In an effort to increase interest returns, reports are that quite a few local residents are putting small (and large) amounts of their savings out on private loans. So-called street mortgages seem very appealing with interest rates as high as 9.5 percent. Is this a good idea?

Caution: These are composite cases. They are not intended to resemble any specific business, individual or anyone you may know personally.

Providing Financing

They had been trying to sell their small business for some time; they had put every bit of themselves into it over the years. Massaging their clients; promoting, constantly promoting their services; watching the cash flow; watching the discounts and inventory; saving every penny they could; doing their absolute best to be a stand out in a crowd of similar businesses.

They did it; they had pulled it off financially. Because of their devotion, they felt supported by the whole community. From a health perspective, it had taken its toll on both of them. Now he had some diabetes kicking up, and she had bit of high blood pressure.

They hated to let go, as it represented their entire retirement. They had found a buyer, like them in their customer comes first attitude. Just one small problem, the buyer didn't have anywhere near enough borrowing power, and had asked them to hold a mortgage of more than 60 percent of the sale price. He'd offered a good bit of interest, 8.5 percent, a lot more than they could get at the local savings bank. What a decision, it was so tempting, but should they become a lender?

Second mortgage

He is retired, aged 75. He has a gorgeous home, filled with lovely antiques, on a large lot, but little else, but a small pension from a local firm, and a government pension. Medical costs for him are getting to be more than he has left in cash each month, plus he is still paying off some of the debts from when she was ill.

He drifts back, thinking of a life constructed together. He and the wife socked away every cent to buy this place, renovated painstakingly over time. When times were tough, he'd go to the local hardware store and buy as many tiles, or paint, or concrete blocks as he could afford, finishing everything off bit by bit. It was hard work and great fun, just to see what they could do.

And now it was time to sell. He had few regrets. He found a smaller place and with the residual from the sale of the big house, enough to invest and give him a cushion for his remaining years, God willing. The new owner can't quite get all the financing together. He said: "Why should I give the bank all the interest when you can a decent return, too? He wants him to hold a second mortgage. He'll give him 9 percent simple interest. It sounds wonderful and it would bring in more than enough to take an occasional trip away to see the grandchildren. Should he do this, he's not sure that he feels comfortable with the whole concept?

Well, should they, engage in the business of street mortgages? Let's look at the pros and the cons of these very tempting arrangements.

PROS

A great return, better than local institutions can pay, they all think. You won't have to go through a lot of paperwork and in the case of the business, the money will come right out of future cash flows. Everyone wins.

CONS

Let's take the business first.

?Any lending institution is going to ask for some collateral (something they can sell to cover the amount they loaned out) if things go wrong, along with solid evidence of the ability to repay the debt. So should you, but what kind, and can you make it legally binding?

Buyer One could use the future business income as collateral, but what if he/she doesn't know what they are doing? And two years later the business fails? What can you attach to sell then?

?What if Buyer One passes away, will he/she have enough life insurance to cover this debt?

?What if the business simply fails (through no fault of the new owner) because customers no longer want that service? It happens.

?What if the buyers simply decide this business is not for them, and walk away? Again, what is left to collect on? The answer ? nothing.

?Even if the new owner allows you to keep the deed on their home as collateral, are you as an elderly retiree prepared to have them evicted so that you can realise your business proceeds?

Home sale:

Have you collateralized this loan by holding the deed? You may not be able to if a bank is in first position to be paid on default. You could lose big-time if the property is sold for the amount of the first mortgage.

Same issues as above, what if the buyer passes away? What if he/she divorces? What if they just stop paying? Are you prepared to use the full force of the legal system to take back your property?

I've seen several of these tough cases involving retired individuals. One elderly woman had to repossess the house, which had been completely trashed by the time the legal system returned it to her. After spending a small fortune in legal and renovation fees, she was finally able to resell the property at less than half of the original sales price because the bottom had fallen out of the housing market. $54,000 ? this was, she said to me, her only remaining asset. She was 76 years old and virtually penniless.

These types of street mortgages often appear on the surface to be perfectly acceptable, but are built on the future performance of an unknown quantity. And yes, I am sure you have friends who will boast of doing just fine. I have only one recommendation. Take the entire lump sum at the closing of the sale and do not look back.

A bird in the hand is worth more than Street Mortgages on the Street.

Martha Harris Myron CPA CFP? is a Senior Sales Manager at The Investment Centre, Bank of Bermuda where she provides investment advisory services and financial planning, particularly for clients contemplating lifestyle / career changes and retirement.

She can be reached at 299-5578. Send confidential email to marthamyronnorthrock.bm

The article expresses the opinion of the author alone. Under no circumstances is the content of this article to be taken as specific individual investment advice, nor as a recommendation to buy/ sell investment products or financial plans. The Editor of the Royal Gazette has final right of approval over headlines, content, and length/brevity of article.