Private Mortgage Notes
I am frequently asked to instruct, lecture, or explain to people more about the weird & wonderful world of investing in debt. also known as “Note Investing”. And why it is one of my favorite investment vehicles.
Over the years, after doing many presentations & a lot of study, I found that when I addressed some common very questions & misconceptions students had about the note biz, it was extremely helpful in furthering their understanding.
To be fair, on the surface there isn’t really anything “weird” or unique to typical note investing. Investors lend money, in return they receive monthly payments or interest income. That was my understanding until 12 years ago when my obsession & “REAL” education in notes began.
Common misconceptions & questions:
1) Why would you want to buy a note, or lend money & just collect payments for the next umteen years? BORING BORING BORING, I would rather attend a FREE EVENING INTRODUCTION from Rich Guy Poor Guy Inc. with special guest Alonzo Montebigbucks, you know, the guy with a Ferrari, Bentley, and Gulfstream . He will teach me how to FLIP MY WAY TO RICHES (In my sleep, using only an iphone & craigslist). Oh yeah, and he offers a special intensive bootcamp with secret contracts & documents that have been guarded by a underground society of billionaires which will be “revealed” to me for a ONE TIME ONLY low price of.$$$hellip;……oh yes they are even going to allow me to finance my education!
RESPONSE: Yes, I agree flipping properties can be a very lucrative & exciting method of generating money. I have made excellent profits by flipping properties & I have some very good friends that cash some big fat checks by flipping. Flipping is a job, granted it can be a very high paying job, but you don’t get another paycheck until you find your next deal & sell it …rinse & repeat. Wouldn’t it be great if you had some income coming in between flips, that was steady like clockwork, month in & month out that you didn’t have to work that hard for? Would that take some pressure off you & bring you closer to getting out of the rat race?
Being a note investor doesn’t mean you are limited to 6% ,7%, or even 12% yield. There are many strategies where your returns can equal & surpass the returns of a house flipper.
Just because a $100,000 loan with an interest rate printed on the note says “6%” (for example) for the next 30 years doesn’t mean that has to be YOUR return on investment.
Savvy note experts know how to “CREATE” incredible yield by negotiating & tweaking the essential elements of all notes:
2) I want to buy a $100,000 note on this house because the house is easily worth $200,000, if they don’t pay I can get a $100,000 profit when I take it back.
RESPONSE: Cool your jets Turbo… Being a note holder doesn’t give you instant title or ownership. There a rules & regulations that have to be followed to enforce your rights as a lender to get the “right” to sell the property. As a lender you have the right to collect the remaining balance of the debt owed to you plus some allowable expenses. Your dream payday may not be what you expect.
3) It’s illegal to charge more than 10% interest in California, because that’s usury.
RESPONSE: Usury is an issue if I you are unlicensed & originating loans. However, if you are acquiring existing debt, your rate of return is based on your ability to negotiate & structure your deals.
4) It seems pretty easy to evaluate notes, if the borrower is paying on time & has good credit, that’s a good note right?
RESPONSE: I apologize in advance, but here is where I give the dreaded answer that I get when I ask an attorney a question… IT DEPENDS.
How note investors evaluate notes vary greatly across the board depending on their goals & strategies.
If your goal is to beat CD rates at your local bank where you get 1% annually if you are lucky. Then that’s easy to do with notes… too easy. In fact, I wonder why people ever sit down in the carpeted area of their local bank to become lucky owners of CD’s a.k.a. Certificates of Depreciation, instead of investing in a solid portfolio of secured notes.
However, if your goal is the seize & create opportunities by using more “advanced” skills, then pairing knowledge of real estate acquisition with a great depth of understanding of notes will put you at a much higher level of investment mastery. How you evaluate notes at this level is entirely different. There are many more avenues to profit. Creating those avenues requires a deeper level of evaluation.
The qualities of smart real estate investors can be applied to note investing.
1) Clear understanding of the current value of the collateral or property.
2) Clear understanding of the current income a property will generate.
3) Know how to add value by:
a) Stabilizing or increasing income
b) Reducing risk
c) Increasing the predictability of income
d) Improving liquidity or marketability of an asset
4) Evaluating Risk
5) Know the exit strategies & the potential gain or loss for each scenario.
Okay now here is the big secret: When I say I am note investor, that doesn’t tell the whole story. A more accurate definition is:
I am an INVESTOR, I find and create opportunities to acquire or control equity and/or cash flow at a discount. Most likely it involves real estate because I understand that asset class better than any other. It doesn’t matter if it’s a note, lien, property, option or a combination. These are just the tools used to capture equity or income.
The Essence of Note Investing is using debt to acquire or control income or equity at a discount.
Trust Deed Basics
Note investing is buying a contract that promises to pay you a stream of payments. To keep things simple, although there are hundreds of kinds of notes, we specifically specialize in notes secured by real estate.
The Trust Deed or Mortgage is the security instrument that gives the investor “collateral” .
We like secured notes because you have a degree of safety if you are smart. You have recourse to sell the collateral to protect your investment if the payments aren’t payed to you as agreed.
Below are some handy definitions used in the industry:
Performing notes: They are by definition a note where the borrower is making payments on the note as agreed.
Non-performing notes: These are notes where the borrower is not paying according to their agreement & in many cases are in default.
BPO: Brokers Price Opinion-an opinion of property value from a real estate broker. This differs from a full appraisal used by lending institutions.
FMV: Fair Market Value- an opinion of value if marketed properly to the general public
LTV or ITV%- Loan to value or Investment to value-typically expressed as a percentage. How much an investor would pay for a note as a percentage of the value of the asset.
UPB: Unpaid principal balance – the remaining balance due on the note that the borrower owes the lender
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Private Mortgage Note Investing