With a little ingenuity, you may be able
to change the terms of an apparently bad note and turn it into a good note. There are a number of circumstances where a real
estate note can be modified to turn a bad situation into a good one.
As an investor, you could buy this note at a deep discount then
talk to the payor and get them to agree to a modification of the note. Thus you end
up with a good note from a bad situation.
As a finder you can explain this option to the note holder and
have them make the modification to make a note that is more appealing to an
investor. Teach them what needs to be
done to modify the note and then let it season slightly. (2 – 3 months) Once it
is seasoned a small amount you can sell it to an investor for a better price.
Both parties need to agree to the modification…
Here are some common modifications:
Extend the time period of the note: This is called forbearance. Suppose
you are offered a note that is in default. The payor has missed some payments
or has stopped paying. The modification
extends the term of the note (adds years) and lowers the payments. She now has
payments she can afford. The investor will discount the note based on the new
terms.
Change of
interest rate or other terms of the note: These changes can be made so that the payor will be able to handle the
debt, stay current with the payments or act as inducement to the payor for
other modifications that will make the note attractive for purchase.
Change to the
payment date: Changing the payment
due date can often be all that is needed to make a payor happy and make the
adjustments that will make the note attractive to both the payor and the
investor because now it is up to date.
Eliminate the
Balloon: Removing
a balloon that is coming due soon can alleviate stress for the payor and
therefore make a safer investment for the investor
Transfer the
responsibility for payment of the note: This is called delegation or assumption. You find a
problem note. You talk to the payor and learn a member of his family is willing
to take responsibility for making payments on the note, so the current payor
will not lose his home.
Modification, Not New
Creation
Remember that we are talking about
modification of the note, not the creation of a new note. A new note should not
be created under these circumstances, because the date on the new note will
differ from the mortgage or trust deed that secures it. This could cause
problems on reconveyence or foreclosure. You must
create a written modification, which is attached to the note. This is called an
allonge or an addendum or amendment. The provisions of the new attached document become part of the original note.
Before the modification of the note takes
place be sure that a title insurance company will reinsure the continued
priority of the mortgage as a lien on the property. In other words, say there’s
a first, second and third note on the property. You are interested in buying
the second. Be sure modification of the note won’t cause the mortgage to lose
its second position and move to third position. Loss of priority can occur if
the modification of interest, payments or due date is so substantial as to put
the third mortgage holder at a greater risk of loss than already existed.
In most cases you will be turning a bad note
situation into a good one by modifications that make it easier for the payor,
so we will not be increasing the risk for any junior lien holders. Even so, the
title insurer may be so cautious that they will ask any junior lien holders to
sign subordination agreements, (assuring that the note’s position will be
maintained) before issuing insurance. You may want to make a small cash payment
to the junior lien holder to win his or her quick cooperation. Figure this
payment into the cost of buying the note.
Option the Note
The best purchase strategy involving note
modification is to option the note from the seller, supervise the modification
and then purchase the newly modified note from the seller.
Laws vary state by state, so be sure you seek the guidance of your attorney in note modification situations. Many states treat a note modification as an act separate from the original agreement. Even though the note and its debt remain the same, the terms have changed. Usury laws may control the modification. There may be tax considerations for the note seller but they are beyond the scope of this article.
Big Returns on Small
Money
by
Terry L. Vaughan
I constantly see on the News Group questions like,
"Will this method work for me in my state?" Or, "I like this
technique, but I've never see this kind of opportunity in my area." Or, "Is this really legal?" Somehow, people are
more ready to disbelieve than to believe!
All that any of us who teach creative techniques are really trying to do is
pass on what we've learned. The methods and techniques most of us use have been
around for many years. The pros of today, for the most part, simply adapt
yesterday's techniques to fit to today's marketplace. But the principles never
change. You just have to learn to adapt to your local market to get the
results.
Case in point . . .
Ed, a close friend of mine (25 years now), owns a mortgage
company and has been a successful real estate investor for many years. He likes
warehouses and owns many of them around the country. Although Ed is one of the
best lenders I know in the business, he somehow has never allowed himself to
see the "Note" side of the business. Working notes is different from
making loans. Similar, but different. For years, I've
tried to get Ed to partner with me on several different note deals, but Ed has
always said, "No, that's not my kind of deal."
Recently, Ed read the How I Made $100,000
For One Dollar on our Success Stories page and gave me a call.
"Maybe I better read your book again," he said. (I
had given him a copy of Paper
Into Gold back in 1992 when I first published it.) You see, numbers
like $100,000 are more noticeable to experienced investors than smaller
numbers. I took advantage of the call and offered to take Ed to dinner the
following day.
When I picked Ed up at his office. I told him I needed
to go look at a mobile home in a park in
Here's the deal
|
Current Balance: |
$24,635.38 |
|
Interest Rate: |
11% |
|
Monthly Payment: |
$258.05 |
|
Months Remaining: |
189 |
|
Collateral: |
1977 Skyline 24x56 |
|
Payment History: |
Late every month. |
Ed asked me why I was fiddling with a little note like this.
I told him the deal had been sent to me by one of my finders and after I
noticed the consistently late pay history, I thought there might be an
opportunity for a quick profit, with no real work. He asked me what I had the
deal under contract for. (He knows, like him, I won't waste my time unless I
have control of the deal.) I told him I would tell him after we had seen the
collateral and the park. He smiled.
When we got to the park, both Ed and I were pleasantly surprised to find the
park an extremely clean, manicured, obviously well-managed place. We were
almost immediately stopped by the security guard (in his golf cart) to ask if
he could give us directions. A very good sign of safe,
well-run park. The management was on top of things. With the guard's
help, we found the home and parked right in front. The home was beautiful! Very
well kept, very clean and in excellent condition!
Ed walked along with me as I went to the front door and knocked. The man who
came to the door confirmed he was the payor on the loan. I explained I was with
a company that bought mobile home loans and that we were considering the
purchase of his loan. I asked if we could talk to him and his wife just to
confirm some information about the loan. He agreed and offered us a seat at the
kitchen table.
Turning a problem into an opportunity
Both the man and his wife were very nice. The home was
immaculate and extremely clean and well cared for. After confirming the normal
numbers, like balance, payment amount and interest, I asked why their payment
history reflected a consistent late payment. They explained that the husband
was paid once a week at his job. Although they made enough money to get by,
they had encountered some difficulties about a year earlier, had gotten behind
a couple of months and, because of the way their paychecks came in, it meant
that the space rent had to be paid first and then they would have to wait until
the next two paychecks came in before they had enough money, including the late
charge, to make the monthly payment. They were just never able to catch up.
Ed immediately saw what I had seen--an opportunity to change the pay schedule
and turn this poor history note into a good paying (and more valuable) note
just by changing the payment schedule. He couldn't help it and quickly
introduced himself as my business associate and asked the couple if they would
happy if the payment date could be changed to the fifteenth of each month
instead of the first. Would they be able to make the payment on time and enable
themselves to build a better credit history, if we (we???) would be
willing to change the date?
I laughed quietly to myself. My close and dear friend had always been a natural
at dealing with people. The payors were astonished that we could make such changes.
We assured them that we could make the changes once we owned the note, which
should happen the following week. If they were agreeable, I would send them an
amendment to the note which, once signed, would put the changes into effect.
They heartily agreed and shook our hands as we left.
"I'll take half"
Once in the car, Ed asked me, "Okay, what are you
going to pay for this note?" I asked, him what he thought the collateral
was worth. He looked around the park and said, "Well, even if you got the
home back, you should be able to blow it out fast for $15,000." I told him
I agreed. Then I told him the price for the note: $5,000.
Ed almost choked. "5,000!" "5,000
dollars?" I nodded. "What's the yield on that?" he asked.
I told him, "About 64%"
Ed, laughed and said, "Well, I'll take half of that deal! I'll put up
$2,500 and you put up the other half." It was my turn to laugh.
"Ed", I said, I can't afford to sell you half of this note."
"Why not", he asked. "Because, where can I get that kind of
yield for such a small amount of money?"
Ed had to agree. It's hard to put out small amounts of money for such a great
yield with such little risk. The trick is to find the same deal for $50,000 to
$250,000 with the same risk. Hard to do. Or is it?
That night over dinner, Ed wanted to know more about the note business and what
we might do together. (Finally, after all those years!)
I told him we might watch for a portfolio of these notes and then do something.
I would let him know. It was a great dinner, even though I paid.
Your money doubles every 13 months
If
you have some cash sitting around in a retirement account, or earmarked for
investments, you can find a little mobile home note and get the same kind of
great return. At 64% annual yield, your money DOUBLES every 13 months! If
you're short of cash, and can find an investor who would like a 20% return, you
could flip this note for a $10,000 profit.
One more example:
From the desk of Jonathan Richards (slightly
modified);
“His name was really Ringo
Jones. He had a note that he desperately needed to sell. We agreed to meet
at my office, and he would bring a copy of the note, deed and closing
statement. He insisted that we meet in the next hour, which I reluctantly
agreed to do.”
The documents showed that the house Ringo had sold was sold for $249,000 with a $227,000
first mortgage. The closing statement showed that the buyers had put down
$22,000 cash and gotten a bank loan for the $227,000. Ringo,
it turned out was holding a "hidden second." This means that somehow
the bank thought that the buyers had made a cash down payment, but after escrow
closed, the second mortgage that Ringo was
holding was recorded against the property. The effect was the sellers had
bought the house with no money down. Ringo was
holding a note with no equity in the property; and the buyers of the house had
no cash invested in the house. This is
a great deal for the buyers! Not so
great for Ringo.
The terms of the note were 12% interest only. With a balloon of the full amount due in two years. The
monthly payments were $220.00. The note was a year old so it was only one year
from the balloon. (at least it has some seasoning)
This note is so risky it should have had a skull and crossbones warning label
on it. However, for the clever note buyer there may be a way to buy these types
of notes.
Counting himself a "clever" note buyer Jpnathan did several things. First, he told Ringo he only wanted to buy a part of the note since
it was so very risky. he pointed out him that the
chances of the note being paid were about same as Bill Clinton marrying Monica
Lewinsky. He asked him what the smallest amount of cash he needed was. He
reluctantly admitted he needed $10,000 cash. Second, he told Ringo he needed to talk to the payors. He agreed.
Third, he asked Ringo to guarantee the note on
a piece of his own property. He agreed.
Jonathan met with the payors the following day. The
payors were a young married couple and the wife's brother. They were all
working and all lived in the house with two young children. He suspected they
were worried about the balloon payment due in a year, and he was right.
He proposed the following. First, he would lower their
interest rate from 12% to 10%, second he would
amortize the note over 6 years and eliminate their balloon. In return, they
must agree to raise their payment to $407.57 per month, and add some other
collateral to the note, to insure they would pay it.
They owned a small lot in Shelter Cove,
Their new note looked like this:
|
N |
I |
PV |
PMT |
FV |
|
72 |
10% |
$22,000 |
$407.57 |
$0 |
Jonathan then met with Ringo and proposed that
he would buy the next 52 payments on this note for $10,000. When he had
received the 52 payments, he would turn the note back to him and it would still
have a balance due of $7,479. Ringo was
thrilled. He got $10,000 now and a note with 20 payments of $407.57 remaining
for a $7,479 balance due.
We opened escrow; he funded the note and ended up the
following:
|
N |
I |
PV |
PMT |
FV |
|
52 |
40% |
$10,000 |
$414.98 |
$0 |
If anyone thinks that 40% is an unconscionable yield consider:
*We get paid for what we know, and should not
apologize for making a profit on our knowledge.
*Ringo had no other
place to go. He was lucky he found us, and thankful he did.
*This is still a risky note, and no reasonable person
with buy with less than a 40% yield and the extra collateral.
The lesson is many "bad" notes can be made
into "better" notes if you can talk to the payor and restructure the
terms and collateral.
by Jonathan Richards, Publisher of The NoteWorthy
Newsletter.