FAQ: What every note investor needs to know

Q – Hi Tim,

Can you tell me what successful investors are looking for when they evaluate a privately-held note for purchase? In other words, what are the criteria that make up a good note in today’s market?
Ken

A – Hi Ken-  I like to see AT LEAST a 10% CASH down payment and a 15 to 30-year amortization with at least three months payment history (the longer the better).

Now, while the above example constitutes what I would ideally LIKE to see, in practice, we don’t always see notes that have these terms. However, don’t be afraid to submit a note of lesser quality to an institutional buyer.

Thanks for a great question — hope this helps!

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Skin in the game?

QUESTION: I’m selling off some investment property, and I’m considering taking back a 1st position note from a potential buyer who also wants me to take back a second position note for the down payment at a higher interest rate. It’s tempting because of the potentially higher net return, if I did so, would this diminish the value of my note if I want to sell it down the line, and, if so, how badly?
 
ANSWER: This would absolutely diminish the cash value because an investor wants to see ‘skin in the game”. No cash down raises a red flag. The buyer has essentially nothing at stake except for his potentially having to give the property back through foreclosure if he defaults. There may be a buyer who  would go for that, but the discount you’d have to take would be considerably higher than it otherwise would if cash was put down at closing. Anything less than, say, 10% cash down (at a bare minimum) is just plain undoable for just about any investor you present this to. My general advice in cases like these would be to run the potential “deal” by some volume note investors and see what they say and/or if they quote and at what terms. Defer to their experience. If it isn’t good enough for them, it almost certainly shouldn’t be good enough for you unless you are a very seasoned note investor and are buying for your own account to keep for monthly income and have performed your own thorough due diligence. Move on to the next deal. The climate’s too fertile right now to be wasting your time on these.

We’ll show you how to get started brokering notes— and you’ll get paid for your qualified referrals!

It’s that simple. We’ll show you how to find notes and qualify them— then we take over from there, negotiate and fund them.
Then we pay you.
There is absolutely zero risk on your part– we put up all of the money!
If you want to get started today, click here to learn more.

 

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Selling notes to investors: potential pitfalls

I always recommend people start out brokering notes before even thinking about buying notes for themselves. However, you want to be careful about who you broker that note to. Institutional investors are best- they know how to mitigate potential losses, as they assume all of the risk themselves– they have strong knowledgeable management and hedge on their own against losses.

Private investors, on the other hand, Continue reading

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Buying notes for your own account- best practices

Profits from brokering notes can be substantial, but investing in notes for your own account should be the ultimate goal of any note broker. That’s where the big money is.

Far and away, the best way to learn about the process of investing in notes is by brokering notes to institutional investors and watch what they do. These are professional buyers who Continue reading

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Marketing is a Numbers Game– and the note business is no different

Finding note sellers is a numbers game— the more you reach, the more quote requests and closed transactions you’ll get. Therefore, the key is reaching as many bona fide note holders as possible with the right message.

Some combination of direct mail and internet (website, social media, email, etc) should be used to maximize your reach. Speaking of direct mail, it’s a highly targeted approach– you can Continue reading

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PUT THE OFFER IN WRITING AND SPELL OUT WHAT THEY CAN EXPECT TO HAPPEN

Far too many brokers are weak in presenting a purchase offer to a note holder. You want to make sure that you send a WRITTEN offer before you initiate conversation. It’s kind of amazing to me as far as the actual # of brokers who just call and give an offer verbally. This is incredibly minor league. The initial answer to a verbal offer is ALWAYS going to be “no”. Ever hear of the saying “The first one to mention a figure loses”? It’s true. Call it human nature or the way things are or whatever you want to, that’s just the way it is.

So, to paraphrase one of my old high school teachers, Jessie May, “Let’s not be stupid”. BE PROFESSIONAL. First of all, you need to be confident that you have a good, competitive quote in hand from a bona fide, reputable funder. The next thing you want to do is write the offer up, and give them at least a couple of options, i.e. full vs. partial purchase (the latter is a lot easier to make if the seller has given you an amount of cash he specifically needs to come away with).

Finally, you need to make the offer in a manner something like this:

- quote them the figure that you ‘will pay them for the entire note’, and add some more language such as ‘when you add up the $___ that you have already received plus the amount we will be paying you, I am sure you will find this to be a very generous offer’. (This is a pretty powerful little approach, as it prompts them to mentally tally up the figures for themselves rather than just reading a number off a piece of paper.)

- quote them the partial offer and tell them ‘I will pay you ____ for the first ___ # of payments, after which you will resume collection of payments after payment # X. Then say, ” when you add up [this and this plus the total amount you stand to collect], I am sure you will find this to be [a very generous offer as well].

And then, at the end, tell them what will happen next if they accept: “If you decide to go with this, I will need copies of [documents] and your OK on [the initial purchase agreement which gives them an opt out if you fail to perform, and most importantly gives you the option to purchase but also the option to opt out if there are surprises or something doesn't check out].

THEN and only then, AFTER you’ve sent them the written offer, it’s time to call them to talk and review the offer as well as answer any questions they may have.

You’ll find that you’ll get a lot more offers accepted this way. Be precise, be specific, be professional. And always remember: Even if the offer is not accepted this time, it may well be another month from now. BE SURE TO FOLLOW UP methodically because that’s where most of the acceptances come in (that is, “down the line” a little bit). When they accept a couple of months later, all things being equal, you simply reduce the original offer by the # of principal payments that have been received since then.

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Note holders are not directly marketed to by nearly as many brokers as you might imagine.

note-holder-direct-marketingAfter the initial rush of mail they typically receive when their newly-recorded note first appears in the public records, we’ve found (through years of interactions with note holders and also by virtue of our extensive experience in holding notes ourselves) that after the initial 1-2 months, broker mailings then drop off drastically– to an average of less than one postcard a month!

So, that’s good news for you if you know how to take advantage of this situation, with the level of competition out there being as lousy as it is (most brokers have unbelievably bad marketing plans).

Recognize that a big, big opportunity exists for you to swoop in and market to these note holders after the initial 1-2 months pass and the competition drops off. Just pick any list that doesn’t consist of brand new notes.

Furthermore, follow-up marketing to the same note holders again and again is especially important for cultivating new business because people become motivated at different times. They’re only going to respond to you when they become motivated, so one single mailing is too “hit or miss”… you may or may not be hitting them at the point in time when they’re ready to sell.

So, to increase your chances of doing so, repeat your marketing message to the same people 2-7 times.

(This is also important for building credibility and trust as well as a strong recognition factor. People will only do business with people whom they recognize and trust, so you want to establish yourself as their “go to” source for help in cashing out of their notes.)

That’s all part of the science of direct marketing. Drill your message into the prospect’s brain by following up, following up, following up to cultivate all of that business that’s literally right there for the taking at any given time!

Side note: Also keep in mind that marketing can be automated. There are mail fulfillment houses that can do mass mailings for you on the cheap.

Also, don’t forget–you need to say the right thing(s) in your message. It always pays (if you’re new and unsure of what works and what does not work) to use proven marketing material that’s properly worded so that you can be sure that your campaign is truly on track to yield maximum response.

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Examples of various ways you can sell a note

Listed below are some examples of the various ways you can sell a note generated from the sale of real estate. The payment streams can be secured by real estate contracts, mortgages or deeds of trust. They can be seasoned or “green”, and in some cases investors can purchase notes less than one year old.

Selling your note will generate a specific yield or return to an investor. Yield requirements are based on type of property, location, equity, position and time remaining to collect the payments. As in any investment, yields are risk-sensitive. (Risk factors from lowest to highest: Single Family Residence/4-plex, Mobile Home plus Land, Improved Land, Commercial, Unimproved Vacant Land.)

The time value of money is an integral part of the yield calculation that goes into making an offer to the note seller. Each payment has a specific value that diminishes rapidly the longer the investor needs to wait for it; in other words, the longer it takes to receive the payments, the less those payments are worth. Therefore, long-term contracts of 20 to 30 years must be severely discounted in order to produce a reasonable yield.

It is important to remember that an investor is buying only the payment stream, not the property. The property only secures the payment stream. Do not assume that, because a property has high equity, a strong buyer, or has been tremendously improved, it will result in more cash to the note seller (lower yield to the investor). It only ensures a more secure investment.

Selling a note, either seasoned or green, on a single family residence

$75,000 Sales price (free and clear property)

-25,000 Down payment by buyer

$50,000 Contract, 1st position, @10% int., 15 yrs, $537.30/mo, no calls

Cash value of contract: $39,348 (14.5% yield to investor)

Cash value if a five year call is added and the same amortization schedule is retained. The balloon due in five years would equal $40,658.

Cash value (with balloon): $42,614 (14.5% yield to investor)

Selling a note after closing, but seller splits the balance owed to him into two contracts because he doesn’t need all the cash or wants to avoid the bigger discount.

$75,000 Sale price (Free and clear property)

- 25,000 Down payment by buyer

$50,000 Balance: Split into two notes

Note 1) $25,000 1st pos, @10%, $268.65/mo, 15 yrs, 7 yr call

Cash value of note 1: $21,796.87 (12.5% yield to investor)

Note 2) $25,000 2nd pos, @8%, $238.91/mo, 15 yrs, no call

Seller keeps note 2 and collects payments monthly.

Total proceeds to seller:

$25,000 Down Payment from buyer

+21,796 Proceeds from sale of note 1

+25,000 Face amount of remaining contract

$71,796 proceeds plus interest on balance

Total income: $25,000 + $21,796 + (180 pmts x 238.91) = $89,799
Partial Purchase of a contract, seasoned or new.

Contract: $50,000, 1st pos, 10%, $537.30/mo, 15 yrs, 7 yr call of $35,409

Sale 1: Sell first 60 of the 84 payments due; remaining payments and balloon revert back to seller after 60 payments collected by investor.

$22,836 (14.5% yield to investor) Cash value for 60 payments

+40,658 Still owed to seller

$63,494 Proceeds plus interest on balance

Total income: $22,836 + (23 pmts x 537.30) + 35,409 = $70,603

Sale 2: Sell all the payments (84) plus a portion ($17,500) of the balloon due.

$34,634 Cash value of partial

+17,909 Paid at balloon due date

$52,543 Proceeds
Sale 3: Seller keeps payments but sells the future balloon payment for an immediate lump sum of cash.

$12,911 Cash value of balloon (14.5%)

+44,596 Proceeds of 83 payments ($537.30 x 83 pmts)

$57,507 Proceeds

Partial sale of a payment.

Sell a portion of the total monthly payment, such as in cases of divorce, family estates, cash flow needs, etc.

Contract: $50,000 1st position, 10%, $537.30/mo, 15 years, no balloons.

Sell $250.00 of each monthly payment for 15 years. Seller keeps $287.30 per month plus receives lump sum of cash up front.

$18,308 Cash value ($250/mo)

+51,714 Proceeds of 180 payments x $287.30

$70,022 Total proceeds

Financial Planning- Sell short-term contract(s) to apply to other long-term debt.

STEP ONE:

Proceeds from a home sale:

$80,000 Sale price ( Existing $40,000 1st mortgage on the property)

-20,000 Cash down payment

-40,000 1st mortgage assumed by buyer

$20,000 Contract, 2nd position, @9%, 10 years, $253.35/mo, no balloons. Total of pmts: 120 x $253.35 = $30,402

STEP TWO:

The seller now intends to make a NEW PURCHASE:

$100,000 Purchase price

- $20,000 Cash down payment, 80% LTV

=$80,000 Mortgage @10%, $702.06/mo, 30 years, no balloons. Total of pmts: 360 x $702.06 = $252,741

Sell Contract (Described in STEP ONE) for cash:

$16, 006 proceeds (14.5% yield to investor)

Add proceeds to down payment:

100,000 purchase price

- 36,006 NEW down payment, NOW 64% LTV

$63,994 Mortgage, @10%, $561.59/mo, 30 years, no balloons. Total of pmts: 360 x $561.59 = $202,172

(BETTER LOAN POSITION FOR LENDER, AND IMPROVED EQUITY POSITION FOR NOTE SELLER- OR HE CAN BUY A BIGGER, BETTER HOUSE)

Savings to note seller:

$252,741 Total of pmts on original new purchase

-202,172 Total of pmts on REVISED “new” purchase

= 50,569 Gross savings

- $30,402 Income lost due to sale of Contract

=$20,167 Total savings to note seller

Advantages of this transaction:

Saves note seller money

Lowers exposure to lender by improving LTV

Provides additional lender funds to loan to other customers

Removes note seller from the “lending” business and all associated problems (foreclosure, late payments, the need to re-assume first mortgage to protect interest, depreciation of property through neglect, market, etc., or estate problems resulting from a deat

Financial Planning example #2- An individual with existing mortgage and an owner carryback as an asset:

Existing home mortgage:

$30,000 balance, @9.5%, $398/mo, 115 pmts remaining (115 pmts x $398 = $45,770)

Owner carryback:

$10,000 balance, @10%, $200/mo, 65 pmts remaining (65 pmts x 200 = $13,000)

The individual in this example sells owner carryback for $8859 to yield investor 15%…

Then, applies proceeds to the existing mortgage as follows:

$30,000 mortgage

- $8859

$21,141 Is resulting new balance and reduces remaining term to 69 months

Savings:

Original balance:

$45,770 (115 x $398)

- 13,000 (65 x $200 Was being applied to mortgage payment)

=32,770 (Would have been the total paid)

New plan:

$27,462 New total paid (69 x $398)

Resulting new savings- $5,128

If you require guidance, or would like to direct questions, comments, inquiries, etc. to us, please contact us.

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Buying notes brings high returns

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:

  1. 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?
  2. 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.
  3. What is the quality of the property itself’? Is it well maintained?
  4. 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.
  5. What is the mortgagor’s credit history on loans other than his mortgage? This information will not always be available to you.
  6. Review the mortgage and note. Are they assumable? Is there a penalty for late payment? How long before the loan is considered in default?
  7. Run a current title search.
  8. If it’s available, review the original agreement of sale and the settlement sheet to make sure the transaction was as represented.

Simple Arithmetic

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

I/Y= 10

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)

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Direct Mail vs Internet as a means of marketing for notes

I’ve had a number of questions resulting from last week’s Tip re my comments on direct mail vs. the web as a means of reaching note holders. Did I mean to say that the internet is LESS important than direct mail? Absolutely not. A combination of both mediums is the most effective approach, depending on which market you’re going after. Why is this? Well, when you consider:

The note market is LARGE. The industry has expanded so much over just the last few years– in addition to private note holders who take back seller financing (best reached by direct mail if they’re not actively looking to sell at the moment– more on this below), we now have hedge funds who buy large portfolios of non-performing loans from banks and then resell them to other investors– sometimes after doing loan modifications to get them re-performing. Probably best directly identified and reached by way the internet (although you can also reach them through direct mail or indirectly through professional referral sources generated by direct mail).

Then there is a whole other market made up of the many private investors who create their own notes by taking back financing on their own properties and do this over and over every year. That’s a huge market unto itself. Again, most likely best identified and reached by way of the internet but you can also contact them through direct mail or referral sources.

And then there is the market which has traditionally been our “bread and butter’ long before these other markets became so large–  and that would be the private “Mom and Pop” note sellers who take back seller financing when selling their home to increase the pool of potential buyers who can’t all qualify for conventional loans because of the lending crunch that continues to this day.

And THESE are the people who are best reached AS A WHOLE by direct mail. Why? Well, when you think about it, these people aren’t always actively looking to sell their note. Sure, they probably have or have had an IDEA about selling it but they may have tabled the issue for a while or perhaps have just become accustomed to receiving the monthly payments and THIS is where a direct mail campaign is highly effective because they are NOT looking on the web for a note buyer at the moment.

Your mailing reaches them directly, and they hold it in their hand and it grabs their attention— and if they have a need for cash, they CANNOT ignore the message. And, what’s more, there are NO competing messages coming at them at the same time as yours.

(If you think about it and pay attention to the direct mail that you yourself receive on a daily basis, I’m sure you notice a lot of attractive four-color postcards from various venues or businesses or politicians. These advertisers know that the majority of these mailings will be discarded but the return on investment is still well worth it for the new business that results from the mailing. Believe it, they crunch the numbers had have the whole mailing thing down to a science. And, these companies WOULD NOT be spending on direct mail if it did not work so you can take your cue from what works in the real world).

Can you get the email addresses or phone numbers of private note holders? Well, I would ask you: where you are going to find them? Unless they come to your website and request a quote or get in touch with you directly and give them to you, there is no real means of obtaining them. And the public records where the notes and mortgages are recorded are not going to contain the email addresses or phone numbers either.

But, let’s carry this train of thought a bit further. Even if you did have the email address, your message may not even be read by the note holder or it may get dumped into another folder etc. It’s just too hit-or-miss whereas direct mail is a sure shot.

And, I don’t like the approach of cold-calling note holders on the phone, either– even if I had the phone number. It’s too time-consuming and my experience has been that the INTERESTED parties will respond to your mailing and call YOU.

If you think about it, no one’s going to call you unless they have a NEED, and these are the only calls I want to get. And, a need for CASH is a POWERFUL motivator. Need I say more?

So, just get your mailings out and then field the responses. You’ll be much more efficient that way and do a lot more business.

If you want to see the direct mail list that I use to find and market to note holders (which I’ve been using with outstanding results for years– it really zeroes in on my target market better than anything else), you can find it here.

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