People spend cash on real estate for a variety of reasons. Probably the most common reason for spending any cash at all is that the bank making a new mortgage on the property requires a cash down payment or it won't approve the mortgage.
Some people make the biggest cash down payment they can to keep their monthly mortgage payments lower. Others try to pay with as much cash as possible because they don't want to pay interest on borrowed money. And some folks, especially those who remember the Great Depression, prefer to own their property free and clear of any debt.
However, what most cash-paying real estate buyers don't realize is this: Equity in real estate and cash are not the same thing. There is a fundamental difference between the two. While cash goes into the equity market at full value, equity comes back out into the cash market at a discount. Equity is not a liquid commodity and does not move very quickly. Cash is absolutely liquid. It is important to understand this difference.
To illustrate this dynamic difference, let's assume we have $100,000 in cash to buy a piece of property. We find a well-priced home for that amount. We pay cash for it, close escrow and it's ours free and clear. Now, can we break off a piece of the roof and buy groceries with it? Can we take the front door and use it to pay our doctor bill? The answer is "no" because cash is not the same as equity.
We've converted our cash from the cash marketplace, at full value, into $100,000 worth of equity in the real estate market. Soon after the purchase, however, a financial emergency arises. Having no other cash in reserve, we must convert our equity back into cash immediately. We have to sell the property today.
To convert our equity into immediate cash, we need a buyer for the property right now. Finding a buyer willing to pay full cash value for the equity might reasonably take 60 days to six months. Add to that another 30 to 60 days to close the transaction and, when we total it up, it's going to take a long time. And that's if everything goes smoothly.
But we need immediate cash not maybe in six months. To get immediate cash, there are two options available to us. First, if we structure the offer attractively enough, someone will buy our property today. The most obvious way to do that is to reduce the price to an amount that no serious buyer could refuse.
Depending upon the stability of the real estate market, that could mean discounting the price by as much as 35 to 50 percent. That's 50 to 65 cents on the dollar! Now, would you take your dollar bills to the bank and trade them in for the same number of fifty-cent pieces? Would you trade in 1,000 dollar bills for $650? Most likely, you would not. Yet, that's the price we have to pay to convert our equity into cash right now.
Our other option is to refinance the property. We can refinance and get some of our cash out that way. Here again, the full $100,000 equity will not be converted into the same amount of cash.
If you have excellent credit, you may be able to borrow as much as $80,000 against the property. If you have less than excellent credit, or poor credit, you won't get a mortgage for anywhere near $80,000. If your credit is really bad, banks won't loan you a dime on your property.
In both instances, we are faced with the same problem. Everyone agrees the equity in the property is worth $100,000. To convert it to cash, though, we must discount that equity.
Now that you understand the difference between cash and equity, you should always think twice before you exchange very much of your liquid cash for real estate equity. Knowledgeable investors use a variety of creative methods to overcome this dilemma.
Showing posts with label notes. Show all posts
Showing posts with label notes. Show all posts
Sunday, June 27, 2010
Making Real Estate Money-Discounted Notes | No Money Down--Cash Back at Closing
This article will suggest the most creative way to buy real estate with discounted notes. It is a wonderfully intriguing method. Even if you cannot do this exactly, you will still have the very real possibility of trading notes you bought at a discount for full face value on a piece of property. These ideas come from such innovators as Joe Land, Pete Fortunato, and others.
The scenario
First, consider that there is a $160,000 duplex for sale with a $40,000 first trust deed on it. The owner of the property, Sally Seller sells the duplex to Paul Payor. Paul puts down $40,000 cash, he assumes the $40,000 first mortgage, and Sally agrees to carry back an $80,000, 30-year second mortgage. She is happy with the extra income from the second mortgage, and the $40,000 cash down payment.
Second, consider the older, conservative home owner who owns his home free and clear, Harry Homeowner. He decides to sell the home. He does not need all the cash but would like to have a steady income for retirement. Their home is worth $100,000., so Harry and his wife advertise that they will sell their home with a 20% cash down payment, and they are willing to carry an $80,000 first mortgage.
Third, reconsider Sally Seller who has been receiving payments on her $80,000 note. She is offered a chance to buy a share in a restaurant with a friend. She is excited about the opportunity, but has spent all of her money including the down payment she received. She is not able to borrow the cash to invest.
The only asset she owns is the $80,000 note. She calls you, Ned Notebuyer (or Nancy Notebuyer). You offer Sally Seller $48,000 for her long-term $80,000 note, which she gladly accepts after you skillfully explain to her the discount she must take on this very long-term note.
Second, consider the older, conservative home owner who owns his home free and clear, Harry Homeowner. He decides to sell the home. He does not need all the cash but would like to have a steady income for retirement. Their home is worth $100,000., so Harry and his wife advertise that they will sell their home with a 20% cash down payment, and they are willing to carry an $80,000 first mortgage.
Third, reconsider Sally Seller who has been receiving payments on her $80,000 note. She is offered a chance to buy a share in a restaurant with a friend. She is excited about the opportunity, but has spent all of her money including the down payment she received. She is not able to borrow the cash to invest.
The only asset she owns is the $80,000 note. She calls you, Ned Notebuyer (or Nancy Notebuyer). You offer Sally Seller $48,000 for her long-term $80,000 note, which she gladly accepts after you skillfully explain to her the discount she must take on this very long-term note.
Buy a $100,000 house for $68,000
Think for a moment about this situation. You have Harry Homeowner who wants an $80,000 note and Sally Seller who wants to sell her $80,000 note. The only person missing from the picture is you, Ned (or Nancy) Notebuyer!
Your obvious solution to helping the two parties is, perhaps, shortsighted. You are saying, "Great, I will buy the note from Sally Seller for $48,000 and trade it to Harry Homeowner for the full $80,000. If I give Harry Homeowner $20,000 cash down, and he agrees to accept Sally's note, I will have bought a $100,000 house for $68,000." ($20,000 down plus $48,000 for Sally's note.)
"Terrific," you say, "but this costs a lot of money". You would need $68,000 in cash. Can you think of a way to consummate this transaction with no cash??
Your obvious solution to helping the two parties is, perhaps, shortsighted. You are saying, "Great, I will buy the note from Sally Seller for $48,000 and trade it to Harry Homeowner for the full $80,000. If I give Harry Homeowner $20,000 cash down, and he agrees to accept Sally's note, I will have bought a $100,000 house for $68,000." ($20,000 down plus $48,000 for Sally's note.)
"Terrific," you say, "but this costs a lot of money". You would need $68,000 in cash. Can you think of a way to consummate this transaction with no cash??
Make a great deal even better
First, you must convince Harry Homeowner to take back a note on a property other than his own. He was expecting to have a mortgage on his own home. But you can point out to him that by taking the second mortgage on the duplex he has more equity protection and a seasoned note.
He has no idea how you, the new buyer, will perform on the loan. But Sally Seller's loan is several years old and is well seasoned with a good payor. After seeing Paul Payor's credit report and his payment record, Harry agrees to accept Sally's note from you. If Harry is willing to sell you his house and accept Sally's note, then his house if free and clear.
If you are buying Harry's house, and it is free and clear, you can get new financing! You go to the bank, and the bank says they will loan you $80,000 if you will make a $20,000 payment. You say okay, and perhaps show the note as your down payment.
He has no idea how you, the new buyer, will perform on the loan. But Sally Seller's loan is several years old and is well seasoned with a good payor. After seeing Paul Payor's credit report and his payment record, Harry agrees to accept Sally's note from you. If Harry is willing to sell you his house and accept Sally's note, then his house if free and clear.
If you are buying Harry's house, and it is free and clear, you can get new financing! You go to the bank, and the bank says they will loan you $80,000 if you will make a $20,000 payment. You say okay, and perhaps show the note as your down payment.
I'll take the leftovers, please
All parties agree to the deal, and you go to escrow to close the purchase of Sally's note, and the purchase of Harry Homeowner's house. The bank has given the escrow officer a check for $80,000 secured by the house you are purchasing from Harry. The escrow officer writes a check for $48,000 to Sally Seller for her note.
The escrow officer then writes out a check for $20,000 to Harry Homeowner and gives him Sally's note. She transfers the house to you with the $80,000 mortgage on it. She writes out a check for $4,000 in closing costs to the bank. She then says to you: "Wait a minute, I still have $8,000 left! What should I do with that?" You raise your hand and say, "I'll take it!"
You have picked a home with $20,000 equity, you have $8,000 in cash, and you have spent none of your own money! The lesson is that real estate notes bought at discount can trade at full face value in the real estate market. Great profits can be made if you learn this lesson.
The escrow officer then writes out a check for $20,000 to Harry Homeowner and gives him Sally's note. She transfers the house to you with the $80,000 mortgage on it. She writes out a check for $4,000 in closing costs to the bank. She then says to you: "Wait a minute, I still have $8,000 left! What should I do with that?" You raise your hand and say, "I'll take it!"
You have picked a home with $20,000 equity, you have $8,000 in cash, and you have spent none of your own money! The lesson is that real estate notes bought at discount can trade at full face value in the real estate market. Great profits can be made if you learn this lesson.
About the author...
Jon was a licensed real estate broker, long time real estate investor, and an expert in finding, appraising, buying, and brokering discounted notes and mortgages. He was the professor and tenured instructor of Real Estate at the College of Alameda in California.
Making Real Estate Money-Ten Simple Steps to Buying Bank Notes
As the real estate market slow down continues, and with foreclosures on the rise in most of the country, lenders are finding themselves overwhelmed with many sub-performing and non-performing loans.
Many lenders are willing to consider a "short sale" where the lender will accept something far less than what is actually owed to them. However, actually owning the debt instrument itself (the promissory note) may be more useful for the savvy investor.
So, what are "sub-performing" and "non-performing" loans?
Many lenders are willing to consider a "short sale" where the lender will accept something far less than what is actually owed to them. However, actually owning the debt instrument itself (the promissory note) may be more useful for the savvy investor.
So, what are "sub-performing" and "non-performing" loans?
Sub-performing loans
Often called a "high maintenance" account--that is an account that requires a tremendous amount collection effort in order to reason, cajole, harangue, and beseech the tardy borrowers to make their payments month in and month out.
In some cases there may be rolling late payments, back payments already added to the outstanding principal, or an existing forbearance agreement between the lender and the borrowers to stave off a foreclosure.
In some cases there may be rolling late payments, back payments already added to the outstanding principal, or an existing forbearance agreement between the lender and the borrowers to stave off a foreclosure.
Non-performing loans
These are accounts where attempts to collect have been unsuccessful and the account is simply not paying at all. It is in arrears with back payments and other expenses due.
Often, lenders in need of cash liquidity are willing to steeply discount the amount they will accept for the sale of their sub-performing or non-performing loan accounts (the promissory notes). These problematic accounts are a drain for the lender both monetarily and from a human resources standpoint.
For astute real estate investors, opportunities can be created by acquiring these secured loans, which can then be "scrubbed" up and become performing again or simply foreclose and repossess the collateral securing the loan. Lenders sell these notes to create liquidity and get these loans off their books.
Often, lenders in need of cash liquidity are willing to steeply discount the amount they will accept for the sale of their sub-performing or non-performing loan accounts (the promissory notes). These problematic accounts are a drain for the lender both monetarily and from a human resources standpoint.
For astute real estate investors, opportunities can be created by acquiring these secured loans, which can then be "scrubbed" up and become performing again or simply foreclose and repossess the collateral securing the loan. Lenders sell these notes to create liquidity and get these loans off their books.
Ten simple steps involved in buying bank notes
The mechanics surrounding the purchase of ANY real estate secured debt instrument (the note) are essentially the same whether you are purchasing from a private note holder or from a bank-type lender.
The Unity of Real Estate & "Paper" home study course contains the forms and useful documents you need. It also contains several pre-closing, closing, and post closing documentation checklists for handling such transactions.
Here are ten steps to follow:
The Unity of Real Estate & "Paper" home study course contains the forms and useful documents you need. It also contains several pre-closing, closing, and post closing documentation checklists for handling such transactions.
Here are ten steps to follow:
Verify the outstanding balance due on the note and theactual repayment terms of the note. I cannot stress enough that you MUST review the actual documents that were executed!
Verify with the seller of the note (the Assignor) the interest paid through date (or last paid date)
Verify the next payment due date.
Ascertain that the mortgage (or trust deed) is an insurable FIRST lien position loan (assuming you are buying a 1st lien). This is where a review of the existing mortgagee/lenders title insurance policy comes into play. Such a loan title insurance policy was probably issued when the loan was originated.
You also want to establish the status of the property taxes, whether they are current or delinquent, and any impound escrow funds that might be held and be transferred to you for such payment as taxes and fire hazard insurance premiums.
Confirm the value of the collateral property that secures the note (that is today's fair market value). You can do your own evaluation, or have a BPO (broker price opinion) report done, or a formal drive-by, exterior only appraisal, etc.
Get the actual mortgage (or trust deed) security instrumentassigned over to you or your entity. The assignment, once executed and recorded, will accomplish this and transfer all rights, title, and interest in the instrument to you; the assignee.
Have the original promissory note instrument endorsed over to your or your entity (making sure the assignment of the security instrument and endorsement of the note match one another). The endorsement can take place right on the actual original promissory note instrument or via a separate note allonge (an attached endorsement).
Have physical possession of the original promissory note instrument given to you. This is the negotiable instrument you are purchasing and whose rights you will be able to enforce for non-payment of the debt.
You may want to obtain an estoppel affidavit from the Assignor. They will affirm for you the actual balance and terms of the note and might be useful in a later dispute with the debtor.
Obtain notification letters to both the note payor and fire hazard insurance agent notifying them of the transfer of the note account. (These are often referred to as so called "goodbye," "welcome," and change of loss payee letters).
It would be wise to further consult with your own attorney to make sure that what you are purchasing is what you bargained for. Once you own the actual debt instrument (the note) there are a number of options available for you to pursue in an attempt to collect or get the note instrument performing.
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