Your Mortgage : Making Money on Other People’s Borrowings : Trust Deeds: Investments can pay high interest, but there is the risk that delinquency can result in foreclosure.

We usually write in this space each week about how to save money on your mortgage, but this week we’re going to suggest a way to make money on other people’s mortgages--by investing in trust deeds.

Profits from a trust deed investment can be hefty. “Right now, returns on TDs are running from 12.5% up to 21% a year,” said George F. Coats, a Covina-based investor and author of “Smart Trust Deed Investment in California.”

A trust deed is much like a mortgage. There’s the borrower, known as the “trustor,” and the lender, or “beneficiary.”

The trust deed shows that the borrower has pledged his house as security for the loan. If you invest in a trust deed, you’ll be the beneficiary and you’ll be the one who collects monthly checks.

Most small investors put their money in second trust deeds.

The first trust deed or mortgage on the property is typically held by a bank or savings and loan association.

While investing in trust deeds can yield hefty profits, it’s not without risks.

Perhaps the greatest danger is that the borrower may default, in which case you’ll probably have to initiate foreclosure proceedings.

If the property is sold through foreclosure, the holder of the first trust deed will get its money back, and whatever is left will be used to pay you back.

However, if the foreclosure sale doesn’t generate enough money to pay off both loans, you’ll be the one who loses out because you won’t get all your money back.

There are different types of trust-deed investments. If you invest in a “purchase-money” trust deed, the borrower will use the cash to actually buy a home or other real estate.

Conversely, a “hard-money” trust deed is usually secured by real estate that the borrower already owns.

You can even buy older TDs, which are commonly called “discount” trust deeds. They’re typically sold by other trust deed investors who want to raise cash, so they’re willing to accept less than the face value of their TD in order to cash out.

If you’re willing to accept the risks involved in investing in TDs but have never done it before, Coats suggests enlisting the help of a mortgage loan broker. These professionals make a living by linking up borrowers with lenders.

If your local realtor can’t recommend a good mortgage broker, you might ask your accountant, financial planner or attorney if they know one. You’ll find several mortgage brokers by looking under the “loans” heading of your local Yellow Pages.

Using a mortgage broker to invest in trust deeds provides several benefits. A good broker typically handles all the paper work involved in setting up the loan, pre-screens potential borrowers and will even offer advice if the borrower defaults.

Depending on the size of the loan and a variety of other factors, the broker will usually charge the borrower a commission ranging from about 3% to as much as 18% of the total loan amount, Coats said.

Although you probably won’t have to pay anything for the broker’s services, Coats points out that the fees paid by the borrower will impact the interest rate he can pay on the loan. “So in a way, you’re actually sharing the expenses,” he said.

Some financial experts say that the hassle of finding good borrowers and the possibility of eventually having to initiate foreclosure proceedings make trust deeds a bad investment, even though the TD might generate a better return than you could get by putting your money in some other type of investment vehicle.

“If the borrower quits making his payments, you won’t be getting the monthly income that you expected to receive and you’ll probably have to spend lots of time and money to foreclose,” said Thomas Gau, a partner in the Torrance-based tax and financial planning firm Kavesh & Gau Inc.

Coats said you can cut some of the risk involved in investing in trust deeds by sticking to TDs with relatively low loan-to-value ratios.

A trust deed’s LTV represents the relationship between the amount of your loan plus all senior loans--loans that will take priority over your TD if the borrower eventually defaults--and the total value of the property.

For example, say Buyer Baker is purchasing a home for $200,000. He’s making a down payment of $30,000, getting a $150,000 first mortgage loan from a bank, and wants to finance the remaining $20,000 with a second trust deed.

To calculate the LTV, add $20,000 (the size of the second TD) to $150,000 (the first mortgage) and divide by $200,000 (the property’s value). The result is .85, meaning that the LTV is 85%.

“The lower the LTV, the lower the risk,” said investor Coats.

Your mortgage broker can explain more about loan-to-value ratios and can help you find a trust deed with an LTV low enough to make you feel at ease with your investment.

To play it safe, Coats said, conservative investors generally shouldn’t accept a TD with an LTV higher than 70% on owner-occupied single-family homes or small rental properties; 65% on rental projects with more than four units; 80% on buildable lots in fast-growing areas and 50% on raw land.

If you want to know more about trust deed investments, the California Department of Real Estate can help.

The agency recently published a 26-page pamphlet that explains the purpose of various documents involved in trust deed investments, defines basic terms, explains how to gauge the credit-worthiness of a borrower and professionalism of a mortgage broker.

The pamphlet, “Trust Deed Investments: What You Should Know” can be obtained by sending a check for $2 plus tax to California Department of Real Estate/Publications Orders, P.O. Box 187006, Sacramento, Calif. 95818-7006.

Coats’ book can be ordered by sending a check for $24.75, including tax and shipping, to Barr-Randol Publishing Co., 136A N. Grand Ave., West Covina, Calif. 91791.