As a real estate investor, you can use many different ways to make the most of your capital.
You’ve seen the fix-and-flip TV shows, and that’s something a lot of people think of when they think of real estate investing. But some investors, especially those who are looking at the coming retirement years, would rather look at real estate as something that brings them a continuous stream of income.
Banks are great at getting a continuous stream of income if they sell mortgage notes. The reason the banks are in those big buildings is because it’s a great way to build a long term investment income. And there’s no reason why a real estate investor can’t do it too.
If you’ve purchased real estate, then you’re in a great position to sell, buy or create new notes. You can BE the bank.
But banks also sell their notes – and you’ve probably seen this happen if you have a home mortgage that was suddenly sold from one service to another. You can believe that the bank made money on selling that note, or got rid of a note they didn’t want.
This is something you can take advantage of using your accruing capital from rental properties or other real estate investments.
What are bank notes?
Simply put, bank notes are a contract between parties for the lender to loan money, and the buyer to pay it back with regular amounts over a period of time, with a specific interest amount.
In real estate, that note is a mortgage and it pledges the property as collateral so the note holder can sell the property to make a profit on the investment if the payer defaults.
Why would an investor buy a note the bank doesn’t want?
Like I mentioned early, banks sell notes all the time, and buying bank notes is a widely used practice. Since investors can expect to purchase a bank note at a discount, it’s like buying the property directly FOR LESS, and then not having to be responsible for managing the property. If the mortgage is a non-performing mortgage – meaning the original buyer has failed to pay as promised – the new note holder can choose to:
- take back the property as a “deed in lieu of foreclosure” and rent it out as a landlord or sell as an REO
- foreclose using that state’s foreclosure laws and rent it out or sell as an REO
- modify the loan with the original buyer
Since many non performing bank notes can be purchased at 50% of the ARV, the new note holder usually has plenty of ‘room’ to choose the best option.
Banks often want to get rid of bad notes to allow their books to make space for new ones. It also helps them stay in compliance with federal laws that require them to have a certain amount of cash on hand for every dollar of notes they hold. When those notes go bad, and the foreclosure process is too time consuming or expensive, it’s easier for a bank to straighten out their financial balances by selling the notes.
For investors, that can be a great deal because banks will sell the note for cash for a lot less. From our perspective, this is a much cheaper way to acquire new assets than buying a foreclosure on the courthouse steps, or waiting for a bank to negotiate on a sale price for an REO. Plus, most banks won’t write down the REO value because of their up front expenses.
We’ve found that when homeowners want to stay in the home, they’re anxious to work out a modification. That can mean an opportunity for the investor to do some real good, and to arrange for some of the arrears to be paid back in order to set up the loan mod.
It gives homeowners a chance to save their home, build equity, and they usually have an emotional tie to the property that makes them a good bet to make payments. Once there’s some equity, the homeowner then can decide to stay in the home, or sell it and make a profit.
What are the risks in buying bank notes?
Let’s compare it to simple real estate investing on a house or condo. The payments are made directly to you, and you are responsible for fixing anything on the property if you have tenants or the homeowner remained in the home.
Just like a bank, if the mortgage is not being paid, you have the right to take the home and evict the tenant.
There are a number of things that can occur:
- The value of the home could go down
- You may purchase a property that has too many repairs which makes it a bad investment
- The rent does not cover the repairs and monthly maintenance
The same elements can occur with a bank note investment, although instead of being a landlord, you’re simply the bank. Instead of tenant issues, the mortgagor is usually the homeowner making regular payments.
Self Directed IRA’s
One of the greatest advantages of buying bank notes is that you can purchase them in or out of a retirement account, such as a traditional IRA, Roth IRA, or 401(k).
That allows you to quickly build money in the account on a tax-deferred based, or in the case of a Roth IRA, tax-free.
How does it work?
Let’s say the seller agrees to lend a buyer most of the purchase price, and the borrower must pay off the principal after 5-10 years. In most instances, the borrower obtains a conventional loan to keep the home.
But if the borrower fails to pay after the time period has elapsed, the note holder can legally take back the home and sell it to somebody else. The only risk the note holder has is if the net sale proceeds don’t cover the note balance.
Once an investor purchases a mortgage note they can operate as a private lender to lend money to home buyers at rates above the market. They do this by using the property as collateral.
This practice is very lucrative and attractive to investors who have obtained the note at a discounted rate.
A note investor should be comfortable with the market they deal in, and should start by buying or selling mortgage notes to people in their local market. It makes it easier to track and to follow through — if and when things go ‘south.”
With the right support team of title companies, attorneys and mortgage servicing firms to do all the technical aspects of the deal for you, the upside is building a cash-flowing portfolio that works on auto pilot when you want to retire.