What Can Notes Do For You?
By Joy Oliver
© 2016 Joy Oliver
All Rights Reserved
Hi, I’m Joy Oliver and I buy notes for Prominent Capital LLC. Sometimes, when people outside real estate ask what I do, I hear questions like: “You buy notes?” “Is that a music thing?” “What do you mean, you buy notes?”
I wrote this e-book to provide a brief, bird’s eye view of what notes are, how they can benefit investors, where to find them and how to avoid the major pitfalls that cause investors to lose money. This book is written for those people with no expertise in the note industry, but are interested in learning about little-known alternatives to traditional investing. So, turn the page and discover what notes can do for you.
What are Notes?
Anytime a person goes to a bank or any other lender for a loan, he or she has to formally promise to pay it back. A note is an asset that spells out the terms of repayment and there is also paperwork that explains what happens if the borrower stops paying as agreed.
Types of Notes
There are two types of notes: secured and unsecured. An unsecured note is more risky to the lender than an unsecured one. Why? A secured note has some property (collateral) that the lender can foreclose on and sell if the borrower stops paying.
Collateral can be anything, such as a car, boat or house. Banks are very picky who they lend to, so they give lower interest rates to people with better credit histories.
Those with the worst credit histories tend not to be able to get bank financing and look to alternative lenders like pawn shops, payday and title loan companies for financing. The latter two are notorious for their extremely high interest rates and fees, but the higher the credit risk, the higher the interest rate lenders will charge to protect their investment in a borrower.
Real Estate Notes
At Prominent Capital LLC, we invest in real estate notes, which are secured loans. Notes can be performing or nonperforming. Performing notes are being paid on a regular basis and a non-performing notes have borrowers that have stopped paying. Both types are great investments if you have the knowledge needed to properly manage them.
So, what can notes do for you?
Provide Passive Income
The best thing about performing notes is the passive income they provide, but unlike rental real estate, you don’t own the property: your borrower does! When their plumbing bursts or the roof needs to be replaced, they don’t call you! Performing Notes are also great for self-directed retirement accounts because they are a hands-off investment and you avoid the unrelated business income tax (UBIT) that can cause your IRA to pay taxes before retirement.
UBIT can be an issue with rental real estate held in an IRA but with notes, every aspect of the management process is outsourced to a professional company (a note servicer) who sends deposits directly to your account. Below is a link for more information about UBIT.
Better Rates than CD’s
If you had to choose between putting your money into a 5 year CD earning 2% interest, and getting monthly payments on a note written at a 6% interest rate, which would you choose? Current rates for CD’s can be found at bankrate.com; as of this writing, they’re only about 2%. But if you look at mortgage interest rates, they give customers with the best credit about a 2.5 to 3% interest rate (a little higher than 2%, but not by much).
What about those with credit that’s not quite perfect? They pay a little more, but they still pay every month for the most part. What if you were to buy an owner financed note? Borrowers for these types of notes can’t get bank financing because they may be self-employed. However, they are more than capable of paying on time and maintaining the property; they just don’t have the credit history banks prefer. However, their interest rates are going to be much higher than 2%.
People default on their loans every day. In fact there are hundreds of houses from the 2008 debacle that still haven’t been foreclosed on and the borrower hasn’t paid a dime in years. So, what do you do in case of default on a real estate note? You foreclose! Well, that isn’t your only option. Note investors can be a little more creative than the bank. You can hire a company, like a note servicing company to negotiate a workout plan to keep the borrower in the house and paying. If staying in the home isn’t an affordable option for the borrower, you can have them give you back the house in exchange for moving and leaving the house in good condition. You can rent out the property or sell it to someone else for cash or owner finance them. It’s just a matter of properly adhering to the local laws for that particular property and hiring the right professionals to help you.
The key is being flexible. You as an investor are not restricted to the bureaucratic red-tape of a bank. Inflexible rules and regulations do nothing but slow everything down and confuse already stressed-out homeowners. You, with the help of a professional company can quickly negotiate a re-payment plan that provides a win-win for both you and the borrower.
Finding the Right Notes to Buy
If you’re interested in finding notes to buy, you need to know what to look for. First, you want to make sure you find a legitimate note seller. This can be a hedge fund, community banks or credit unions, note servicing companies that have platforms to buy and sell notes, or even an individual or company that has owner financed a property.
Next, you want to make sure that the note is legally enforceable with the correct documentation and disclosures. Find out if the borrowers are really paying. If the note is nonperforming, you want to make sure the property hasn’t been lost to non-payment of taxes.
What lien position is the note? First liens must be paid before subsequent liens when a property is sold; tax liens will always come first if the owner has not paid taxes within a specific time frame. Both first and second lien notes do provide passive income, but there are going to be different strategies involved to ensure you get the returns you’re looking for.
You also want to know what security agreement is being used. Is it a deed of trust, mortgage or is there a contract for deed? Knowing the type of security agreement helps you determine your exit strategy if you have to foreclose.
In non-judicial foreclosure states, you will see a deed of trust securing a note; this means the deed is held by a trustee until the note has been paid in full. Should the homeowner default, the lender can get the deed from a trustee. In judicial foreclosure states, the homeowner holds the deed while paying the note and the lender must go to a judge to get the deed and sell the property. This takes significantly more time depending on the state. Many who seller-finance in these states will use a contract for deed; the seller keeps the deed until the note is paid in full. See foreclosurelaw.org for information about each state’s foreclosure process.
Avoid Major Pitfalls
Before you pull the trigger and buy, you want to be prepared and ready to handle some obstacles that could trip you up.
Do you have an exit strategy?
If you buy a note without thinking about what you’re going to do with it in the future, someone else may decide for you. You may end up selling your note for significantly less than you want because you didn’t prepare for the possibility that the loan might stop paying when you need the funds for an upcoming expense.
Why are you buying a note? Do you want passive income? Look at performing notes.
Do you want to buy a discounted property? Non-performing notes may be for you.
Each note is different. Even if the same private lender made two identical notes selling identical houses to borrowers with the same income, each note will perform differently because you have different people in each house. You have to be flexible to deal with the possibility that one might get behind every month while the other pays like clockwork.
Be ready when you’re ready
If you want to buy notes, do not start the buying process until you’re ready to send the funds.
If you tell the note seller you want to buy a note but don’t have the funds ready, you will have ruined your chances of buying anything from that seller in the future. You will have time for due diligence, but if you’re short on funds, do not commit to buy. Do not waste the note seller’s time and yours.
Zip your Lip
Most institutions and private sellers have prospective note buyers sign a non-disclosure agreement (NDA) before they let them look at their notes. Why? There is personal information about the borrower (address, personal data, etc.) and the note seller doesn’t want just anyone looking at it. They want to keep their borrower’s information protected, so they do just that. If you want to be able to buy notes and not get sued, zip your lip. Do not broadcast information about a note you don’t own.
If you do own the note, keep the borrower’s information private; make sure you do your research on who wants to buy notes from you and have them sign a non-disclosure agreement as well.
Research BEFORE you Buy
If you don’t know the basic information about the note before you pull the trigger, how will you properly execute your exit strategy? If you just buy a note because the basic information looks good but don’t dig further, you are asking for trouble. Below is a list of some of the things you should check for during your due diligence process.
You need to find out if:
It is a non-performing or performing note
What lien position it is (1st, 2nd)
What type of security agreement is in place (deed of trust or mortgage)?
If there is a title policy in place
If the borrower is paying hazard insurance
Condition of the property
Information about the location (city, state, etc.)
The status of the taxes (current? Delinquent?)
There is a professional servicing company managing the note
And, most importantly, is the borrower going to continue paying the note.
What if you buy what you thought was a performing note but the seller neglected to mention that the last 3 payment’s came back as non-sufficient funds and the borrower is filing for bankruptcy? Or, the note is not a first position note, but a second and they owe more than the house is worth? Second position notes, while providing passive income, require an entirely different strategy to properly manage.
Whenever you buy a note, you essentially do preliminary due diligence, make an offer to buy from the seller and perform more thorough research before you close. Take the time to make a list of everything you should check for and go through that list. Never skip a step or you will pay dearly for it later.
So are you ready to buy a note?
A few books and articles on the internet are not going to give you every piece of information you need to buy notes. It took me months to get the information I needed to buy my first note and there are still things I need to learn.
Notes are just like any other type of investment: do your own research beforehand to make sure you’re making the right investment for you.
Thank you for reading this eBook!
If you would like more information or have questions you can visit ProCapFTW.com where you can view the free What Can Notes do for You video series and get updates on the upcoming book, Keeping Your Note Profits.
Have you thought about investing in real estate, but don't have the time to find, flip or rent houses? Want to find an investment that can be explained to you and by you in plain English? You can get the return you want. Real Estate notes are loans backed by land, houses, and even commercial buildings. Think of regular (monthly) income from real estate without the hassles of tenants, toilets, taxes (unless that's what you want). First, you need to find out if this is for you. In order to reach your investing goals, you have to have the right information. This book is written for people who are unfamiliar with real estate and real estate note investing, but are interested in discovering alternatives to help boost their investment portfolios. Get a birds-eye-view of notes, learn how find the right notes for your portfolio and avoid the major pitfalls that can make a seemingly good investment drain your bank account. Get this ebook today and take the free companion video course at procapftw.com.