Mortgage funds are real estate investments reserved for hedge funds and other institutional investors, but private lenders are now incorporating more mortgage funds into their portfolios. When getting a mortgage, you might wonder where the money comes from and how lenders operate. Mortgage funds are a type of investment used by brokers and lenders to increase their revenues. Want to learn more about mortgage funds? You’ve come to the right place. Whether you’re a homebuyer or just wondering how mortgage funds work, we’ve got you covered.
What Is the Purpose of Mortgage Funds?
Mortgage funds, also known as mortgage pools, help mortgage lenders earn more money because they can make more money with a pool than they can through traditional loans. Mortgage brokers also make origination fees, but mortgage funds allow them to earn fees and arbitrage from buying and selling mortgage assets to generate a higher profit.
These funds are chosen, approved, and funded by fund managers without the need for approval from individual investors, giving managers the flexibility to fund more deals and increase production, which directly increases their income. Mortgage pools also benefit lenders by offering more protection against risk. Because a fund requires risk disclosures to investors, lenders are protected against risks associated with investments.
Investors may choose to invest in a mortgage fund instead of other investments because it allows them to generate a passive income through a variety of real estate assets without having to take out mortgages of their own or being too involved in funding the loans.
Investors have the option to invest in any type of real estate or make plans for a new real estate and construction project to diversify their investment portfolios and hedge against risk to receive better returns and protection from changes in the market. In addition, these lenders are protected from defaulted borrowers, lawsuits, and foreclosure risks because the capital itself isn’t affected, thanks to the pool of other real estate investments.
How Do Mortgage Funds Work?
Mortgage pools are typically Limited Liability Companies (LLCs) and sell membership interest to investors. Investors receive revenue from the returns of the fund from loan activities. The company itself is managed by another company that brokers mortgages to the fund and oversees the assets daily. In exchange for managing the company, they receive compensation from a variety of fees, including management fees, servicing fees, and origination fees. They may also generate income from interest.
Mortgage funds don’t typically register with the SEC, thanks to federal exceptions, but shares of the pool may require regulatory oversight.
Risks of Mortgage Funds
Investing in a mortgage fund is a great way to earn a passive income. However, running a mortgage fund is not passive because it has to scale and grow to support a lender’s business. Mortgage funds require employees, software, vendors, marketing, and all of the different tools, technologies, and departments any other business needs.
Additionally, while there’s less risk associated with a mortgage pool, funds may have liquidity or cash flow problems even though funds have protections in place to mitigate this risk. For example, accountants typically put safeguards in place to protect the fund or fund the wrong loans based on set guidelines.
How Do Mortgage Funds Benefit Borrowers?
Mortgage funds can help individuals move into a new home. So far, we’ve talked a lot about why investors choose to invest in mortgage funds, but we haven’t covered an important piece of the puzzle. Without borrowers taking out mortgage loans, there wouldn’t be any mortgage funds. Therefore, borrowers must get something out of the deal.
Many loan borrowers don’t qualify for traditional bank financing when they’re buying a house for a variety of reasons ranging from not having enough income to a high debt-to-income ratio. Mortgage funds have debt-servicing requirements that are more flexible for borrowers if they believe the debt can be paid off. However, if the debt isn’t paid off, the asset (the house) will cover the amount of the debt and accrued interests, so if there’s a foreclosure, there’s no loss for the investor.
Additionally, unlike banks, mortgage pools fund loans quickly to help them get more deals and help borrowers whose purchasing may have fallen through. Borrowers typically refinance with the banks at lower rates after a few years if they can get a better deal.
What Happens If a Borrower Defaults?
We’ve already discussed what may happen when a borrower defaults, but let’s cover this topic a little more in-depth because it can affect investor returns. Fund managers mitigate risk with a thorough vetting process of the borrower. However, defaults and foreclosures can still happen when a borrower can’t afford to pay back the loan. In these cases, the property is owned by the mortgage fund and can be sold to recuperate loan costs. If the house can be sold at its original value or higher, there’s virtually no risk for investors.
Are Mortgage Funds a Good Investment
Mortgage funds are a great way to earn passive income while diversifying your portfolio. They can provide strong and steady returns as long as they’re well managed. Of course, you don’t have to put all your trust in a fund manager, but it’s typically easy if you can find a manager you trust to make good decisions when you’re not around. Mortgage funds are just one small part of an investor’s larger portfolio, but they’re popular because they can add value, especially when mixed with other investments, including stocks.
Before jumping into a mortgage pool investment, you’ll need to consider the risk and how risk is being managed. You should also vet the fund manager to ensure they have a good track record managing mortgage funds.
If you decide you want to start investing in mortgage pools, it’s actually quite easy. However, you do need a large sum to begin investing. Some companies allow you to buy in with a minimum investment of $10,000 or higher. However, even if you can afford to do it, this type of investment is not right for everyone. It’s best to talk to a financial adviser to determine if you’re financially stable enough to invest in real estate.
Ashley Nielsen earned a B.S. degree in Business Administration Marketing at Point Loma Nazarene University. She is a freelance writer where she shares knowledge about general business, marketing, lifestyle, wellness or financial tips. During her free time she enjoys being outside, staying active, reading a book, or diving deep into her favorite music.