Can Buying Mortgages
Bring Higher Returns?

Here's one way to gain income from real estate without actually owning the property itself: buying mortgages.

The way it works is an investor buys a mortgage, or "note," often from a seller of a property, at a discounted price and receives the monthly principal with interest until the mortgage is paid off. If an investor pays $25,000 for a $30,000 mortgage, for example, the borrower makes payments on a $30,000 mortgage, with the investor pocketing the difference.

Investing this way can get expensive, complex and risky. Among the bigger risks: The borrower defaults, meaning that the investor who bought the mortgage wouldn't get his money back and would have to foreclose on the property, an often costly and lengthy process.

But buying mortgages is attractive now for a number of reasons. Rising prices have caused some property buyers to supplement primary mortgages from traditional lenders, such as banks, with second mortgages, seller financing and other sources of financing to help pay for the property. In addition, interest rates are low, so other investments such as money-market funds, for instance, aren't offering rates of return as high.

These are usually private mortgages between individuals, not mortgages from traditional lenders, and tend to have higher interest rates. The rates tend to be higher because it's a loan the borrower couldn't get from a traditional lender, either because the amount was more than the traditional lender was willing to lend, or because of the borrower's credit record. The holder discounts the mortgages in order to get cash right away; also, without a discount, there would be no incentive for the investor.

Once an investor has agreed to purchase a mortgage, he or she sends the check to the title company. The money is held in escrow until the transaction is closed. The seller of the property (and mortgage) sends the original documentation of the transaction and the mortgage to the title company along with the signed assignment of the mortgage. The title company records the transaction, then the money is given to the seller and the documentation is given to the investor. The investor then officially owns the mortgage. (The investor can also just deal directly with the mortgage seller without using a title company.)

All this involves a fair amount of paperwork and expense. And that's before even factoring in how much investors have to come up with upfront. "The minimums involved are enormous," says Ben Utley, president of Utley Financial Planning Inc., Eugene, Ore. "The minimum you would need would be the same amount of money you would need to buy half of a [property] in one shot. One has to have enough [money] to be able to fund that whole [mortgage]."

What's more, he says, if the investor eventually wants to sell the mortgage, the potential sale profit is minimal. "If you find someone else to buy that note from you, usually they want a discount off the price," he says. Still, mortgages are less expensive than properties.

So how does one find a mortgage seller? Among other options, Lorelei Stevens, president of Wall Street Brokers Inc., a Seattle firm that buys private mortgages, recommends looking in classified ads for buyers of notes. Contact them, and ask if they also sell notes and know anybody who does.

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