Money Angles

By Andrew Tobias

A young investment banker I know went bankrupt not long ago. He had let his debts get the better of him and had gambled recklessly in the market. But he was of essentially good character and excellent financial prospects, so if only his creditors had borne with him until he got his bonus, everything would have been fine. "Sure, sure," said three of his creditors, who had heard it all before. They forced him into bankruptcy over $60,000. Six months later, he got a quarter of a million dollars bonus and paid off all his creditors except the three. When his rage at them subsides, he may pay them too. I hope so.

Now he wants to buy a $300,000 house in Connecticut with $100,000 down. Have you tried getting a mortgage after going bankrupt? Never mind the circumstances or the size of your down payment; almost no bank will touch it.

But that's where you or I might come in. You or I might look at this and say gee, bankruptcy or no, the $300,000 house supports a $200,000 first mortgage. You might not want to lend that kind of money -- if you have that kind of money -- at 11% for 30 years. But how about lending it at 14% for two years, backed by a first mortgage and the borrower's personal guarantee? With the borrower paying all closing costs? And perhaps with even a point or two thrown in for good measure?

If you have a spare $50,000 or $500,000, that's a mortgage you might want to make. It matches the yield on all but the junkiest junk bonds and, if you're careful, entails a lot less risk. Such deals are widely available. There are borrowers who can offer good security but, for whatever reason, can't get a conventional loan, or can't get it as fast as they need it.

To find them, start by contacting mortgage brokers in your area and letting them know you might be a source of funds. A second possibility: talk to local real estate agents and attorneys, who may frequently encounter buyers in ) search of mortgage money. A third: take an ad in the real estate section offering to buy existing mortgages, typically from home sellers who had to finance their buyers by taking back a mortgage.

It's crucial to be represented by a knowledgeable attorney and get ample security -- or at least an interest rate commensurate with the risk. If it's a second mortgage, the going rate can be 16% or more, but it's all the more important to ascertain the true market value of the property and obtain other collateral. You must be certain that there's title, fire and flood insurance on the property and that your mortgage is recorded properly. And you should never assume that a property appraised at $300,000 today will yield anything near $300,000 in the event of foreclosure. The appraisal might have been high, selling costs will typically eat up at least 6% or 7% of the proceeds, the property could have deteriorated in the meantime, and the bottom could have fallen out of real estate prices.

Still, for careful investors, here is a way to earn high interest on large chunks of cash, with some additional effort but little additional risk. Other points to note:

-- When the loan matures, you may have the opportunity to renew it on similarly favorable terms. The borrower has an incentive to stick with you: by doing so, even at an above-market rate, he saves what may be thousands of dollars in a new set of processing fees, points and closing costs.

-- The interest you earn is fully taxable.

-- If you'd rather not deal with the borrower directly, your lawyer can serve as your trustee, disbursing the loan and collecting the monthly payments.

-- If the borrower is a friend, he probably won't be one for long.

-- You must always be prepared for the possibility you might one day have to foreclose on the property. Considering all the costs -- financial and emotional -- is it something you could do?