The Paper Source Virtual Note Symposium October 2020

5 Critical Mortgage Investing Mistakes You Don’t Want To Make

Part I
As published in THE PAPER SOURCE JOURNAL, January, 2020
by Paul Wells

These five critical mistakes are certainly not the only mistakes made by investors in private
mortgages, but they are common mistakes that are repeated over and over until a hard lesson is
learned. Avoid these critical mistakes and you will be a much better investor. Learn from the
mistakes of others!

First Critical Mistake: The Investor Does Not Inspect The Property

Would you negotiate a price to buy a car or a house without
seeing it? If you commit your money to a mortgage without seeing the real estate it is just like
buying that real estate without seeing it. Why? Because if you have to foreclose on the property
that you did not physically inspect before you committed your money then it is just like
negotiating a price to buy the house without having seen it.

Let us imagine for a moment that you have to foreclose on a house you did not see with
your own eyes before closing the mortgage transaction. Sometime during the foreclosure process
you go to the property to see what soon will be yours. Surprise! Surprise! It is not what you
thought it was or what you were told it was. You were shown pictures of the house before, but
now it just does not seem like that house you saw in the pictures.
When you step onto the front porch your foot goes through it. As you walk through the
house you discover it is infested with termites and seems ready to collapse.

You begin to panic: “I made a HUGE mistake buying this
mortgage!” Then you remember that you only invested 40% of the appraised value of this
house. Now you begin to think, “if I have to bulldoze the house and just sell the land, I will
probably come out even, and everything will be OK.”

But then you take a closer look at the neighborhood. The house is across the street from
an abandoned gas station with EPA hazardous waste warning signs plastered all over it. The
house lot may very well be contaminated as well. Now you not only have a house that you
cannot sell, you also may have a property that will costs thousands of dollars to clean up. What a
nightmare! Do not think this has not happened.

How do you reduce this kind of risk as a private mortgage investor? It’s pretty obvious,
but often ignored: Simply inspect the property and the neighborhood before you commit your
money to the mortgage! Appraisals can reduce some of this risk, but there is no substitute for
you looking at the property.

Second Critical Mistake: The Investor Fails To Require Flood Insurance


How many private mortgage investors have had their money invested in mortgages in
coastal areas when powerful hurricanes destroyed them? How many made sure the properties
securing their mortgages had federal flood insurance? If the real estate wasn’t covered by federal
flood insurance you know they are crying the blues now. After devastating hurricanes, how
many of these mortgage investors wished they had checked to see if the mortgaged property had
flood insurance?

Homeowners insurance policies do not cover floods. The mortgagee (investor) needs to
be sure he is listed as a loss payee on the homeowners policy, but when it comes to a flood those
policies do not protect the homeowner or the mortgage holder. Private mortgage lenders and
investors often fail to check the flood zone of the property they are going to loan against or the
property securing the mortgage they are going to buy. There are a number of private companies
that can check for you, or you can have the surveyor put the flood zone information on the
survey. The appraisal also has a place to make note of the flood zone, but that is not as accurate
as a survey. Sometimes the property is at the edge of a flood zone and only a survey with an
elevation certificate can determine the property’s flood zone status. The elevation certificate
helps to measure the exact risk within a particular flood zone.

If the property is in a federal flood zone make sure the property owners (mortgagors) have
federal flood insurance in place. They can buy it through their insurance agent. This protects
the payor as well as the investor who owns the mortgage.

Third Critical Mistake: The Investor Buys A Mortgage That Is Not A First Mortgage

Successful private mortgage investing is dependent on a number of important factors. One
of the most important factors is the Loan-To-Value Ratio or LTV. The LTV formula is simply
the amount of the loan divided by the value of the real estate. A $100,000 first mortgage loan
against a $200,000 property is a 50% LTV ratio. A 50% LTV ratio is a typical private mortgage

If the homeowner owes $40,000 on a $200,000 house and he wants to borrow $60,000 as a
second mortgage interest-only loan from a private mortgage investor, what would be the LTV
ratio for that second mortgage? It would be the same thing as the above scenario a 50% LTV.
Yet, the risk for the second mortgage holder here is greater than the risk for the mortgage holder
who is owed $100,000 on a first mortgage against the $200,000 house.

The problems begin for the second mortgage holder when he finds out three years later
that the first mortgage is going into foreclosure. The first problem is that the borrower now owes
$71,000.00 on the first mortgage. He is over 30 months behind on the first mortgage, which is
also with a private investor who is charging 18%. The first mortgage holder did not foreclose
sooner because he felt well secured and tried to work with the borrower to resolve the financial
crises. The interest has been adding up fast.

Another problem for the second mortgage holder is the mortgagor (borrower) is counter-
suing the first mortgagee because the borrower thinks the original first mortgage was not
disclosed properly. Now things are dragging out for another two years. Now the first mortgage
balance owed is over $100,000 with back interest, late charges and attorney fees. The borrower
eventually loses the case, but the borrower decides to appeal. They lose the appeal, but now the
balance owed on the first mortgage is $115,000.00. Now your $60,000 second mortgage is an
87% LTV.

If the mortgage investor wants to protect his $60,000 interest in the property he will have
to pay off the $115,000. Need I say more?

Many more risks come with making a second mortgage. As a private mortgage investor
you should not be taking unnecessary risks. Pass on the deal that is a second mortgage position.
The best position a private mortgage investor can be in is a first mortgage. The very experienced
mortgage investors know this. Do not make the mistake others have made; always be in a first
mortgage position.

* Read your title commitment closely.

* Be sure that when you close, your position will be a first mortgage and that the title insurance
is for that purpose! Make sure all liens shown on the title commitment are required to be paid.
Make sure these liens are paid, either before closing (with releases in hand for recording), or
paid from the loan proceeds at the closing.

To be continued in the February issue of THE PAPER SOURCE JOURNAL. For more information:

Paul Wells is president of a Florida mortgage brokerage company and has been a private
mortgage investor for over 30 years

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