IntroductIon to note InvestIng€¦ · Introduction to Note Investing by Dave Van Horn 5 it all. On the first day of class, he took out our textbook and said, “There’s nothing

IntroductIon tonote InvestIng

by Dave Van HornPresident, PPr note company

2Introduction to Note Investing by Dave Van Horn

table of contents

1. From 100 Houses to 100 Notes 32. Why Invest in Notes? 123. How Notes Work 224. Where to Find Notes 265. Due Diligence 316. Profitable Note Investing 377. Recapitalization 458. Sources of Capital for Notes 509. How to Get Started in Real Estate Notes 5410. FAQs 5911. Note Investing Glossary 63


Part 1

from 100 Houses to 100 notes

“100 Houses.” That’s the answer I often hear when I ask real estate investors new and old: “What is your ultimate investing goal?” Believe it or not, I actually used to have the same response: not 100 notes, but 100 houses. That was my original plan for building wealth, and by the age of 45 with 40 units to my name, I was well on my way to getting there. At the time, I was a seasoned investor, who had tried everything from stocks and bonds to precious metals, and, with real estate, I thought I finally had it all figured out. My plan was to reach about 100 properties or units, ultimately getting as many as possible fully paid off. Doing so would allow me to have versatility with my holdings with the ability to buy, sell, or borrow against properties to generate income or to acquire more assets. More importantly, my debt-free portfolio would also provide me with more than enough cash flow to finally be financially free, especially in retirement. After all, isn’t financial freedom what we’re all after?

My Early Days as a Property Investor

When I first started investing, the idea of financial freedom wasn’t even on my radar; I just wanted to “get ahead.” At the time, I had


just started a family and was working two jobs, just barely getting by. I was also looking to move out of our apartment and upgrade into a house of our own. So, I thought the best way to solve both problems was to buy a multi-unit property that I could live in and rent out to make extra money on the side. And guess what? It worked! It was a great first step and one that inspired me to keep going. Like many investors reading this book, this is how I started my investing career.

I eventually moved onto purchasing buy-and-hold rental properties as well as flipping houses. And, like most people, I was using traditional bank financing and personal income (the extra money I made in commissions from my second job as a realtor) to buy my first few properties. Implementing both of these things was what got me over the first hump of buying my first few houses, but it didn’t last very long. One problem was that it was a get-rich-slow model, especially when working two jobs just to save up for a down-payment. The other problem was, after buying my first few houses, I started to look for more properties to rehab and couldn’t always qualify for traditional loans. I was running out of financing options, or so I thought.

Trying to figure out my next move and still unsure of my investing future, I decided that maybe the answer (or at least more income) lay in becoming a real estate broker. The teacher of my real estate brokering class was an old realtor/broker, who had seen and done


it all. On the first day of class, he took out our textbook and said, “There’s nothing in here that I can teach you,” and he threw it in the trashcan! Everyone was speechless, including me. He then exclaimed, “But what I can do is show you how to buy a house with none of your own money.” Needless to say, all of us were skeptical, but we listened. After that day in class, I went home and thought over what he told us, finally deciding that what he said could really work.

So, without any disposable income left to invest or a bank to turn to, I found the only thing I had left was good credit and the ability to take risks. At the time, cash advance fees didn’t exist like they do today, and credit card companies would provide customers with credit card checks for cash advances. The strategy was simple: I would write a credit card check out to myself, deposit it, and then obtain a certified check from the bank to pay for a house. I’d essentially pay cash for the property (allowing for me to negotiate a better deal), fix up the house with another credit card, then find a tenant and refinance to pay off all of the credit card debt I accumulated.I’m working to quickly go through and break up the longer paragraphs where it makes sense.

Sometimes I would pay off the credit cards and still have some refinance money left over (tax free because it was technically a loan), which I could then use to reinvest. So, I basically got the house for free, had tax free cash in my pocket, and the tenant would pay back the refinance loan while I would still be earning positive


cash flow. This is how I got started on my path to financial freedom, and this strategy exemplifies what I learned in class that day: that leverage is the key to building wealth and that it can be applied to nearly every business in a multitude of ways.

Something Happened On My Way to the Local REIA Group

It wasn’t until I discovered notes, mainly by accident, that I realized how cumbersome and time consuming my goal of 100 houses would become. After getting to 20 units by utilizing bank financing and my credit card strategy, I hit another wall when looking for capital for my next project. The banks would no longer lend to me because I had too many “doorways” or mortgages in my name, and credit card companies became stricter with their cash advances, eventually raising the fees so high that my old model wouldn’t work. I thought I was finished, but then I remembered hearing about a local REIA (Real Estate Investors Association) group holding meetings in my area. It may seem like a no-brainer today to join a real estate networking group to find a hard money lender, but I was a bit of a lone wolf when it came to my properties and actually had no clue how hard money worked. I went to my first meeting just to network with others and hopefully learn how they found capital for their real estate deals.

I’ve since learned that networking isn’t just crucial to the real estate industry, it’s crucial to every industry. After I attended a few


meetings, my network started to grow, and this new network of mine taught me something the bank never could: instead of saying “I can’t,” they taught me to ask “How can I?”

Turning to Private Money and Private Notes

It was at a meeting of this group that I was first introduced to private money. Through one of the speakers at the event, I learned that just as a bank can issue a loan and make a profit through the interest payments, so can an individual investor or hard money lender. It was this speaker, who personally introduced me to a private money lender, who lent me the capital I needed for my next purchase. So, just like that, I was back on my feet purchasing properties, faster than ever. Using private money, I was able to obtain my highest number of real estate rentals ever, 40 units total, all in the span of a few years. I even started managing other investor’s units as an agent alongside my own since most of the properties were located in the same area as mine, it was an “easy” way to make some extra money on the side.

Everything was going great, and I was busier than ever. I mean really busy... so busy that I didn’t have much time to spare between the management of my own properties as well as other investors’. Then one day it hit me: between the maintenance, tenant complaints, inspections, and constantly going to eviction court, I realized I was working for my money rather than letting it work


for me. I was squandering my greatest asset of all: time. It was at that very same moment when I figured out who wasn’t doing any of these things for their investments but still making a profit: the private note owner. That’s when I decided for a bit of a career change, and became a private money lender myself. With many of my properties having risen in value in recent years, I had built up quite a bit of equity. I refinanced this equity out of my properties and started lending it to other investors I met at networking groups, again utilizing leverage. This is what is known as a private note, and it’s how I first got started in the note business.

note : a promise to repay a loan.In the note industry, this promise is in the form of a contract in which one party (the borrower) agrees to repay a certain portion of the loan to the other party (the lender) within a set period of time and under specific terms (including interest rate on the loan, penalties for late payments, etc.).

From Private Notes to Institutional

I had come to private notes looking for a better investment - one that was passive but just as secure and versatile as real estate. In many ways I found those qualities creating notes as a private money lender--I was no longer bogged down by maintenance or tenants,


and I was making a safe and comparable return to my cash flowing rentals. But, as the real estate market nearly came to a halt with the 2008 recession, I was again looking for a change. With investors purchasing less property due to declining values and their main exit strategy of refinancing becoming increasingly harder to accomplish due to lending restrictions, private money was turning into more and more of a struggle with a high default rate.

Like all investments, private notes are not without their disadvantages, and scalability had always been one of them. With current legal requirements limiting the amount of private notes that can be originated per year for an individual, scaling the amount of private notes was proving to be difficult. Even lending to entities or LLCs, which can be much less limiting in terms of usury laws and origination requirements, still involves extensive underwriting and due diligence. Not to mention, the duration of most private notes are fairly short (24 months or less), leaving investors like myself constantly searching for the next borrower and another deal to deploy capital. These disadvantages were only heightened by the economic downturn setting the stage for my next opportunity: institutional notes.

Luckily, a few years before I found myself at this crossroads, I had started a real estate networking group of my own to accommodate my expanding network; it was at this group that a new speaker came to visit. He was an institutional note fund manager looking


for capital to purchase pools or tranches of delinquent mortgages. At the time, I wasn’t familiar with how you made money on a delinquent mortgage, which I soon found out was a mortgage in which the borrower is more than 90 days late on their payments. He explained a bit about how it worked, and I was intrigued by what he had to say, but like most of the people in that room that day, I didn’t act. Fortunately, my future partner John did.

John invested some money in this note fund and began earning significant returns. More importantly, he became interested in the business model behind delinquent notes. Eventually, John set up a meeting between our friend (and future partner) Bob and myself to determine if we would be interested in raising money for a note business. After explaining to us what he knew about the business, we agreed to form an entity and purchase our first few notes. It was soon after working through our first batch of notes, profiting from some and learning from the rest, that we decided to raise money to buy more. Once I started receiving the passive income from these, without all of the headaches of my past ventures, I decided to change my goal of 100 houses to 100 notes.

The New Goal to Financial Freedom: 100 Notes

Now 100 notes may seem like a daunting goal to strive for and may even be a bit of an arbitrary number. The real goal is to have as many notes and properties as possible to create and maintain


financial freedom. But, just like when I started buying property, gaining more assets was a steady incline.

When starting out in real estate, my goal initially was to purchase one property, then five, then ten, and so on and so forth. The longest and most arduous process wasn’t when I went from ten to twenty notes, or even from one to ten, it was buying my first one that proved to be the biggest step. The reason for this is that when I started out there wasn’t much information available on buying, working, and managing notes, and I certainly didn’t know very many people doing the business who had gone through a similar process as me. That’s why after years of owning and managing a note company that now purchases and owns thousands of loans, I decided that I would take on this position that still needed to be filled.

The goal of this book is to show through my personal experience how notes work, how to get started, and how along with real estate and other investments, notes can be a great investment vehicle to becoming and staying financially free.


Part 2

WHy Invest In notes?

Almost everyone is already in the note business, they’re just on the other end of it. It’s hard to find a person who doesn’t have a credit card, car loan, student loan, or mortgage. The problem is that most people are writing a check to a note owner instead of receiving one as a note owner. The best way to get to the other side of that equation is to start owning notes, rather than the other way around, and to do so one must start by gaining a better understanding of the institutional note business.

A performing note (also referred to as a re-performing note) is a loan on which payments of interest and principal are less than 90 days past due. A re-performing loan is simply a note that had gone delinquent but has since entered performing status after at least a twelve month pay history.

A non-performing note is a loan that is in default or close to being in default. Many loans become non-performing after being in default for three months, but this can depend on the contractual terms.

**When reading this book, it is important to remember that any further mention of notes refers to secured notes; and, more specifically, it refers to secured residential notes in the first and


second position. Keep in mind, there all kinds of notes that vary in type and position. The previously mentioned are notes that are backed or secured by an asset (in this case hard real estate), but there are also unsecured notes as well; examples can include student loans, medical debt, and credit card debt.**

Advantages of Investing in Institutional Notes

#1 - Passive Cash Flow

For me, owning hard real estate always had and still does offer many great tax advantages, especially when including depreciation deductions that can offset positive cashflow. Although I consider my real estate to be passive from an IRS tax perspective, what many people including myself have failed to realize was how much active work is required for managing and maintaining property. For the owner/landlord active work can include everything from dealing with tenants and their liability to maintenance and townships, as well as the ever increasing property taxes. Even for those who own property “hands free” they are still oftentimes managing their property managers.

When a note is re-performing and being repaid by the original borrower, the holder of the note will receive payments every month with little or no work required to continue receiving these payments making their investment entirely passive.


•• When notes are paid off early, also known as a “cashout,” they can be a great short to medium term investments with the entirety of the balance owed paid to an investor in a shorter span of time than performing all the way through to maturity. This can be anywhere from a few months to a few years.

•• When paid until maturity, many notes offer a very significant profit over the course of many years, especially considering that most mortgages have terms with decades worth of monthly payments.

•• Whether the balance is paid back in monthly installments, a lump sum, or a combination of the two, re-performing notes offer a fairly predictable profit.

#2 - Volume and Control

Although I mostly bought residential property locally, I did venture into commercial real estate in other parts of the country. Despite the successes and failures of the investments, managing people and properties in other areas proved to be both tiresome and inconvenient. Even owning and managing residential properties locally could prove cumbersome when passing a certain number. Managing a portfolio of notes is much easier than managing a large portfolio of properties for the following reasons:


•• A note portfolio (either performing or nonperforming) can be managed from the phone and computer without ever requiring one to leave the house or office. This enables servicers to manage notes on properties all across the nation.

•• Fortunately, it’s less likely to have to deal with a lot of tenants and maintenance issues since notes deal more with the paper behind the property.

•• In the rare instance there are these issues, in the note industry we have what are known as mortgage servicers and property preservation companies. Servicers handle not only accounting and payment management but also any issues that arise with the resident. Property preservation companies deal with any physical issues with the property.

#3 - Profitable In Various Market Conditions

Unlike with the volatility of the stock market, note prices in the marketplace function in relation to supply and demand and are directly correlated with real estate values. So in an up market when the economy is in full swing where there are fewer foreclosures, and home prices are high and climbing:

•• There is a smaller supply of delinquent notes available in banks’ portfolios which enable the bank to gain a higher price for their notes especially because all notes are more likely to be fully covered by equity.


•• Although investors might have a higher acquisition cost, they now benefit from a quicker exit. When there’s a question of time vs. money, the old adage “A fast nickel beats a slow dime” is proven true. What’s better, a 50% return in 3 months or a 150% return in 12 months?

Conversely, in a down market there are more delinquent assets available (along with more junk assets), and there is less equity in the marketplace. So in a down market:

•• It takes longer to exit the deal because there are fewer buyers for an asset backed by a property that may be dropping in value or has little remaining value.

•• This situation creates more assets in the marketplace for less capital invested. For the same amount of money in an up market, a note investor could acquire a larger quantity of assets than they could in a down market.

•• Even if there is little to no equity, as the market improves so does the value of a note investor’s portfolio.

#4 - Collateral

Unlike owning stocks that offer no real collateral, real estate is one of the safest investments on the market since the investment itself is actual physical property. It wasn’t until I learned about notes that I discovered there was an investment option that offered a


very similar style of security. So what are the risks associated with nonpayment? What exactly is the recourse if a re-performing note stops paying? Since a performing note is secured by real physical property, there are multiple means of protecting a note investment:

•• Owning a secured lien that is tied to property, especially if the property has equity, involves little or moderate risk because a note owner has a right to foreclose on the property and to recoup some or all of the initial investment. The investor who owns the note has a claim on the property just as the bank would if they were to own the note.

•• Unlike in an eviction, in a default of a property with equity, the note owner could recover missed payments, late fees, attorney fees, and corporate advances at a future date.

•• Even junior liens with no equity or low equity can still be viable investments because the borrower usually has a vested interest in the property and traditional equity may not always be the sole factor when it comes to remaining in the home.

#5 - Versatility

My favorite aspect about investing in property or hard real estate has always been all the opportunities it affords me for making a profit. What many real estate investors may not know is that nearly all the versatility property ownership offers, notes work in a


similar manner. Not only can purchasing notes be a unique way to obtaining property, especially when buying vacant 1st mortgages, notes can also be flipped, rehabbed, and borrowed against or leveraged like real estate.

•• Flip or wholesale a note - Whether a note is performing or nonperforming, it can potentially be sold in any condition to an investor at any time. Generally, a note is not required to be held for a certain amount of time before it can be sold again. For example, in an upmarket someone could purchase a performing note and hold onto it for a few months as they collect payments, later selling it for close to if not the same as the purchase price. More importantly, the note doesn’t need to be performing to be sold, either.

Another strategy to recapitalize is by selling what is known as a “partial.” This practice refers to selling a partial amount of payments to an investor for a designated term at a designated price. This option can be a great way to quickly recover a portion of the initial investment while still maintaining ownership of the note. It is beneficial for the partial note buyer as well because it requires a smaller amount of money to invest for a shorter period of time.

•• Rehabilitating a note - Like rehabilitating a house, notes can be rehabbed or retouched by reworking the original note. If


a borrower were to miss one or more payments because of an unforeseen circumstance, the note owner has the ability to rework the terms of the loan to fit the borrower’s new needs. This allows the borrower to stay in the home while also maintaining a steady stream of cash flow to the investor.

•• Borrow against the note - The most versatile strategy of note investing involves an investor’s best friend, leverage. Since the note is generating monthly income for the investor, it can be considered a cash flowing asset. As an asset, this note can then be used as collateral for a loan with a private money investor; this is known as a Collateral Assignment of Note & Mortgage. Just as a motor vehicle is collateral for an auto loan, a performing note can be collateral for a private investor loan. In fact, the private investor loan allows the investor to recapitalization in a tax free manner. Since this is a loan, the new private money creates an opportunity for a revenue stream that is exponential because the loan can be used to purchase more notes.

#6 - Socially Conscious Investing

One thing that always attracted me to real estate was the fact that everyone needs a home, and through my rentals or flips, in some way I was responsible for helping someone and their family find


that place. With notes, investors are helping borrowers stay in their home without incurring any more debt that could cause further repercussions down the road. Unlike stocks which are a zero-sum game with investors playing either side of the investment, always leaving one party at a loss; notes can actually be advantageous for not only the investor but for every party involved.

•• Borrowers benefit from working with note buyers to create a viable solution to stay in their property or move on and/or buy time without incurring debt that can be detrimental to their financial life.

•• Banks benefit from others investing in notes as well because they are able to remove what are considered to be “toxic” assets off their books,therefore, they are given a greater lending power to do what they do best, lend money.

•• Housing makes up a large percentage of the economy and reforming distressed debt in that area is beneficial to the entire economic system. When a person is not paying their mortgage, they’re also not paying their taxes or insurance escrowed in their mortgage. By turning these delinquent mortgages into performing ones, note investors not only help an individual through their financial struggles but they also help improve the community at large.

When we first started in the note industry, my partners and I weren’t really aware of all the advantages until we started


purchasing and managing notes. Notes are a learn by doing business, so to learn the business an investor has to be apart of it. Before getting started it’s important to know the life cycle of a note.


Part 3

HoW notes Work

Before a note ever reaches an note buyer’s hands, an investor should know a note’s origins and the life cycle of a loan. All notes start with a borrower. More than half of all Americans walk into a bank or mortgage broker’s office in need of a home mortgage, a home equity loan, or a line of credit and from there a loan can only follow two major paths - it can remain a performing note or become a non-performing note.

If a Loan Performs

In a normal market, nearly all loans perform, and when they do, there are generally two directions a performing loan can take:


1. The borrower keeps the loan and diligently makes payments until they sell or refinance their home.

OR

2. The borrower keeps the loan and diligently makes payments until the mortgage reaches maturity. This option is less likely, because the average homeowner sells or refinances their home within 5 to 7 years after purchase.

Occasionally banks and other institutions will sell these performing loans to large servicers, brokers, loan exchanges, or even an individual investor. But the majority of notes that go to market and make up the industry, go through the next process - from non-performing to re-performing status.

If a Loan is Non-Performing

In a small percentage of loans, an unforeseen circumstance occurs to a borrower that causes a note to stop performing. What generally happens in this case is that the borrower pays down a loan for a certain number of years until an unexpected event disrupts their life, such as a death, divorce, job loss, a medical emergency, or any combination of these events. This causes the borrower to be unable to afford to make their payments. At this point the bank is stuck with a non-performing asset that can impact their reserve requirements, impeding their lending abilities. Most banks will


consider a loan to be delinquent, or non-performing, after 90 days of non-payment. This leaves the bank with a few options. There may be as many as 6 options the bank has for this non-performing loan:

1. The bank can modify the loan.2. The bank can accept a short sale.3. The bank can accept a discounted payoff from the borrower.4. The bank can obtain a deed in lieu, where the borrower signs

over the property to the bank.5. Foreclosure - with the bank typically liquidating the property

(selling the home as an REO).6. The bank can sell the note and mortgage to a third party.

The sixth option is where I and other note investors come into play. The primary reason banks sell loans is for liquidity. Depending on the lending institution, there are many reasons to seek liquidity: tax payments, legal fees, loan loss reserve requirements, or even just loss mitigation overload. Banks may also service loans, but it’s usually easier for a bank to liquidate their notes through a trade desk, loan exchange, or a brokerage. Because of this reason, banks will sell these notes at a discounted price usually to a note buyer or speciality servicer. A speciality servicer is a company hired to collect on mortgages that are either delinquent or in default. The discount that a speciality servicer or note buyer obtains at purchase is what creates the opportunity for the note buyer to have more flexibility when exiting the note.


The sale of notes is occasionally done on a “loan level” basis (or one at a time) but more often they are sold in larger portfolio packages containing up to hundreds or even thousands of loans. The speciality servicer has more of an economy of scale if working these types of loans is their primary occupation, as opposed to a bank who is in the lending business more than the collections or real estate business. So non-performing loans generally make up only a small percentage of the bank’s overall portfolio. Whatever the reason, the banks have assets they need to sell and the next step for the bank is either to sell these notes individually on a loan-level basis or to put these assets out to bid.


Part 4

WHere to fInd notes

When searching for institutional non-performing notes, it would seem that the natural place to find them for sale would be banking institutions. Starting out, my partners and I thought the same thing but what we learned over the years was that although many banks do originate, buy, and sell non-performing notes, for a single note buyer (especially a loan level buyer), banks can actually be one of the most difficult places to purchase from. With buying requirements that include references, proof of funds, and a documented trade history, we found it to be easier to purchase notes from a hedge fund, broker, or a speciality servicer. In fact, the note seller that taught us the business was one of these types of companies. It wasn’t until we sought to buy elsewhere that we learned one of the most important parts about finding notes: it’s a relationship based business.

Fortunately for us in the beginning, we were with the same speciality servicer for the first few years. As we grew, we started expanding our network to other speciality servicers and brokers. Today, we use all types of note networking that is done both online and in person. Local and non-local networking events for real estate investing, distressed debt, and the banking industry can be an important gateway into the note buying community. Some websites


such as LinkedIn and Bigger Pockets offer groups dedicated to note investing, while others like Meetup integrate both online and local networking to connect those interested in working with notes nationwide. But who are the people to connect with, and what type of sources do new note buyers need to look for?

Sources for Notes

Online Networking - There’s no need to sit around and wait for a meeting to start when you can connect with people at the touch of a button. Online, new note buyers cannot only connect directly with others in the industry, but they can also join groups to ask questions and find notes for sale. Many note groups on the web have notes listed for sale on an individual or small pool basis that are either sold by other note investors or by brokers. Over the years, we’ve realized how important online networking could be for note buyers, sellers, and those wanting to learn more; thus, we have started our own LinkedIn group that provides such a service: Distressed 2nd Mortgages Group.

Brokers - In some cases, a note-buying transaction can occur directly between a note buyer and note seller, but other times someone else facilitates the connection. This person is called a broker. It’s important to note that brokers usually fall into one of two categories: the first kind of broker has access to product and

https://www.linkedin.com/grps/Distressed-2nd-Mortgages-Group-3900405/about?


is solely trying to benefit from positioning their way into a deal and charging a mark-up fee. The second kind of broker, although still charges a fee, has an ongoing relationship with a large number of note buyers and banking institutions. This type of broker also facilitates the sale in a compliant way and may even assist the note buyer after the transaction if any problems arise like missing documents, collateral, etc. The second kind of broker usually is interested not only in the sale, but also future business, and they can be paid a fee by the buyer, the bank, or both. Although both types of brokers may gain access to assets available for purchase, it’s usually the latter type that remains a long-term, reliable connection to note sources.

We found our first broker through our initial note seller. When we went into business purchasing and managing notes, our broker friend went in a different direction connecting note buyers with note sellers. Our network of brokers also grew from online connections such as loan exchanges and social media but also through word of mouth recommendations from other note sellers and even fellow note buyers.

Loan Exchanges and Servicers - Some smaller community banks and even some large banks without trade desks often have notes to sell, but they don’t always have the means to do so in an efficient way for the best possible price. In this situation they employ


what is known as a Loan Exchange. Loan Exchanges don’t always require a direct personal connection, and they have online venues for purchasing notes, making it much easier for note buyers to find institutional assets. Servicers operate in a similar manner by providing an online note sale platform for the assets they manage. Many newer buyers purchase from smaller servicers, just like PPR did when we were starting out, because of the access it allows.

Note Funds - With such a fragmented market, it’s not always an easy environment for a new note investor to navigate. One of the simplest sources for notes can be note funds. A note fund normally has a more direct source for product, buying notes in bulk from large banks and servicers allowing them to purchase for a better price than the average broker or note buyer. They then hold and/or resell assets on a wholesale or loan level (individual) basis depending on their business model. Unlike buying from individual note sellers, certain brokers, or loan exchanges, this loan level retail environment means customer service and support is an important element in providing repeat business. This customer service and support can be found helpful for note buyers in a multitude of ways.

For example, some note funds offer reps and warranties guaranteeing non-performing assets are both a valid lien and in the stated lien position as listed. As for performing notes they may even provide a performance warranty so that if a note goes non-performing, the warranty will protect a note buyer’s


investment principle reducing their risk. Many note funds also have a document custodian in place or a document management department in house, utilizing an inventory checklist or exception report when notes are bought and sold. This allows a fund to provide an accurate representation of what documents are included in the loan file and improving the overall collateral delivery process for customers. Note funds may also have another option for accredited investors to diversify their capital, share expenses, and limit their liability by pooling together several investors’ capital to make larger purchases. Some of these types of funds may even allow investors to redeem shares to buy individual notes from that fund’s note inventory.

Just like buying that first piece of real estate, the first note is usually the most difficult to find. It’s important to remember that as time goes on and a note buyer continues in the business, their track record begins to grow along with their company brand and image, making note seller connections much easier to discover. Once an investor finds a note to purchase, they must know how to determine if it’s the right note to buy for them.


Part 5

due dIlIgence

Due diligence varies for both the type of note and the position it is in, making it a necessary step prior to purchasing any asset. The first place to start, no matter the type of asset, is with the note seller. It’s vital to know and trust the note seller. Just as banks need to perform their due diligence when finding buyers, note investors need to perform due diligence when choosing their note sellers. If an investor is purchasing from a seller that they don’t know, it’s important to put safeguards in place before deciding to move forward with a trade.

Vet The Seller

Thoroughly vetting an unknown or new note seller can be done in multiple ways:

•• Complete a background check on the seller (and their partners if possible) to look for any past criminal activity, prior judgements, etc.

•• Ask others in the note buying community about their previous transactions with the seller. This could help an investor understand the seller’s purchase process, collateral delivery, etc.

•• Require a Bailee Letter: this letter identifies an individual who


temporarily gains possession, but not ownership, of property under a contract or bailment.

•• Ask for an exception report: this is essentially a collateral inventory report, usually done by a third party document custodian, that is used to reference any documents that may be missing.

•• Escrow some or all of the funds until the deal is complete. Involving a third party who can facilitate the transaction, such as an escrow attorney or another type of third party custodian enables note buyers to review all of the collateral prior to finalizing the purchase

Although it is often unintentional, note sellers aren’t always accurate with information on the trade, so it’s important to do research and verify their information. When analyzing what information the seller is providing, keep in mind that sometimes the status, equity, or value of notes can fluctuate. If the seller has provided data that proves incorrect, it could end up being unfavorable for the unknowing note buyer. For a note buyer who knows what to look for, it could also mean getting a great deal or creating a situation where the investor could negotiate a lower price.

Performing notes

With performing notes, whether it’s first or second mortgages, many investors tend to focus on four things;


•• Borrower’s Pay History: A solid pay history is important because the longer a note pays, the odds of a default decrease, which affects a note’s classification and pricing. The same rule of thumb applies for arrears payments, which can show how financially committed a borrower is to their new payment plan.

•• Credit: The borrower’s credit, which is usually more important at origination, can also be used to study the trends of a borrower’s credit in relation to their other current bills. With second mortgages, the most important factor a credit report provides is the senior lien status.

•• Equity: Equity in the note backs up an investor’s capital; therefore if for some reason the borrower were to re-default then the note owner would most likely have to foreclose, exiting through the property.

•• Geography: When buying a first mortgage or a high equity second, an investor may be more concerned with geography for a variety of reasons including determining foreclosure costs and timelines that differ from state to state, as well as demographics, population and job growth.

Non-performing notes

No matter what type of lien is being purchased, it’s absolutely


necessary to get clear on value, the property, the borrower’s intent, and the potential exits.

First Mortgages

Specifically for first mortgages, due diligence items can include:•• Value (FMV or Fair Market Value): Determining value is critical

since it shows how much equity is backing the property. •• Title & Occupancy: An investor should obtain an E&O

(Encumbrance and Occupancy) Report to determine liens, ownership, and occupancy status.

•• Taxes, insurance, municipal liens, and HOA (Homeowner Associations or Condo Associations) Fees: depending on the note and its location, any of these can be risk factors because said fees could be lien-able in some states.

•• Location, Comparables, Property Condition: Also, obtaining a BPO (Broker Price Opinion) is recommended to validate location and to try and get an idea of the neighborhood and/or property condition. It can help determine occupancy and value as well.

Second Mortgages

Due diligence on residential junior liens can vary dramatically depending on the type of lien. For example, high equity 2nd


liens require due diligence similar to that of a 1st lien because they’re backed by equity, so these junior liens go through a similar foreclosure process leaving investors with a favorable outcome even if they have to exit through the property. When looking to purchase a no equity 2nd mortgage, there are a few other factors to consider:

•• Senior lien status: More important than value, senior lien status and monitoring is important for all 2nd liens but especially for no equity 2nds. This is because when a borrower is current on their senior lien, it tells the investor two things: the borrower has a likely source of income and a desire to stay in the property.

•• Occupancy: Occupancy provides better odds for a favorable outcome since the borrower would likely want to stay in their home.

•• Fair Market Value (FMV): FMV is crucial to determine which category of note to buy at the right price.

•• Title: Rarely pulled at acquisition on 2nds since it’s normally done at origination, title is usually not a big risk since it’s usually covered contractually in the NSA (Note Sale Agreement) for lien position and validity.

•• Taxes and insurance: Also not as important since they are usually escrowed and paid for by the senior lien.

Depending on the type of asset and class, an investor will eventually start to know what’s relevant and what is not. Now the best advice is to track the data. The information collected going forward about


the performance of the assets an investor has purchased will prove invaluable when making future trades.


Part 6

ProfItable exIt strategIes

There are many ways to profit with both non-performing and performing notes. Depending on the borrower’s intent as well as a note investor’s goals, cost of capital, and experience level, the exit chosen can greatly affect how much profit an investor stands to gain. If an investor is not planning on selling the note or doing a quick flip, there are typically two ways to exit the note: through the property or through communication with the borrower.

Exiting Through the Property

When exiting through the property, an investor faces either an adversarial situation where they are exiting through the legal process and foreclosure, or a more cooperative scenario that will involve a “deed in lieu of foreclosure” or a short sale type of transaction. Exiting through the property could happen with both first and second non-performing mortgages. Most re-performing notes however, whether firsts or seconds, are created when a note owner agrees towards a mutually beneficial solution with the borrower. From a strategic standpoint, some investors may prefer to exit through the property to obtain hard real estate, which is accomplished more often with vacant properties.


Deed in Lieu of Foreclosure - If the homeowner cannot afford to stay in the property, a note owner can offer to pay an administration fee, often referred to as “cash for keys,” if the homeowner signs over the deed in lieu of doing a foreclosure. This strategy can save the homeowner from a foreclosure that could damage their credit.

One example of this situation occurred when we bought a first mortgage back in March of 2013 for $5,208. The deal had plenty of equity as the Fair Market Value was showing as $70,900. Although the property was vacant, we were still able to contact the homeowner, and we discovered they had no interest in keeping the property due to health issues and their advancing age. Our company ended up completing a deed in lieu with the borrower, allowing them to relinquish the property without a foreclosure. So by May of 2013, we listed the property for sale and within five months we sold the home for $20,818.42, netting a profit of approximately $15,000.

REO – When a homeowner is unable to make full principal and interest payments on his/her mortgage, the lender can exercise their rights to protect their interests through the foreclosure and ejectment process. Taking place after the foreclosure, ejectment is where the borrower is contractually obligated to vacate the


premises due to non-payment, leaving the lender the ability to take title to the collateral through the sheriff ’s deed. This is now known as a REO (Real Estate Owned). The note owner can then resell the property as is, rent it out, fix it up and flip it, or offer owner financing to recoup as much money as possible. Even after foreclosure, in some cases a plan can still be created with the borrower -- for example reversing the foreclosure, selling them back the property, lease to own, etc.

Exiting Through the Borrower

In many cases, the note owner’s exit is dependent upon the borrower - not the note owner - because the outcome is usually contingent on the borrower’s ability and willingness to pay. It’s important to keep in mind that unlike the bank, who originated the loan, the note owner purchased the note at a discount, giving them flexibility to offer the homeowner the best option that suits the needs of both parties. There are many different exit options when dealing with delinquent mortgages, with unlimited combinations.

•• Discounted Loan Payoff – In this case a note owner will accept less than the full payoff remaining on the loan. For example, a note owner can offer a homeowner an opportunity to pay off their loan without incurring additional late fees and penalties that have been added. A possible scenario might be if a note owner paid $20,000 for a second mortgage with a face value


of $50,000, they could contact the borrower by mail and make an offer like, “If you pay $30,000 in the next 60 days, the loan will be considered paid in full.” Some homeowners can access this capital in their 401(K) while in foreclosure, often without penalty, making this course of action a viable option for them.

•• Reinstating the Loan – The delinquent loan is considered reinstated when the amount of money needed to bring the past due loan current has been paid. The term for this past due amount of money is also known as arrears which can consist of missed payments, interest fees, late fees, and corporate advances (i.e. back taxes, HOA fees, legal fees, etc.). Sometimes a note owner can accept a partial reinstatement or discounted arrears plan and put it into action with the homeowner.

•• Payment Plan – Sometimes called a Loan Modification, there is no one size fits all payment plan for borrowers. Every loan is different, as is every borrower, making for different combinations of arrears and monthly payment options. A typical situation utilizing this strategy is a payment plus arrears plan, which would typically spread the reinstatement amount over a defined number of months along with the regular or reduced payment.

For example, we bought a second mortgage for $14,610 in January of 2012. The original note was $76,500 and the original


payoff was $97,182. The borrower’s original payment was $698.34 and their interest rate was 12.25%. The loan term was for 180 months. The arrears owed was $20,496. The FMV was $450,000 and the senior lien was $370,000. So it was a partial equity 2nd mortgage.

After purchasing the note we had reached out through through our mail campaign and the borrower called in soon after receiving a letter. What had happened was the borrower had gotten injured on the job and fell behind on his monthly payments. He had since gone back to work, but he wanted to keep his payments around $500/month instead of $698. So what we mutually agreed upon was that we would extend his term to a 30-year loan with an interest rate of 5%. We accepted a payment of $5000 from the borrower’s wife towards the arrears from her IRA and discounted the rest of the arrears owed.

With the arrears payment alone we recouped a third of our investment very quickly, and we were set up with a payment stream of $500/month for 30 years. This is a great example of a discounted arrears and modified payment plan.

•• Refinance – Another type of plan instituted with a borrower includes a full or partial reinstatement and regular or reduced payments with the goal of refinancing. This option could take up to twelve months of re-performance and would usually


require sufficient equity in the property. Here is an example of a full equity 2nd mortgage refinance that we purchased a few years ago:

The original note was $27,500, and we paid $17,000 to purchase the delinquent asset. The total payoff was $32,302 and the arrears was $8,359. The fair market value was $260,000 and the the senior lien was only $76,517. After getting in touch with the homeowner, we learned she wanted to keep her home. She had lost her job prior to going delinquent but had since gotten remarried and was able to work out a deal where her husband would refinance the house. We agreed to accept a slightly reduced payoff of $31,000. We subtracted our legal fees of $1250 before fully refinancing, leaving our net income at approximately $13,000. We were able to complete this deal in less than seven months because her husband had good enough credit to complete a refinance.

•• Seller Assistance – If the borrower can’t afford to stay in the property, the note owner can assist them by helping to pay for a realtor, a mover, a down payment or even rent for a new place. The note owner could also allow them to stay in the current property and buy them some time until the property sells. A note owner could even pay the homeowner a commission if a buyer or tenant is found for the property.


Utilizing a Servicer

Upon purchasing a performing note or after modifying a note to re-performing status, an investor should keep in mind that there is some minor financial work involved. Payments from each note need to be tracked, delinquent payments that may arise need to be addressed, and all of the related accounting needs to be done correctly--these tasks should be handled by a licensed servicer in order to maintain compliance and accuracy. This is similar to a real estate investor or landlord hiring a property manager to manage their properties. Instead of property maintenance and tenant management, a note servicer is responsible for all of the maintenance and management of a note or note portfolio.

When placing a loan with a servicer, a low setup fee is typically required along with a modest monthly rate. Unlike property management, with fees that can run anywhere from 8% to 10% of gross rent, the flat fee paid to the servicer every month is the same whether the note payments are $300/month or $3,000/month. The reason for the drastic rate difference between property management and mortgage servicing is that the latter is much more automated and scalable. So, unlike property management, note servicers don’t have to be local, and they don’t have to deal with as many tenants or turnover issues since borrowers usually have a vested interest, especially when it comes to staying in their primary residence.


It’s also important to note that in nearly all cases, the cost of hiring a servicer (who can work in multiple states) will be covered by the monthly payments being earned from the note.

The biggest benefit to hiring a servicer is that it makes performing notes great for a buy-and-hold passive investor. With all of the accounting and collecting taken care of, there really isn’t much for the investor to do other than head out to the mailbox to collect their checks and hand their monthly statements to their accountant.


Part 7

recaPItalIzatIon

The initial goal for most new note investors is to build a steady portfolio of performing notes, whether they purchased them performing or rehabilitated a note back to re-performing status. Then they just sit back and collect the payments, right? This business model is very similar to investing in rental properties or any long term buy and hold type of investment. It offers the opportunity to continue building wealth over time, especially when the cash flow from the notes enables the purchase of additional notes -- but is there a quicker way?

The key to speeding up cash flow is velocity. By turning non-performing notes into re-performing notes through a workout with the borrower, a note owner not only increases a note’s value but can also make a substantial profit along the way. They can collect arrears payments as well as a number of monthly payments to season the notes, thus allowing a note owner to collect payments for a period of time to determine if the borrower’s workout agreement plan is working effectively. This seasoning generates a return for the note owner while also increasing the note’s value by demonstrating that the note is consistently performing and the borrower is reliably making payments. After this is complete and


the note owner decides they want to recapitalize sooner rather than later, they can implement a velocity model by either selling the note, selling a partial note, or creating a collateral assignment of note and mortgage.

Selling the Note

Since a note is an asset, it can always be sold, whether re-performing or non-performing. Note buyers can be found almost anywhere; some of the best places to start are local REIA meetings or real estate and note meetup groups. Many buyers can be found online through websites like FCI Exchange, LoanMLS, Bigger Pockets, and a variety of LinkedIn groups (including a group started by PPR, Distressed 2nd Mortgages Group). Keep in mind that the best note buyer is the one that’s already a customer, so some of the best ways to proactively continue sales include providing reps and warrants with notes to give buyers more security and offering them quality collateral and follow-up service.

Another method of selling the note is to flip it, which simply means buying it for one price and selling it for a higher price. If an investor were to go through the work of purchasing a note wholesale, they can sell it at a retail value either “as is” or modify it if they choose to do so. To reiterate the value of “seasoning” a note, keep in mind the longer a note investor holds onto a re-performing or performing note, the more it will raise in value because many risk averse note

http://www.fciexchange.com/

http://loanmls.com/

http://www.biggerpockets.com

http://www.biggerpockets.com

https://www.linkedin.com/grp/home?gid=3900405


buyers are looking for a borrower that has a longer pay history. If an investor buys a low equity or no-equity note, they could also wait for the equity to come back in the marketplace and flip the note for a higher price.

Selling a Partial Note

Another recapitalization strategy allows a note owner to sell part of their note to an investor where the amount, term, and interest rate may align with exactly what they want in a note and can afford. For example, with a 15 year note, if one investor didn’t have the available capital or preferred a note with a shorter term, they could purchase the first 10 years of monthly payments from a current note owner. By doing so, the current note owner would reclaim their initial note investment, while still remaining entitled to the last 5 years of payments. This option can benefit both the partial note investor and the note owner.

Benefits for the Investor buying the partial•• Partial notes limit the amount of money invested since they

only require a portion of the total cost of the note.•• Due to partial notes containing only a portion of payments,

this shortens the term for the investor and returns their capital in a much shorter time span.

•• In the event of a foreclosure, the investor is the first to get paid.


Benefits for the note owner selling the partial•• A note owner will regain a portion of their initial investment

capital bac k after a partial note is sold, leaving them with less risk in that particular note. That capital can then be reinvested in another opportunity.

•• If interest rates rise in the future, a shorter period of full ownership reduces inflationary risk.

•• The overall risk is cut in half because the investor and note seller share the risk of the note together.

•• If a note owner had a note that wasn’t fully covered by equity they could still sell a partial or the portion of the note that was backed by equity.

Collateral Assignment of Note and Mortgage

A Collateral Assignment of Note and Mortgage enables a note owner to borrow money from an investor and use their note as collateral (Once again, capitalizing on the idea of leverage). Very similar to a car loan where the car acts as collateral for the loan, a collateral assignment is done by using a promissory note between a note owner and their investor, spelling out the terms and interest rate on the new loan. This recording will “perfect” or permanently attach the collateral that’s being used to protect the new lender. The velocity factor comes in when the note owner uses this borrowed capital to purchase more notes, again utilizing leverage, creating


exponential growth. Also it’s a great way to recapitalize tax free because it’s a loan, just like a real estate investor refinancing a rental property.

In fact, it was this exact type of leveraging that we used to build our business. After our first few notes, some of which we flipped and others we held onto for the long term cash flow, we decided to do something different. When we began our business the note industry was even more of a niche field than it is today, so finding buyers for all of our notes was tougher than we first imagined.

Raising capital to purchase more pools of notes was still a challenge, so when we discovered Collateral Assignments we found a way to solve both of our problems. Using our previous private money contacts in the real estate industry, we came up with the solution: borrow against our notes that had equity, creating new private notes with hard or private money investors. We would then use these performing note as the collateral for our new private loans, purchasing new notes with tax free capital. Now we were moving and reinvesting private equity much like a bank leverages depositors money, creating a both a profitable recapitalization strategy and a source of capital to buy more notes.


Part 8

sources of caPItal for notes

For note buyers looking to purchase a performing note that has equity, current senior lien status (in the case of buying a 2nd lien), significant pay history, or other desirable qualities, one needs to understand that these conditions come at a price. These elements can make notes a capital-intensive business, and as with any business, learning how to find or effectively raise capital can be the best way to grow exponentially. I talked a lot about the use of leverage and how I used it to grow my note business, but it isn’t always necessary for everyone. In fact, here are a few examples where an investor wouldn’t need leverage:

•• Savings: The first place most people will turn to for capital is their savings. Many people have a certain amount of money tucked away in a low yield savings account. This money is essentially stagnant, hardly earning enough in interest to cover inflation.

Although some people may be uncomfortable removing money from their savings, it is important to consider that the return available on a note is drastically higher than that which is available from most savings accounts. Also, with many different ways to sell or recapitalize on a note, they can be a fairly liquid asset.


•• Retirement Funds: Self-directed accounts such as Individual Retirement Accounts (IRAs), Education Savings Accounts (ESAs), Health Savings Accounts (HSAs) and even 401(k)’s can provide another resource for capital. Many investors who hold a day job or have earned income of some kind have paid into a 401(k) for a number of years and built up quite a balance. In many cases money from accounts like these can be used to purchase notes. Each retirement account is different, and it is important to understand the rules governing any such fund. This is especially the case with any self-directed accounts.

•• Assets: Stocks, collections, insurance policies or personal financial assets that can be liquidated are another wonderful source of investment capital. Whether it’s gold coins or foreign stamps, liquidating these assets can transform static capital into a performing note that provides monthly income.

Using Leverage to Buy Notes

After most investors purchase their first note or first few notes, they may run into the challenge that my businesses faced early on: the need for more capital. After our first batch of notes we got together and started raising capital to buy more product. We started with friends and family, then eventually, leveraging our notes as well as the capital we raised to purchase even more notes. Aside from collateral assignments of mortgage, there are a few other ways that


leverage can be used to obtain notes:

•• Loans and credit cards: Borrowing capital is another strategy that investors can use to gain resources to buy notes. However, this option carries the risk of becoming over-leveraged, with interest fees and penalties that can occur with these types of transactions. Unless an investor has other assets to pay off a credit card or loan, a possible note default can make investing this way a riskier endeavor. That being said, using this source of capital can still be a viable strategy especially if a note buyer has access to low interest loans.

•• Home Equity Loans: Similar to a traditional mortgage but usually with a shorter term and a higher rate, Home Equity Loans generally come in two varieties. One is usually for a fixed term and fixed payment, and the other takes the form of a line of credit or HELOC (Home Equity Line of Credit) with a variable rate and a fixed draw period. A home equity line of credit is a loan that uses the equity in a home as collateral for additional leverage.

•• Partnerships: Although most investors start by simply purchasing one or two notes, others want to progress rapidly and begin buying multiple. At a certain point, investing in notes can become more than a personal project and evolve into


a business. In this case an investor must start a partnership or create what is known as a private placement.

A partnership consists of a group of investors getting together, pooling their money, and creating a partnership agreement. A group of investors can also start a private placement and collect money from people outside themselves to purchase notes. The greatest benefit to the partnership is that investors will have increased buying power, better pricing, and economy of scale, all while deploying a limited amount of their own capital. Alongside utilizing collateral assignments, we used this strategy simultaneously to purchase notes in the beginning, and we still do it today.


Part 9

HoW to get started In real estate notes

When a note investor finds themselves at the final step in the note cycle, what they’ve actually done is arrived at the beginning again: finding capital for the next purchase to start the whole process over. The only difference is hopefully this time around they will start with more affordable capital, a reliable source of product, better data to make a more profitable trade, a knowledge of the workout or loan modification process to create superior deals for both themselves as well as the borrower, and the willingness to do it all over again.

Fast forward several years from our little money-raising problem and that’s where PPR is today; now working on our business instead of just in it, we have far surpassed my initial goal of 100 notes and are looking to teach others the path to finding success in the note business. Now, not everyone is able to or even interested in going through our exact same journey, nor should they. Like with any industry, there is no one size fits all way to become successful with notes and it all comes down to where you would like to be in the industry.


What Kind of Investor Are You?

Before starting to search for available notes to purchase, it’s important for an investor to ask: “Where do I see myself in the note business?”

As with real estate and other types of debt investing, notes offer limitless possibilities for investors. Sometimes these possibilities reveal themselves while working in other aspects of the industry, but to start to determine this niche, it’s a good idea to visualize an endgame. This endgame could be a business, becoming a part time investor, making retirement money, or simply supplementing income. When it comes to choosing a note niche, it is helpful to start by evaluating risk tolerance, knowledge level, time commitment, and available capital to deploy.

Fund Investing

The simplest solution for many investors is to invest in a note fund. This is where a company or group of investors attempt to diversify their risk by combining their money together into a fund to buy a tape or pool of mortgages. An investor can passively invest capital with one of these funds and expect recurring cash flow in the form of a preferred return. Although some funds allow unaccredited investors, the majority accept capital solely from those who are accredited. Currently, accredited investors are those who


meet the criteria of income of $200,000/year if single or $300,000/year if married or who have $1 million in net assets, not counting their primary residence. Some note funds may also allow up to 35 unaccredited “sophisticated” investors as well. For more detailed information on the full SEC regulations, consult http://www.sec.gov. Fund investing offers limited time commitment and liability, as well as fewer constraints on how much capital can be deployed -- often times with a comparable return to performing notes.

Note Investing

For those who are unaccredited or wish to invest in multiple options, investors can also of course purchase non-performing and/or performing notes. Performing note buyers generally need more capital to purchase notes but much less expertise and time commitment to own and maintain their portfolio versus non-performing note buyers. With either option, investors can become the bank and utilize high yield assets, all secured by real estate.

So whether you’re a high net-worth individual who is looking for mailbox money from a note fund, or a more hands-on investor looking to use leverage to build a portfolio of passive cash-flowing assets, notes are an alternative investment that offer a clear path towards financial freedom.

http://www.sec.gov

http://www.sec.gov


Continuing Education

Whether through Non-Performing Notes, Performing Notes, or any combination of the two, an investor’s journey to building wealth with notes begins with education. Reading and studying this book is a great first step to learning about the note business. Another valuable resource to learn more about note investing is BiggerPockets. With over 300,000 members, BiggerPockets is one of the most respected and useful online real estate networking and information resource platforms on the web.

The BiggerPockets Blog features articles from writers the world over working in various aspects of the industry. Alongside many other accomplished investors, I personally write a blog on the site dedicated to note investing, real estate investing, and other strategic investing techniques that can serve as a great catalyst to start learning about the note business. BiggerPockets also features a robust forum with over 1.2 million posts, and even a message board dedicated to note investing, called the Tax Liens, Notes, Paper, & Cash Flows Discussion Forum. This is a great place to ask questions and learn from others who are not only just starting out in the business, but other experienced note investors on the site.

Other online resources include one that PPR started, the Distressed Second Mortgages Group (DSMG) on LinkedIn, where many investors actively buy and sell notes, as well as post pertinent

https://www.biggerpockets.com/forums/70-tax-liens-notes-paper-cash-flows-discussion

https://www.biggerpockets.com/forums/70-tax-liens-notes-paper-cash-flows-discussion




news on the industry. And for the in-person networker, we’ve also created an offshoot of the DSMG group on Meetup, where we list many of our future events. And don’t forget to try and check out some of the note conventions across the country, and be sure to ask others on BiggerPockets which events and programs they are going to attend and/or have enjoyed. Having a general knowledge of the industry is important, but like most investments, notes are a learn-by-doing business. You can’t learn it all from a book or a course, an investor must eventually take the leap and purchase a loan for themselves to truly learn the ins and outs of the industry.

To learn more about getting started in note investing go to:www.PPRNoteco.com/resources

http://www.meetup.com/Distressed-2nd-Mortgages-Group/

http://www.pprnoteco.com/resources/


Part 10

faQs

Here are a few of the most frequently asked questions about notes. For a list of terms and definitions, our glossary can be found at the end of this book.

Q: What’s the difference between investing in non-performing notes and performing notes?

A: Aside from the fact that performing notes are receiving payments, the main difference between the two classes of notes is usually how much time is spent to collect a profit and how much risk is involved with each. Performing notes can be a safer, much more passive way to invest, whereas non-performing notes are considered much more active, requiring a more significant time commitment and higher level of risk tolerance.

Q: Why are notes discounted?

A: Notes may be discounted for a variety of reasons, such as performance, value, condition, and status of the property.

Q: How is my note investment secured?

A: When a note and mortgage (or deed of trust) is first originated,


the recording of the mortgage perfects the collateral (the property) for the bank. If and when the note and mortgage are ever sold by the bank in the future, a new assignment of mortgage is drawn up and recorded in the county courthouse where the mortgaged property is located. Once recorded, this transfer of the mortgage to a new owner is now public record.

Q: What do I do if my note stops performing?

A: If a performing note is purchased directly from PPR, it is immediately covered by a performance note warranty. In this instance, PPR will attempt to get the asset re-performing within a six month period or will issue a cash refund and/or note credit for the remaining principal investment (minus payments received) in exchange for the return of the non-performing note and collateral. If the note is purchased from another source, the note buyer would typically initiate legal action and work the loan like any non-performing note.

Q: What do I do if a borrower pays off the performing loan early?A: This is a common outcome with the majority of performing notes since the average mortgage is only kept for 5 to 10 years. When the note is paid off early, the note owner should record a satisfaction of mortgage. This document states that the property is no longer collateral for the loan because the term of the loan has ended or the borrower has transferred ownership of the property.


Q: How can I sell a performing note?A: Notes can be sold in a variety of ways, either by individual investors or through online venues such as FCIexhange.com, LoanMLS.com, or the Distressed 2nd Mortgages Group on LinkedIn, as well as other traditional bidding sites such as Auction.com.

Q: How long is a workout meant to last?A: Every workout is different, and timelines vary from case to case. Many times loan modifications are longer than the original term to adjust for back payments and arrears, while still having payments remain affordable for the borrower.

Q: Can I Invest in Notes While Working a Full-Time Job?A: You can certainly be successful investing in performing notes part-time because the servicer really does the bulk of the work, from collecting the borrower payments to accounting and tax reporting. The same can be said with non-performing notes when an investor employs a servicer, but in the case where an investor is properly licensed, it is still possible to work notes with a full-time job.

Q: Can I Invest in Notes With No Money?A: It does require capital to buy notes, but the short answer is no, you don’t need any of your own money. Many companies are built by pooling investor capital, for example private equity by selling shares. You can also raise capital through debt, for example using a



http://www.loanmls.com/


http://www.auction.com/residential/

http://www.auction.com/residential/


business line of credit.

Q: Is it possible to educate myself on the note industry?A: The short answer is yes. There is plenty of educational material readily available on the note industry, but notes are a learn by doing business. It isn’t until somebody goes through the process of buying, maintaining, and owning a note, that they truly learn about notes.

Q: What are tax implications of note investing?A: Although PPR Note Academy doesn’t give out accounting advice, when you’re owning an individual note and receiving payments, the interest portion of monthly payments are taxed as interest income. If you sell or cash-out of a note, it’s either a short-term or long time capital gain/loss depending on whether you own the note longer than a year and a day.


Part 11

note InvestIng glossary

Organized alphabetically

Accounting – The systematic recording, reporting, and analysis of financial transactions of a business. In the Note Business it specifically refers to the payment history and billing information of a note[sm1] .

Accredited Investors–(A) A natural person who has individual net worth of, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase.(B) A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years, and the reasonable expectation of the same income level in the current year. For more information on the specific requirements, see: http://www.sec.gov/answers/accred.htm

After Repaired Value (ARV) – The projected value of an “as is” property that needed work after it is renovated.

Amortization – Paying off a debt by making regular installment payments over a set period of time, at the end of which the loan balance is zero.

http://www.sec.gov/answers/accred.htm


Appreciation – The increase in value of property over a time period or the difference between the original value of the property and the new value.

Arrears – An outstanding amount of money owed. For example, with delinquent loans it may include missed payments, late fees, and any corporate advances per the loan documents.

Asset Manager - A person who negotiates with homeowners to resolve their delinquent loan status.

Assignment – A written document by which property, other than real property, is transferred from one person to another. Assignment of mortgage, assignment of deed in trust, assignment of lease, assignment of rentals, etc. are common assignments. The “assignee” receives the property assigned.

Assignment Chain – A series of written transfers from one party to another based on the order of ownership of a note.

Bailee Letter – A letter that identifies an individual who temporarily gains possession, but not ownership, of property under a contract or bailment.

BPO – Broker Price Opinion. Estimate of probable selling price of a residential property based on selling prices of comparable properties in the area. It’s a broker’s opinion of the value of a property in the current market. Also known as, a “Drive By” appraisal.


Billing Statement – the monthly bill sent by a lender/issuer to the customer. It gives a summary of activity on an account, including balance or payoff, payments made, credits, finance charges and late fees.

Capital – Money available for investment.

Cash-on-Cash Return – A rate of return often used in real estate transactions. The calculation determines the cash income on the cash invested: Cash on Cash Actual Dollar Income Return = Total Dollar Investment. Cash on Cash Return would measure the annual return you made on the property or note in relation to the down payment or investment.

Cash out – When a note’s UPB and any arrears/fees are paid off early, either in full or for a discounted amount.

CLVT – Combined Loan to Value – is a mathematical calculation which expresses the amount of a first mortgage lien plus the second mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower owes the First lender $80,000 and the second lender $50,000 and the house is worth $150,000, the CLTV ratio in this scenarios is $130,000/$150,000 or 87%.

Collateral – Property, real or personal, pledged as security to back up a promise, usually a promise to repay debt. In the note business, this refers to all paper files including note, mortgage,


loan application, appraisals, and accounting. Altogether these documents make up what is known as a “Collateral File”.

Collateral Assignment – An additional separate obligation attached to a contract to guarantee its performance such as by agreeing to transfer certain property or valuables to insure the performance of contractual agreement.

Collections – The efforts a lender takes to collect past due payments.

Corporate Advance – An advance in fees paid by a lender on behalf of the borrower. For example, when the lender pays to bring delinquent taxes current or for “forced placed insurance” on a property.

Credit Report – A detailed report of an individual’s or company’s credit history prepared by a credit bureau and used by a lender to determine a loan applicant’s creditworthiness. This record includes past borrowing and repayment history, including information about late payments and bankruptcy.

Debt Service – The sum of money needed each month of the year to amortize the loan or loans.

Debt-to-Income (DTI) – A calculation frequently used by mortgage companies when qualifying borrowers for a mortgage or a workout solution to resolve delinquency. It is calculated by


comparing how much a borrower pays on their mortgage(s) to their gross monthly income.

Deed – A signed and delivered document that proves ownership of real estate.

Deed in Lieu – An option in which a borrower voluntarily deeds collateral property in exchange for a release from all obligations under the mortgage.

Deed in Lieu of Foreclosure – The transfer of title from a homeowner to the mortgage company to satisfy the mortgage debt and avoid foreclosure; also called a “voluntary conveyance.”

Deed of Trust – The security for a loan. The document that is recorded in the public records. A deed of trust contains three parties: Borrower, Trustee, and Beneficiary. The deed of trust is an instrument that identifies the following: Original loan amount, Legal description of property being used as security, the parties, Inception and maturity date of loan, Provisions of the mortgage and requirements, late fees, Legal procedures, Riders.

Default – A borrower is in default when they fail to meet the terms of their loan agreement. Usually this is based on the failure to make payments on time.

Delinquent – Behind in payments. A delinquent mortgage is one that is more than 90 days late.


Depreciation – A reduction or natural decline in property value due to the passage of time, market forces, depletion of resources, and wear and tear.

Due Diligence – The process of investigating or auditing a potential investment. With notes, due diligence serves to confirm all material facts in terms of equity, market factors, compliance and legal issues, and occasionally title.

E & O Insurance or “Errors and Omissions” Insurance – A policy designed to protect professionals, such as lenders or realtors’ clients from malpractice or error.

Ejectment – Forced eviction process of a homeowner after Foreclosure.

Emotional Equity - A borrower’s emotional attachment to their property. This may exist even when the amount owed exceeds the value of the property.

Equity – the value of an asset less the value of all liabilities on that asset.

Escrow – a bond, deed, or other account kept in the custody of a third party, taking effect only when a specified condition has been fulfilled. For example, an account held by the lender or note owner where a homeowner pays money toward taxes and insurance of a home.


Escrow Analysis – A periodic review of escrow accounts to make sure that there are accurately sufficient funds to pay the taxes and insurance on a home when they are due.

Eviction – The action of expelling someone as the result of the judgment of a court.

Exception Report – essentially a collateral inventory report, usually done by a third party document custodian, that is used to reference any documents that may be missing.

Face Value – The original loan amount for the issuer of the note.

Fair Market Equity (FME) - the amount of equity backing the note. With second mortgages, FME it is calculated by subtracting the Senior Lien from the Fair Market Value (FMV).

Fair Market Value (FMV) – A subjective estimate of what a buyer would pay a seller for a given asset.

Fixed-Rate Mortgage – A mortgage loan in which the interest rate remains the same for the life of the loan.

Foreclosure (FC) - the legal process by which a borrower in default under a mortgage relinquishes his or her interest in a mortgage property. This usually involves a forced sale of the property at public auction with the proceeds of the sale being applied to the mortgage debt.


Gross Return or Gross Profit – The return or profit prior to taking out any expenses or costs.

Home Equity Line of Credit (HELOC) - A line of credit that’s based on a percentage of the equity in a property.

Indicative Bid – Preliminary bid on a pool of loans prior to a complete verification of data.

Institutional Note – A note originated by a financial institution, as opposed to a “private note” originated by an individual.

Investment Property – A property not considered to be a primary residence that is purchased by an investor in order to generate income, gain profit from reselling or to gain tax benefits.

Junior Lien – Another name for any lien subordinate to the senior lien.

Leverage – the principle of increasing one’s yield through borrowing money.

Lien – A form of encumbrance which usually makes specific property security for the payment of a debt or discharge of obligation such as judgments, taxes, mortgages, deeds of trust, etc.

Line Of Credit - See Home Equity Loan. A loan sometimes called a “line of credit” where an owner uses his or her residence as collateral for a loan which permits the draw of funds up to a present amount.


Loan – A granting of the use of money in return for the payment of interest and principal.

Loan Level Buyer – A buyer of loans who has the leeway to choose individual loans from a pool, usually for a premium.

Loss Mitigation – a process used by mortgage lenders to work with buyers who are delinquent on their home loans. Through the loss mitigation process, a lender may modify the terms of a home loan, allowing the homeowner to sell the property for less than is owed, or transfer the deed back to the lender.

Loan Modification – Also may be referred to as a “Workout”. Any change to the terms of a mortgage loan, including changes to the interest rate, loan balance or loan term.

Loan Originator – A primary lender, often used interchangeably with loan officer. A seller of mortgages in the secondary market.

Loan Sale Agreement - Also known as Purchase Sale Agreement (PSA) or Note Sale Agreement (NSA). A contract used to establish the purchase of a note.

Loan Servicing Company –The acts performed to collect and process loan payments during the life of the loan. They include billing the borrower, collecting payments of principal, interest, and payments into an escrow account, disbursing funds from the escrow account to pay insurance premiums and taxes, and


forwarding funds to an investor if the loan has been sold in the secondary market.

Loan Pool – Large group of loans. Also known as a “tape” or “tranche.”

Loan to Value (LTV) - The percentage of loan amount in proportion to the value of the collateral used to secure the loan.

Maturity Date – The date on which an issuer of a mortgage promises to repay the full amount borrowed.

Mortgage – A conveyance of or lien against property (as for securing a loan) that becomes void upon payment or performance according to stipulated terms.

Mortgagee – The lender of money and the receiver of the security in the form of mortgage.

Mortgagor – The borrower in a transaction where the real property is used as security for the loan.

Note (Secured) – Notes are “secured” by the loan in a document known as a mortgage or a deed of trust. These documents are recorded as being liens against the property. The purpose of recording these liens is twofold. First, they establish the priority of the lien, and second, they put the public on notice that the lien exists. In this manner, a prospective lender can determine


the potential priority of lien of any proposed financing. A typical condition of any loan commitment is the payment in full and discharge of any and all prior liens before, or simultaneous with, the recordation of the new loan.

Note (Unsecured) - No collateral or equity backing the original promissory note.

Non-Performing Loan – A loan that is in default or close to being in default. Many loans become non-performing after being in default for three months, but this can depend on the contractual terms.

Owner Financing - a property purchase transaction in which the property seller provides all or part of the capital to the buyer in the form of a mortgage.

Partnership – A business organization in which two or more individuals manage and operate the business, in the note industry a partnership can be used to pool together money in many different ways to purchase notes.

Payee – A person to whom a note states is payable.

Payment Status – The status of a loan. For example, current, late or past due, delinquent, active foreclosure, etc.

Payoff - Amount of the Unpaid Principal Balance plus any missed payments, interest, late fees, and corporate advances.


Payoff Statement -The document signed by a lender indicating the amount required to pay a loan balance in full and satisfy the debt; used in the settlement process to protect both the sellers’ and the buyers’ interests.

Payor – A person who signs a note agreeing to pay the amount owed.

Pay History – A record of a borrower’s past payments, used to determine a note’s classification and pricing. A longer history usually shows a more reliable, committed borrower

Performing Loan – A loan on which payments of interest and principal are less than 90 days past due.

Phantom Appreciation - Also known as Upside Potential. When a partial equity loan is purchased at a discount and the equity in the underlying collateral increases enough to back or exceed the face value of the note.

Private Money – funding that comes from private individuals, friends, family, IRA’s or any source other than institutional or conventional means.

Private Note – Note originated by someone other than a financial institution or bank.

Private Placement – Raising of capital via private rather than public placement. The result is the sale of securities to a relatively


small number of investors.

Rate of Return (ROR) – Also known as ROI (Return of Investment) is a profit on an investment over a period of time, expressed as a proportion of the original investment.

Recapitalization – Getting your investment capital back so you can redeploy it.

Recoverable Revenue – Also known as Targeted Revenue. The amount of money or revenue that is expected to be generated from an individual note or pool of notes at the time of due diligence or purchase.

Refinance – A new mortgage that replaces the current mortgage with new terms, interest rates and monthly payments.

“Rehab a Note” – To take a non-performing note and make it re-performing, usually through a workout or loan modification with the borrower.

Reinstatement – The process of remedying a default so that a lender will view the loan as current.

REO - Real Estate Owned, usually by a financial institution or lender after a foreclosure or “deed in lieu” situation.

Repayment Plan – A homeowner promises to pay down past-due amounts on a mortgage over a specified time period, usually while


still making regular monthly payments.

Re-Performing Note - A once delinquent or non-performing note that has since gone through a workout or loan modification and is now performing.

RESPA (Real Estate Settlement Procedures Act) – RESPA requires that borrowers receive disclosures at various times, outline lender servicing and escrow account practices and describe business relationships between settlement service providers.

RESPA Letter – Also known as a “hello” or “goodbye” letter, that’s required to be sent to the borrower by the previous lender and the new lender whenever a loan and mortgage is sold or transferred. In the case of implementing a new servicer, this letter notifies the borrower and gives them important contact information of the new loan servicer.

Satisfaction of a Mortgage - An act of recording a document that acknowledges the full repayment of the debt and which discharges the lien of a mortgage or trust deed.

Seasoning – An asset that has been held for over a year with a good payment track record.

Senior Lien – Any lien or mortgage having claim before any other lien or mortgage.


Self-Directed IRA – A retirement account in which the owner is allowed to make investment decisions and investments on behalf of the retirement plans. IRS regulations require that either a qualified trustee or custodian hold the IRA assets on behalf of the IRA owner.

Servicer – Party that collects principal, interest, and escrow payments on behalf of the investor.

Short Sale – A Type of pre-foreclosure sale in which the mortgagee agrees to let the borrower sell the property for less than the full amount due and accept the proceeds as a payment in full. The sale of the property at a fair market price that is lower than the loan balance(s).

Speciality Servicer - A company hired to collect on mortgages that are either delinquent or in default.

Title – The documented evidence that a person or organization has ownership of real property.

Truth in Lending Act (TILA) - Implemented by the Federal Reserve through a series of regulations with the intention of protecting consumers in their dealings with lenders and creditors. The most important aspects of the act concern the pieces of information that must be disclosed to a borrower prior to extending credit.


TILA Letter - A letter used to Notify the borrower of the change in ownership of the their loan.

Unpaid Principal Balance – A portion of a mortgage loan at a certain point in time that has not yet been remitted to the lender.

“Upside Down” or “Under Water” – Usually refers to a secured loan or mortgage that doesn’t have sufficient equity to fully secure the property or note.


Dave Van Horn serves as President of PPR, a Note Company, managing several funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 25 years of residential and commercial real estate

experience as a licensed realtor and a previously licensed life and annuity insurance agent, before moving on to raising capital for commercial real estate deals. He is an avid investor in notes and mortgages, as well as a long-term holder of multiple investment properties. In addition to facilitating mentorship through PPR Note Academy, Dave travels to many RE meetings and networking events as a national speaker on delinquent notes.

***All information provided by PPR Note Academy in this book and by its employees is not to be interpreted as legal advice; PPR Note Academy is not a law firm or a certified public accountant and does not hold itself out to be. PPR Note Academy and its employees attempt to provided general information/ideas on issues commonly encountered by Clients. Requests for legal or technical opinions should be directed to your attorney or accountant. All information is subject to change and

is not deemed to be guaranteed. ***

Documents

IntroductIon to note InvestIng€¦ · Introduction to Note Investing by Dave Van Horn 5 it all. On the first day of class, he took out our textbook and said, “There’s nothing