Structuring a note deal for success starts with three key pillars: cash flow, collateral, and terms. First, ensure the note generates consistent cash flow. Calculate the payment schedule—principal plus interest—based on the borrower’s ability to pay. A solid debt-service coverage ratio (DSCR) of at least 1.2 (income 20% above payment) keeps risk low.
Next, secure strong collateral. Real estate-backed notes are gold; verify the property’s value exceeds the loan amount by 25-30% (loan-to-value ratio of 70-75%). Clear title and a first-lien position protect your investment. Non-real estate notes? Over-collateralize with assets like equipment or receivables.
Finally, nail the terms. Set a realistic interest rate—6-10% is common, depending on risk—and a term that balances profitability with borrower affordability (e.g., 5-15 years). Include a late fee (5% of payment) and a default clause tied to clear triggers (90 days late). Balloon payments can juice returns but ensure the borrower has a refinance plan.
Pro tip: Always draft a promissory note and security agreement, then record them properly. This locks in your legal rights. Vet the borrower’s credit and cash flow history—don’t skip this. A deal’s only as good as the payer.
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