Introduction to Private Money Mortgage Pool–Mortgage Funds Explained
My name is Dennis Doss, General Manager at Doss Law. Our law firm was formed in 1983 and is located in the Irvine, Newport Beach area of California. We are very specialized and focused almost entirely on the representation of Mortgage lenders.
My video presentation is about mortgage pools and includes EIGHT (8) reasons why you, as a mortgage broker or private money lender should consider creating a mortgage pool to grow your business.
I will address the following EIGHT reasons in depth in the video:
- Diversification = Less Risk
- One Time Sale = Less Paperwork
- Fast Loan Funding = More Deals
- You Underwrite = Investor Not Second Guessing YOU on Every Deal
- Steady, Predictable Yield = Less Hand Holding of Investors
- Flexible Growth = Ability to Grow or Contract at the Pace You Choose
- Less Government Regulation = Easier To Raise Capital
- Ability To Do Larger Loans = More Income
CLICK to View Video Transcript
Hello, welcome to Doss Law. My name is Dennis Doss, I am General Manager at Doss Law. Before I begin my presentation today about mortgage pools, let me tell you about Doss Law Firm. Our law firm was formed in 1983 and has always been here in the Irvine, Newport Beach area. We’re located very close to the John Wayne airport. Our firm is very unique in that we are very specialized and focused almost entirely on the representation of Mortgage lenders. Those mortgage lenders can be very very small companies up to large public companies. For those mortgage lenders we provide a very wide variety of services including formation, licensing, compliance with consumer credit laws, loan documentation, commercial loan closings, employment matters. We also handle litigation and what we are here to talk about today which are mortgage pools and mortgage-backed securities.
Our firm is the largest creators of mortgage pools in the United States, at least that I am aware of. In 2005 we created approximately 47 new mortgage pools amounting to about five billion dollars worth of mortgage pool securities approved for sale. What makes us different is our innovation for one, and two, our efficiency. When you do a lot of mortgage pools, you learn the tricks of the trade, you understand the efficiencies, and the way we practice reflects that.
The way I broke up my presentation is basically pretend that you are asking me six questions.
The questions are: “Do I want a Mortgage Pool?” This is you talking to me. “Do my private investors want one?” “How do they work?” “Show me how the parts move.” “Can I do one in my state if I do want to do one?” “If I have one, what are going to be the challenges to running one on a day-to-day basis?” And if I am interested, “How do I go about getting started?
Let’s start with the first point. “Why do I want a mortgage pool?” Why would you, as an originator want one? And there are several reasons why I think you would want one. The first and foremost I hear this from clients time and time again, is the diversification that the mortgage pool provides. It is the first rule of investing. Don’t put your eggs in one basket. Diversify what you do. If your portfolio is diversified and your investors are investing in a small piece of a large group of mortgages, their risk is greatly diminished.
The best example of that is a case we had in our firm about two years ago. A mortgage broker had sold 29 mortgages to a private investor. They all performed admirably. Of course number 30 did not, and drew a claim. We succeeded in defeating the claim, but claims cost attorney’s fees. Had that same mortgage originator put all 30 of those loans in one mortgage pool, he would have been judged by the average of his performance, not by just the worst loan he did with that investor.
So that diversification is very, very important and very protective of you. In a mortgage pool you can have some defaults, you can have some non-performing loans, and they still produce cash flow. You don’t get back up phone calls from investor asking where monthly payments are.
The second real important point is that adds up to a one-time sale. The biggest frustration I get from clients who don’t have mortgage pools is the massive amount of paperwork they have to provide to their investors as part of their due diligence process. I’m not faulting them for that, but it is a very tedious process. With a mortgage pool, it is a one-time sale. The investor puts their money into the pool, that money rolls over and over again, and the investor is not involved in micro-managing each underwriting and loan decision.
The third major reason is fast loan funding. Fast loan funding equals more deals. If you’re known in your community as someone who has the financial strength to make loans and close them quickly, you’re going to be the go-to-guy or go-to-gal in your neighborhood. That’s very important, and makes you more efficient.
Fourth reason is you get to underwrite the deals. That doesn’t mean you have carte blanche to do anything you want. You’re offering documents that will describe point-by-point the rules that you must live by in making mortgages on behalf of the mortgage pool. But you don’t have to go out and meet with the investors, present the package, buy them lunch and go through this tedious, slow process and have them look at your deals and second-guess them.
The fifth reason is very, very important to your investors. Many of them are retirees; many are on fixed incomes. They don’t need a roller coaster in way of income with borrowers paying one month, and not paying another. A mortgage pool, because of the large number of mortgages that end up in one, produces a very steady, predictable yield to the investors. Every month when they go out to their mailbox, there is a check for a predictable amount of money. They don’t complain. They don’t congratulate you –frankly– either, and it makes you much more efficient.
The sixth reason is flexible gross. You may want to build an empire and grow very large mortgage fund, or, you may want to grow a small one, or actually downsize it at some point. A mortgage fund gives you that ability. They all start off with zero. And the sky is the limit. So they can go to a $100 million or even higher. We have several clients with well over a hundred million dollars of mortgage pools.
The seventh reason is less government regulation. Makes it easier to raise capital. A mortgage pool, most of them are formed, they exist, there’s no government regulation of how they’re created. You have to rely upon us, and we have to rely upon you to provide truthful information to your investors, and to follow the rules of the law in creating these mortgage pools. But there isn’t the constant eye of the government looking at your mortgage pools provided you’re running them correctly, and doing the things that the documents require.
Eighth and last, a mortgage pool gives you the ability to do larger loans, which means more income to you. Because you’ve got this collection of capital, and hopefully you’ve got investors wanting to come into your fund, at any given point in time, you can make larger loans, and earn larger commissions, and reach a wider marketplace from the small loan to the larger ones. So, that in a nutshell, are the reasons why I think you might want a mortgage pool.
When I connected with Dennis’ team about three years ago, I had fifteen investors and two million dollars in a small Reg D fund. And Dennis introduced me to, and later helped me create a mortgage pool using a California Securities permit. And, since then, we were able to grow to over four hundred investors with fifty million in equity. The mortgage pool that Dennis help me create is really terrific because I am no longer at the whim of Wall Street underwriting standards. I can create a great product for my borrower, and it is really a win, win product for us.
Additionally, from a company standpoint, it’s been very beneficial. It’s cut down on our paperwork, and it’s also improved, and/or cut down, on our investor communications. Whereas before, we would have to talk to each investor about each individual deal, now we simply talk to all the investors about the performance of the pool. So it’s much easier. Additionally. it’s easier to make the loans, so now we focus more on quality underwriting, as well as raising capital. One thing the fund will not do is hide your sins. You have to be more careful with a fund with your underwriting and you’ve got to be very careful to deliver good performance, because it’s now become our livelihood, and a mistake in the fund is going to get to all your investors all at once rather than a couple few that happen to have a bad loan. But, all in all, the benefits of the fund far outweigh any startup costs or any of the negatives that were involved with and I highly recommend it to anybody.
Now let’s focus on” “Why would your private investors want one?” And some of the reasons are very similar.
The first is diversification. We covered that already. That makes their capital safe.
The second is less paperwork. A lot of you mortgage brokers think that you are investors love your beautiful packages that cost you probably $25 or $30 a copy with all the pretty color binding and whatnot. Strangely enough, if you ask your investors whether they keep those or collect them, they will probably tell you they’d rather not have them. So, less paperwork makes you more efficient; makes life a little easier for them.
The third reason is their money is working 365 days a year. There’s no down time between loans. One of the most frustrating things that investors tell me about is the broker sent me back the proceeds of a loan that paid off and then I had to hound him over and over again: “When is he going to give me another deal; when can I have another deal?” If you look at their yield, fractionalized over the period of a year, it’s actually quite modest, compared to a mortgage pool, where their money is working 365 days a year.
The forth reason is related to safety of capital. We require that all of our funds be CPA audited every year; that our report is sent to the investors and they get the comfort of having another professional’s set of eyes look at those numbers and verify the reality of them.
Fifth is the flexibility your investors get by having the ability to have two accounts within the fund. One that produces a steady cash flow — and some number their household needs — and a second account for automatically reinvesting, or rolling the money back into the fund, without any delay in sending the money to them and getting it back.
Sixth. The fund does supply some liquidity. They are not ATM machines, but, because of the massive amounts of money coming in and going out of them, there usually is cash flow to pay someone out of the fun at some measured pace. That is something we go through in a lot more detail when we work on the architecture of your fund.
Last. Predictability of income is equal to peace of mind. The investors want to be able to know that when they opened that mailbox, that their check will be there ready to deposit in the bank and there will be no surprises.
So those are some of the reasons why I think your private investors would like a mortgage pool and, again, why you should consider one.
At the end of each meeting, Dennis would ask me: “When he’s going to allow me to create a pool?” After several years of procrastination, I had Dennis move forward. We don’t have to have the Department of Real Estate looming over us; my staff has a lot less paperwork; and my investors are a lot more secure because their risk is spread out over several different trust deeds. I would recommend the pool for other people.
Next, let’s go to the board and let me show you how mortgage pools work.
My clients like this. I’ve done this many. many times in my conference room. They like pictures. So, I’m going to draw you a picture. OK, let’s begin. First of all, a mortgage pool is a legal entity. It can be either a Limited Partnership or a Limited Liability Company. Typically it’s a Limited Liability Company. Let’s call ours Pacific Mortgage, LLC. The Limited Liability Company has two classes of membership. The normal “members” are your investors, and then the other member is “the manager.” We’ll call “YourCo.” Your function is to run the mortgage pool, take care of the investors and make the underwriting decisions. At the same time, your mortgage company is on its own, and acts as a traffic cop. Loan applications come in to your company and you act as the policeman to determine whether they go to the mortgage fund, whether they go to a private individual, or whether they go to an institutional source — we’ll call the bank.
You typically get compensated in two ways. The most important way are points and fees. And you’re getting those whether or not you are brokering the loan to the bank, to the private individual, or to the mortgage fund. These are typically paid directly out of your closings; they’re not income that runs through the mortgage fund itself.
Your second major source of income is servicing and management. This would include some spread — usually 1% to 3% — of the interest rate spread, and ancillary service fee income such as late charges, default interest, prepayment penalties, and the like.
You should budget if you are turning your money over every two years that you’ll probably make — and you’re not making high-cost mortgages — probably about three percent on the total assets managed. So, if that’s a hundred million, that would be three million dollars income to the manager on this side of the operation of loan origination. And then you should figure you’re probably going to make somewhere around three percent on the servicing and management aspect of your mortgage fund.
Like I indicated earlier, the members, or investors, have a choice of cash flow, or automatic reinvestment. This gives them options. Other features you’ll see in our mortgage funds, is what I call “parking lots”. This is either money in an account or subscription agreements for people who want to come into the fund to give you good liquidity.
Other features of the fund. This fund has the ability to leverage its mortgage assets. Typically, today, we can put you in contact with vendors that will take your dollar worth of mortgage loans and give you a five dollar line of credit secured by good quality mortgage loans. Other features of the mortgage fund, of course, is the annual audit. We talked about that earlier. Lastly, most mortgage funds have very little expense within the fund itself. The manager, because the manager is collecting the points and fees, and taking the servicing and management fees, bears nearly all the expenses of the fund with a few exceptions. One would be any type of Limited Liability tax, the cost of the annual audit, the cost of tax return preparation, or the tax return for this entity.
We also will encourage you to create a Loan Loss Reserve. This is kind of a shave off of the income otherwise payable to the investor to set aside for potential losses down the road. The objective of the mortgage fund and your objective in running one is to gain some momentum. That momentum will pick up after your annual audit. You now have the CPA-audited results which you can show to your potential investors. And from that point, it picks up steam.
What you are also trying to do, as you manage the first year of your mortgage fund, and even the second year, is gear it toward, what I call the “President’s Letter”. This is the letter that goes out with the CPA audit typically in February or March, well before the investor’s tax returns are due, and in it, you will describe what the fund has done during the prior calendar year. Its weighted loan-to-value ratios; its default rates; its rate of return; the number of people who requested money and got it out; the number of people that came into the fund; the average loan size; all these very interesting statistics that give your investors a lot of comfort. So that’s what you’re really trying to gear your mortgage fund to.
It is possible within the fund for investors to get some capital out. It’s usually done on a first, best efforts basis, it’s not the fire drill; we’re not going to shut the mortgage fund down in order to to take care of one investor, but it’s done in a measured pace as cash flow allows.
Now there’s a lot more moving parts and complexity, but this should give you, just a kind of a simple big picture of how it’s created. Relatively simple. The entity. Your company runs that entity; runs its mortgage company outside that entity. It, in essence, wears two hats. The members have this flexibility. You see where your compensation comes from: those sources. So that, in a very simple sense, is how a mortgage fund works.
We, at Reprop Financial, had been toying with a mortgage pool for a few years now. We had grown the business substantially, and had been fractionalizing our loans. We talked to a number of law firms, and we decided on Doss Law: not only because of the great law work that they do, but because they’re great communicators. When it came to explaining the pool to my associates, my firm, and others that I needed to do business with, they were able to do that seamlessly. In addition, we liked the idea that they had a fixed price for each of the services they offered us. So that I knew we could spend as much time as we needed working on the pool and other ancillary operations and still get the same good service. So, what’s interesting is, that Dennis also helped us move into a leveraged pool, and in doing that, we had to move a number of our investors back out of the pool. The interesting part of this story is that my office staff went back to fractionalizing some investors. That almost killed me. The point is, is that the mortgage pool is the way to go. It’s really well done at Doss Law. I highly recommend them.
All right, your next question has got to be:”Can I do one in my state?”
Mortgage Pools, and the Securities that are issued from them, are securities: much like stocks and bonds. You have both a Federal government, that has a concern with raising money from the investing public in the United States, and you’ve got states that that are interested and concerned about raising money from the residents of their state.
The rule that we use very frequently, is SEC Rule – Regulation D, Rule 506. This is a law that was passed by Congress that basically says: “If you follow the rules of this Regulation D, you have the opportunity to preempt, or displace state laws requiring you to register your securities.” There may be a notice filing in those states, but you don’t have to go to each state regulator to get their permission. This gives you the ability to raise money in all 50 states, which is very important to some of our clients.
The negative part of SEC Regulation D, Rule 506 is it is limited to “accredited investors”. These are individuals with an income of $200,000 or more; a net worth of one million dollars or more. But you are allowed 35 unaccredited investors. I call that the “family and friends exception”. It allows you to lend money in ALL 50 states. But don’t forget, you may need a lending license in those states. This does not displace lending license laws.
Another kind of a limitation on it is that you are not allowed to advertise. The statute actually says “general solicitation”. So you can’t do radio, TV, —those type of mass media. You can invite people who are accredited to presentations and make one-on-one phone calls and the like.
The other alternative is to actually go to your state regulator — and this is something that we do frequently in California — and get a permit, or approval, to actually issue your securities in that state. It may not be easy in your state, but here in California, given the volume that we do, it is pretty much a very predictable process of approval. In your state it may be a very tough road to hoe. It probably would give you the ability to advertise in the newspaper, radio, and TV — and that might be worth considering the hassle of actually going through the approval.
You may also face some restrictions on the duration of your offering. Reg D offerings do not have a duration; the state-approved offerings typically have a one or two year approval process after which you have to go back and get re-approved. On the other hand, you do pick up what I call “lower suitability standards”. You can come way down from the million dollar net worth individuals into people with a lower net worth.
We’ve been affiliated with Dennis Doss, and Doss Law, for approximately twenty years. Three years ago, we began looking at the possibility of obtaining a consumer finance lender license and a mutual fund permit which would then allow us to get into the mortgage pool or the mortgage fund concept. Today the fund is up and running, and we’ve been — it’s been met with great success and great reception by our private lenders. And we would wholeheartedly recommend anyone going into this facet of the mortgage business to look at Doss Law as the vehicle that will allow them to get their approvals. They were a delight to work with, and I would wholeheartedly recommend them to anyone.
Okay, the fifth question you have to be asking yourself is: “Dennis, what are the challenges to running a mortgage pool?”
There are some. First, I’ve listed here is accounting. The mortgage pools are pool basis taxpayers, which means you have to get in tune with the pool accounting. For example, our pools typically have just very few expenses. Most of everything is borne by the manager. But one of them is the annual CPA audit. That expense, let’s say is fifteen thousand dollars a year. On an accrual basis, you would take one twelfth of that fifteen thousand and charge it against income every month, even though you are not paying the CPA until the very end of the year. So getting used to that is a bit of a challenge for people who are not ‘used to’ it.
Fortunately, there are two software vendors that do provide pool accounting software that will generate your investor checks, do your internal accounting and things like that. So you’re not actually out there blind and without some help and guidance. Of course, we’re here to help you as well.
The second one is managing cash flows. Now imagine, there’s are a lot of moving parts here. You’ve got money coming in from investors, you’ve got money going out on new loans — your pipeline — you’ve got payments coming in from borrowers with interest, you’ve got payoffs coming in from borrowers. And, all of that has to be considered; spreadsheet’ed once a month, and you have to manage that.
You don’t want to have a lot of cash sitting around — that’s basically sitting there idle. You also want to have money ready to come into your fund for the larger loans, and for the immediate funding ability.
So…, if you’re good with managing cash flows, then you’re going to be fine with a mortgage pool.
The third challenge, as I’ve seen it, is investor education. Many of my clients, for years and years, have preached to their clients “the mortgage” or “deed of trust” and that gives your investors a measure of security. You have to reeducate your investors about the benefits and the safety they can get from a mortgage pool vs. having their name on a security instrument in the county Recorder’s office.
Most of my clients have met with very good response from their private investors, and they’ve been able to reeducate them.
Lastly, pension plan investment is somewhat limited in a mortgage pool to 20% of total pool assets. So, if all your clients are in mortgage pools, you may not be able to get them — all their money — into the mortgage pool, but a good percentage of it.
I highly recommend them. It’s a great way to use your business to do your business. The benefits to the fund is that you have a large diversification of a pool. Your investors aren’t tied to any one deed of trust. There’s also you have the ability to direct the dollars to where they go. It’s a great lending alternative, as opposed to fractionalized deed of trust lending. I started working with Dennis three or four years ago. It was very simple to get the fund structured. They did all the paperwork. You come to them with a general business idea of what you want to do and how you want to do it, and they’ll structure your fund that will meet your business practice. They do all the paperwork, they do other documentation, they do all the filings, they’re proficient in just about every state I’ve got Dennis working on: one or two different states for me now. The general benefits to a fund is, again, diversification that you wouldn’t get on a single loan. You have liquidity in a fund that you wouldn’t have in a single loan. You can use that fund as an asset. Take it to the bank and get a revolving line of credit, based on the fund which you can’t do with a single deed of trust. I’ve had great success with it. I highly recommend it. I highly recommend that you use Dennis when you’re exploring your new pool.
Six. If I’m interested in the mortgage pool Dennis, how do I get started? What we normally do, is don’t ask clients to commit to thousands of dollars in mortgage pool approval costs right off the bat. They actually normally hire us at our normal hourly rates to have a firm discussion about mortgage pool, make sure make it’s a good fit before they make the commitment to actually go forward with one.
All of our mortgage pools are done at fixed prices, so there’s no surprises. Those prices include the formation of the entities that you need, creating all the documents you need for your offering, the private placement memorandum, the offering circular, the subscription agreements. It includes the consulting. Most of our clients like that fixed price thing, because there are no surprises, and they can pay the costs of the pool, over usually three installments.
If after talking to us, you decide you do want to go forward with the mortgage pool, the most important thing I have to tell you today is that were here to help you through that process. We have a good staff of very seasoned lawyers and paralegals that will help you through each step of the process.
It begins with a kickoff meeting or telephone conference with me and one of the other senior lawyers. We then do a very thorough due diligence process on you; your company. All this is important for disclosure purposes.
We then craft this mortgage pool in a way that you will like it, that will fit you, and work for your business needs. We are also there to help you with vendors, and what are your choices in terms of loan servicing, mortgage pool servicing, loan documentation, and issues like that. We want to help you through the whole package and make it a very pleasant experience for you.
So, thank you for listening to my presentation today. I hope to hear from you soon. Here’s my contact information: Dennis H. Doss, Esq. | firstname.lastname@example.org | (949) 757-8201949.757.8201 – phone | 949.757.5741 – FAX | www.dosslaw.com
We’d love to work with you on this, or any other legal needs in the mortgage area. Thank you.
It’s really great to work with a specialist, because when you call them, they’ve already been through the problem you’re having many times before, and they have several different answers and can guide you down several possible solutions. You’re not going to have to wait for them to do research, they’re not going to have to talk with four different associates; you’re going to get an answer quickly, and you’re going to get the correct answer. There’s a lot of law firms that can create offering memorandums and mortgage pools, but there are very few that can do it as quickly and efficiently as Doss Law.
Throughout the years, Dennis has been very good at providing charts and check lists that have enabled us to get through the complex legislation that sometimes comes down in our industry. And because he represents a lot of real estate mortgage lenders, he’s been able to effectively, very cost effectively, give us helpful hints as to which way and what practices might be better for us. Additionally, we once had a problematic arbitration that he was able to solve very successfully in a short amount of time. That was a lot better for us than a protracted litigation in which nobody would have won in this particular instance.
I’ve used Dennis, not only for my pool investments, but for a number of different issues as well. He did my construction loan documents, he’s done my commercial loan documents. If I had a particular problem on a type of loan, before I wrote the loan, I would call Dennis and ask his advice or opinion as to how to do it or how to structure a particular loan. In every case, Dennis is extremely knowledgeable, extremely efficient, and can really dissect whatever problem you might have. I’ve also used Dennis for some minor litigation with the Department of Real Estate and in every area, Dennis has an expertise to this lending. He’s a very knowledgeable expert in the field of lending, whether its Truth in Lending laws, or RESA, or whatever problem you might have, I would highly recommend using Doss Law for any problems that you might have.
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