5. What is in the collateral file? The collateral file should include the original promissory note and a mortgage or deed of trust. It may also include information on other transfers of ownership. It’s kind of like CARFAX for your note, and if it is incomplete then you need to find out why. 6. Does the note amount compare favorably to local rental rates? If a borrower would have to pay more to rent somewhere else comparable, they are more likely to stay in the home and pay on their mortgage note than move (which increases the possibility that your note will continue to perform). Those six points are a good start, but there are a few other factors to consider before making a final decision on a per- forming-note purchase: • If the borrower has equity, they are more likely to continue making payments and you have a better margin of safety if they default in the future. Find that margin by subtracting your purchase price from the fair market value of the house. Generally, most note investors look for an investment-to-value (ITV) ratio of 80 percent or less. • Evaluate how the cost of the note compares to the unpaid balance. The investor (you) gets a full payoff if the note pays off early. Usually, this will increase your return. If it doesn’t, think carefully before you buy. Performing Note Case Study: Pennsylvania This is an example of a performing note I bought in Pennsylvania: Unpaid Balance: $32,167.33 Term Remaining: 138 Fair Market Value: $47,000 Monthly Payment: $375 (Principal and Interest, what I receive) ITV: 48.2% My yield: 13.2%
This note shows exactly why performing notes are a valuable asset. It pays consistently, and I have never had to visit the property personally or interact directly with the borrower. I just receive a check every month.
ARE NOTES THE PERFECT INVESTMENT? Of course, no investment is perfect. Here are a few things to consider before buying a performing note: • Performing notes tend to be expensive. Pro Tip: Buy non-performing notes at a discount and work with the borrower to make the note perform again or create your own notes by marketing proper- ties you own via seller-financing. • Notes must be serviced for good record keeping and to collect your monthly payments. Note servicers typically charge between $20 and $30 a month, and you should not try to service the note your- self unless you understand and can perform the account- ing, borrower communications, and reporting to make everything legal. • Even performing notes come with a risk of default. There is always a risk of default. • There may be fewer tax benefits. Although note investing is often compared to landlording, it does not carry the same tax benefits as rental properties. In the end, it all comes down to your goals and circum- stances, but a performing note can be a good diversification with a solid passive investment. •
Bill Griesmer is the Managing Member of Stonegate Capital, which buys and sells performing and distressed notes. He can be reached at bill@stonegatecap.net This material has been prepared for informational purposes only, and is not intended to provide, and
should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
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