fixed rate mortgage.