What Is A Mortgage Paper Security?
A mortgage paper security is an investment in part of a loan that is secured by real estate. Mortgage paper securities are often referred to as loan participations.
Companies that sell mortgage paper securities often offer to receive the monthly payments from borrowers and distribute these payments to the investors who purchased the loan for a servicing fee.
Can I Lose Money Investing In Mortgage Paper Securities?
Yes! Mortgage paper securities are not insured or guaranteed against loss. If the borrower on the loan does not make payments, you will not receive monthly payments. Foreclosure proceedings must be commenced in order to recover your investment in the loan when a borrower defaults. Your recovery will depend on the sale price of the property following foreclosure. The sale price may be less than the value of the property at the time of the loan due to depressed conditions. Further, your ultimate recovery may be less than the amount you invested due to a low sale price, property management and rehabilitation expenses, and foreclosure expenses.
Are There Other Expenses I Should Be Aware Of When Investing In Mortgage Paper Securities?
If the borrower does not make the payments on the loan, you may be required to submit additional money to the company that sold you the mortgage paper securities in order to preserve your investment. Additional funds may be necessary to commence foreclosure, pay outstanding real estate taxes, and rehabilitate the property following foreclosure so that it may be sold.
Can I Sell My Mortgage Paper Securities Before The Borrower Repays The Loan?
Companies that sell mortgage paper securities usually limit your ability to resell these securities. They often impose a complete restriction on reselling the securities for a period of time and require you to obtain their consent before you may resell them after that period has expired. In addition, there is no public trading market for most mortgage paper securities which makes it difficult to find a prospective buyer.
If you may need the money you have invested in mortgage paper securities before the loan is scheduled to mature and a period of time thereafter in the event of foreclosure, you should not invest in mortgage paper securities.
What Happens If The Borrower Does Not Make The Payments On The Loan?
If the borrower does not make the required payments on the loan, the investors will not receive monthly payments and must commence foreclosure proceedings to acquire ownership of the property that secures the loan. Companies that sell mortgage paper securities often handle the foreclosure proceedings on behalf of investors in accordance with the terms of the servicing agreement. The company may pay the costs of the foreclosure proceedings, including attorney fees, out of its own funds or it may require investors to pay the expenses of the proceedings along the way. Once foreclosure is completed, the investors become the joint owners of the property that secured the original loan.
What Happens Once Investors Acquire The Property Through Foreclosure?
The disposition of the property following foreclosure is governed by the agreement entered into by investors when they initially purchased mortgage paper securities (often referred to as a “participation investment agreement”).
Although the company that originally sold the mortgage paper securities will likely have a role in the management of the property, it is up to the investors to decide what to do with the property. Generally, the vote of investors owning a majority interest in the property controls how the property is handled.
Investors may vote to rehabilitate the property (which may require investors to invest more money into the property), lease the property, operate the property as a business (e.g. restaurants, retail stores, etc.) or sell the property, among other possibilities.
If the property is sold, investors will generally receive their proportional share of the proceeds based on their original investment in the loan that was secured by the property. The proceeds will vary based on the sales price of the property and the expenses of the sale. The proceeds will be further reduced by the amount owed for foreclosure expenses, property rehabilitation, management fees, and other expenses advanced by the company. As stated before, it is possible that investors will lose money in the event they are forced to foreclose.
How Can I Evaluate An Investment In Mortgage Paper Securities?
As with any investment, the amount of risk involved correlates with the level of return you can expect on your investment. In other words, the higher the degree of risk involved, the higher the rate of return. Mortgage paper securities often offer higher rates of return than those that are available on other types of investments due to the risks involved. To evaluate these risks you should at least consider:
- Who will service the loan? There are several companies that sell mortgage paper securities and service the loans. Consider the experience, financial condition, and prior loan performance of the company.
- Who is the borrower? Mortgage paper securities may involve borrowers with poor finances and credit histories. Take a close look at the specific offering circular to evaluate the amount and source of the borrower’s income in relation to debts, as well as the borrower’s property experience and credit history.
- What is the quality of the property securing the loan? Mortgage paper securities often involve properties that are difficult to sell, such as those in disrepair. Consider the tax assessed value of the property as well as the appraised value, the type of property involved, local real estate market conditions, and the time it would take to sell the property following foreclosure.
Where Can I Get More Information?
The Securities Division of the Department of Financial Institutions regulates the offer and sale of securities in the State of Washington. We license securities salespersons, broker-dealer firms that sell securities, and those who offer investment advice. We also keep records of companies that sell securities and review some of the securities they sell. You may contact us to request information concerning the registration history of an individual or company you are considering investing with, as well as to find out if any complaints have been filed against them or if the Securities Division has taken enforcement action against them. You may also file a complaint with our office.
Main phone line: (360) 902-8760
Toll free: (877) 746-4334
Fax: (360) 902-0524
TDD: (360) 664-8126
Department of Financial Institutions
P.O. Box 9033
Olympia, WA 98507-9033