All over the United States, millions of dollars are sitting, half forgotten, in desk drawers and safety deposit boxes. This money is in the form of mortgage notes (trust deeds) that owners took back in order to sell their properties. Buying these notes can translate into extremely high rates of return and cash flow to the investor knowledgeable in “paper.”
Show ‘em how
Now there are lots of former owners out there who would love to turn their notes into cash if only they knew how. Showing them how creates win/win opportunities for everyone.
The educated investor can buy these notes at less than face value, creating rates of return higher than the rate of the original instrument.
To smoke out these note holders, you can:
- Advertise for mortgage note holders in small local papers or online classifieds- the weeklies, shoppers’ guides, neighborhood papers- preferably not in the larger metropolitan publications where this game is played by the most sophisticated investors. You can also consult media directories.
- Make phone calls and send letters. Like every other idea, people can’t know what you’re doing unless you let them know. Put out feelers to everyone, including your barber and the mailman.
- Have little cards made that say, “Investor buys mortgage notes for cash” and put them up at supermarkets, laundromats, the local deli, wherever neighborhood people congregate.
- Go to the local courthouse, to whichever department records deeds and mortgages. These are matters of public record and will tell you who took mortgage notes back. when, on what terms, and the address of the note holder. Then, write or call the holder.
Note buying risk factors
Some of these probes will pan out and you will need to evaluate a potential deal. Since risk is frequently a big factor in obtaining the highest possible yield, you must decide how much risk you want to take. Consider these items:
- Normally it’s better to have a “seasoned” mortgage note, one on which payments have been made for some time. Payment history is important: Are payments current, are they usually on time, have there been any problems?
- It’s better to have a note on the mortgagor’s own residence than on a business or investment property because the last thing most people want to lose is the house they live in.
- What is the quality of the property itself’? Is it well maintained?
- Is there equity in the property securing the mortgage? Equity is your protection if you have to foreclose. As a rule of thumb, there should be 20 percent equity in the property; the more the better.
- What is the mortgagor’s credit history on loans other than his mortgage? This information will not always be available to you.
- Review the mortgage and note. Are they assumable? Is there a penalty for late payment? How long before the loan is considered in default?
- Run a current title search.
- If it’s available, review the original agreement of sale and the settlement sheet to make sure the transaction was as represented.
To keep the arithmetic simple, let’s assume that your gold mining technique has flushed out a guy with a brand new mortgage note he wants to convert to cash. The note is for $10,000 at 10 percent for ten years. The mortgage payment would be $132.15. The property and most of the other items on your checklist seem okay, and you have decided to make an offer that will give you a 20 percent rate of return on your cash outlay.
You offer to buy his $10,000 mortgage for $6,838.13 – the amount you have to discount the $I0,000 face value to generate a rate of return of 20 percent. Will every note holder accept your offer? Absolutely not. The person who will accept is the “don’t wanter”-a note holder who wants a lump sum in cash instead of $132.15 a month. If he doesn’t accept your initial offer, you can up the ante; after all, a 20 percent rate of return is pretty high.
Now you decide whether, based on the mortgage in question, you will accept a lesser rate of return. The rate of return on $8,191.08 will be 15 percent, for instance-not too shabby when the market is earning less than 8 percent.
Making you rich
Let’s get to the bottom line. Why do you want such a high rate of return? Because the impact of higher rates of return is what makes you rich. This is the compounding factor you first heard about back in grade school. Investing $1,000 per year for 25 years at a 10 percent rate of return will accrue to $98,347.06. The same $1,000 socked away at a 20 percent rate of return will add up to $471,981.08 over the same 25 years. Compounding, coupled with high rates of return, generates such large numbers that you can afford to be very selective about what notes you buy.
You will need a financial calculator to work out the numbers for yourself. Here are the elements:
N = 120, the number of payments on a ten year mortgage, paid monthly.
I = 10 percent interest rate
PV = $10,000, the present value of the note.
PMT = $132.15, the monthly payment resulting from the terms entered above.
Setting up your note buying program
When you have mastered the basics, you’re in a position to work some spectacular deals by restructuring the notes you’ve bought and/or bringing in investor partners seeking higher rates of return than traditional markets can offer. Obtaining higher rates of return accelerates the wealth-building process. Another benefit is “instant cash,” which can be obtained when you know how to play the paper game.
Dealing with these mortgage notes can obviously be very profitable. They are also much easier to deal with than real estate: Mortgages don’t call you up in the middle of the night because the toilet isn’t working. You might consider starting your own note buying program, salting a few of these deals away for your retirement, and restructuring others for current cash flow, while you buy real estate for tax benefits and appreciation. Your real estate will help shelter the high rates of return you earn on your mortgages.
A Last Word
The documentation and legal work on these mortgage note deals isn’t particularly complicated, but competent legal and accounting advice is essential before you set up your note buying program.
Figuring the Mortgage Payment
N = 120
PMT ? (You solve for payment after entering the other 3 variables and the result is $132.15)
PV = $10,000
Figuring a 20 percent rate of return:
N = 120
I/Y = 20
PMT = $132.15
PV ? (You solve for the new present value after entering the desired 20% interest rate and the result is $6,838.13)
Figuring an 15 percent rate of return:
N = 120
I/Y = 15
PMT = $132.15
PV ? (You solve for the new present value after entering the desired 15% interest rate and the result is $8,191.08)