How to Buy Mortgage Notes [Finding, Qualifying, Funding]

Buying Mortgage NotesAssuming you already know what mortgage notes are and why many real estate investors are now buying notes as an alternative to brick-and-mortar real estate, this post will show you just HOW to do it.

(Again, I caution you, if you are new to this, I would strongly suggest you broker a few real estate notes first so that you become familiar with the entire process by working directly with professional note buyers.)

The four steps to buying mortgage notes

In this order, here are the 4 steps leading up to note purchase:

Find them
Qualify them
Negotiate a purchase price
Fund them

Finding Real Estate Notes to Buy

First, you need to find them. You need to know what you’re looking for..
performing or non performing notes.

Non performing notes are problem mortgage loans secured by real estate whereby the payments are no longer being made due to financial hardship or otherwise on the part of the payor. These notes can be bought at extreme discounts. The investor buys these with either foreclosure or workout (getting the payor to start paying again by reducing his monthly payments to a level that he can afford*) in mind.

* Workouts are possible here because the investor bought the note at such a substantial discount that he can greatly reduce the payer’s monthly payments and still come out ahead.

With performing notes, on the other hand, the investor looks for “seasoning”–that is, a solid payment history which reduces the likelihood of default.

If you’re looking for non-performing mortgage loans to buy, don’t waste your time trying to contact banks directly unless you are a well-established, seasoned pro. Banks only deal in large blocks of assets and in many cases they sell off their bad mortgage loans to hedge funds and large private equity firms at substantial discounts rather than letting the underlying real property go to foreclosure.

So, if you are dead-bent on dealing in non-performing mortgage loans, get yourself established in dealing directly with either hedge fund managers or sourcing out private money.

Another route you can go is to network with private investors who are already well-connected with sellers of these distressed assets and buy them in pools with the intention of re-selling “one-off” notes to individual investors. If you are just starting out, you may do well to start networking with these note investors through online forums such as BiggerPockets. From there, you get on certain emailing lists where you can be notified whenever certain asset classes are offered.

Certainly, you’ll want to protect yourself by enlisting the services of an attorney who can review any potential agreements with you.

These types of connections can also serve as entrée to performing notes when they come up for sale.

You do your due diligence as you would any kind of note purchase; your yield will be less in these cases since the seller is making a small profit on the sale to you– but even so, these deals can still be profitable to you and tend to be much easier (and cheaper) to find as opposed to implementing a full-scale marketing program at first.

Buying Performing Real Estate Notes

In the case of performing notes, you can also find these through the individual investor/sellers that I referenced above who are already skilled at unearthing these assets directly from the note holders themselves.

But if you want to maximize your profits, you can do your own marketing in order to find these individual note holders who are or may want to sell their note(s) for cash.

If I’m looking for performing notes today and I have any kind of a marketing budget, I’m looking at purchased lists of seller-financed note holders which have already been compiled through the public records and pre-screened by experienced researchers .

(I used to do courthouse research myself, but this is a time-consuming and laborious process that is best left to experienced, efficient pros who do this every day for a living– I find that it’s well worth paying the 20-25 cents per lead or whatever the going rate is when you know you are getting a list of actual note holders who are, in fact, holding the types of seller-financed real estate notes you want to buy or broker).

You just craft your “I will buy your note for cash” marketing message and send it out to the list. From our experience, for every 1,000 note holders on the list, somewhere around 2% are seriously interested in selling their note(s) at any given time; this means 20 out of 1,000 and also those not yet motivated will become motivated the next month and so on and so on… 20 out of 1,000 potentially represents anywhere from $60,000- $100,000 in face profit, which can be well worth the $200 bucks or so (plus direct mail marketing costs which are proportionally very minimal).

Buying Notes Through Referral Sources

You can and should also make yourself known to professional referral sources. The big 3 are attorneys, accountants and financial planners. These are people who come into contact with note holders within their client base and they can refer such clients (who may have a need to liquidate assets for
cash) to you.

You market to these professionals a bit differently than you would individual note holders; you speak in terms of “I can help your clients who may be holding a note and are in need of immediate cash”.

The professionals who “get it” will end up referring business to you. If you have, say, just a dozen referral sources who (conservatively) refer you just one note each during the course of a year, that’s one note per month (anywhere from $2000- $10,000 profit if you end up brokering it) or anywhere from $24,000- $120,000 extra income during the course of a year.

Qualify the note purchase

Once you find potential notes to buy, you will need to qualify them. The initial questions you need to ask are:

1. Are you collecting payments on a private mortgage (note) now”

and

2. What are the monthly payments and how many are there?

If they refuse or cannot provide you with this information, then say “good
bye”– end of conversation. Do not waste your time with non-sellers.

One way or another, the info you are looking for at this stage will be:

Mortgage loan amount
Down payment amount
Terms
# Monthly payments remaining
# of Payments made
Current balance

Property info (SFR, Commercial, etc)

You are looking for LTV no more than 90% and ideally below 80% (although not all will fall into that category so there is some gray area here); I like to look for owner-occupied SFRs although I will also look at mortgage loans secured by commercial property or SFRs with tenants with a decent payment history.

Look at the terms of the note, the # of monthly payments already made and the # of payments remaining. The note holder will have already given you the amount of the outstanding balance of the note, but you’ll want to check all of these numbers yourself using a financial calculator and amortization tables.

Assuming all of these things coincide with the information you initially gathered, you then determine the yield that you want to come away with (See discounting a mortgage note). You then calculate the PV (present value) of the cash flow you will be making the offer on and then present your offer accordingly.

You want to request copies of the mortgage, note, and closing statement at this stage and then check your numbers against the actual documents.

Negotiate a purchase price for the note

Always make sure you make a written offer that spells out clearly the $ amount that the note holder will come away with and what they should do next if they would like to “go with this offer”. I ask why they need to get out of the transaction or what they need to get out of the transaction so that I can better tailor the offer and increase the likelihood of it being accepted.

You want them to sign a preliminary agreement which gives you (or your
assigns) the right to purchase the note if X, Y, etc check out “subject to our due diligence [within a certain period of time]”. Only when the preliminary agreement is signed will you then begin the due diligence process.

If there are no surprises*, your attorney or servicing company will draft the formal agreement along with the other closing documents

* If the payor’s credit turns out, upon investigation, to be less than initially stated or if there are issues with title or anything else regarding the mortgage loan or the underlying real estate (i,e. the appraisal comes back low), the potential transaction will not move past the preliminary agreement and the note purchase will either not take place or else a modified offer will then be made to which the seller must agree before proceeding.

Funding the note purchase

Once the due diligence process is complete, it is then time to close.
Oftentimes the closing can take place at the office of the title company. If you are having a servicing company handle all of this for you, then you need not be present at the closing yourself, nor does the seller. Checks are cut and sent (or wired or ACH’d) to the seller and a separate check is cut to the broker if there is one.

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