8 Step Mini-Course

Will your retirement fund be ready when you are?

As we can see in the image below, the stock market can deliver amazing returns.  If we invested in 2009, right after the last crash, we went on a great ride up!  That said, if we zoom out a bit, we see that the average return from 2009 to 2014 is about 2%. Of course, another time period could be chosen that shows tremendous returns in the market. However, the stock market does not care when you retire.


Is your retirement secure?
What happens to our retirement accounts when the stock market goes through one of those downturns again? All the “financial advisors” tell us to hold on, keep calm, wait and the market will go back up. While this might work if we have 10 or more years until retirement, a 2% average return doesn’t even keep up with inflation. What happens if that downturn happens right before we are ready to slow down a bit, smell the roses, and spend more time with our families?

We believe there is a much less risky alternative for growing our retirement. There is no get rich quick scheme and there are no tricks or fancy schemes. We co-invest with other families in residential Real Estate-backed mortgages. This investment vehicle delivers steady returns and the investments are backed by Real Estate.


How does someone invest in mortgages?

As we mentioned in our last email, we invest in Real Estate-backed mortgages. Let’s dig in to how it all works…

There are two loan documents created when a person borrows money to purchase a home: a promissory note, or simply, a note, and its corresponding security document. The type of security document varies by state and can be a mortgage, deed of trust, or trust deed.

Notes and Mortgages

Question: What is a promissory note?  A promissory note is evidence of a promise to pay a debt and is signed by the borrower.  The terms “loan” and “note” are often used interchangeably with “promissory note.”

Question: What is a security document?  A security document, such as a mortgage, is a document that is recorded at the county showing that the borrower pledges the property as collateral against the loan.

Should the borrower default, the lender may exercise their rights as spelled out in the mortgage document.

Trust deeds, deeds of trust and mortgages have similar wording, and have a few differences, but serve mainly the same purpose.

These loans can be bought and sold just like any other commodity. If someone were to buy at “face value” they would be paying the loan amount remaining at the agreed upon interest rate for the remaining term. Buying at a discount means that you purchase the note for less than the face value, thereby increasing your yield.


Do we pay full price for notes?

The concept of “buying at a discount” is fundamental to note investing. Let’s look at an example to illustrate the point.

Why is buying notes profitable?
Example: If we were to buy a $100,000 note at face value of $100,000 and it is paying 7% interest on a 30-year term, our return would be 7%.

As a note investor, we don’t pay face value, so we discount our purchase offer. If we were able to buy this loan for 60% of the unpaid balance, or 60 cents on the dollar, the return on our money would be 13% instead of 7%.

Considering that banks are paying roughly a whopping .2% (that’s right! 2 tenths of 1 percent) on deposits, this strategy multiplies our earnings to returns that few can show.

Buying discounted notes is a powerful way to increase our passive cash flow (or, “mailbox money,” as we call it). These high returns are why the distressed and discount note space is so attractive to us as private investors.


Why do banks sell their notes?

Banks and GSE’s (Government Sponsored Entities like Freddie Mac) are not in the business of owning Real Estate and foreclosing.  They are in the finance business–lending money at a higher rate than the rate at which they borrow it.

Why banks sell
Why would banks and GSE’s sell these notes instead of holding them?

Banks and GSE’s are not good at owning Real Estate and foreclosing. They profit on the spread–the difference between the rate at which they lend money and the rate at which they borrow.

Due to government regulations (that would take up several pages), when a borrower defaults on a loan, the lender must reserve a significant amount of money to service that loan.

When this happens, that money is no longer available to lend and costs the banks the profit that they could have earned.

With the huge volume of defaulted loans in the past half dozen years or so, lenders have found it more lucrative to sell the notes at a discount than to take them through to foreclosure.

Avoiding lengthy and expensive foreclosures (the length and expense vary by state) is one of the many reasons selling loans is a viable option for lenders.

We as investors benefit by being able to work out the loan with the borrower in a variety of ways.


How can we help the homeowner?

What do we mean by “workout” with a borrower?

We have many options to help the homeowner get back on track.

How can we help the homeowner?
When we purchase a note, we are buying the payments as well as all the original rights that are spelled out in the documents. These rights include the right to modify or change the loan with the permission of both parties, and the right to renegotiate or foreclose.

Here is a link from Guild Mortgage that lists a variety of workout options.
Borrower Workout Options

In most cases, your returns are higher when you successfully work with a borrower to return them to the path of on time payment rather than foreclosing.

When the borrower has returned to paying on time and has done so for six months (this is called “seasoning”), we have the option of selling that loan as a re-performing loan at a higher price than what we paid. This spread is our profit.

When we cannot work out a solution to get the borrower paying on time, sometimes the lender must foreclose. Foreclosure procedures vary by state; it is important to research them to determine whether you want to purchase notes in particular states.
Here is a great place to find information.
Foreclosure Laws

An alternative to foreclosure is accepting a deed in lieu. A deed in lieu of foreclosure occurs when the borrower hands over the property to the lender to satisfy a loan that is in default. When a borrower agrees to the deed in lieu, the borrower’s credit remains unaffected, which is why this strategy is often preferable to foreclosure.

When a lender takes a property back via foreclosure or deed in lieu of foreclosure, the lender becomes the owner of the property.


Now we own the property.  What’s next?

As the owner, we now have the right to do with the property as we wish.

Now we own the property. What’s next?
Foreclosures are inevitable in the note business. Despite our best efforts to avoid them, they will happen, and you will end up with a property on your hands. Remember, you picked up the property for the discounted price of the note. That’s the beauty of dealing in Real Estate-backed notes.

As an investor, you will want to put your property to its highest and best use. Sometimes that means getting rid of it as quickly and cheaply as possible, other times it may mean renovating it and keeping it as a rental. Many factors, such as the local Real Estate market and your comfort-level with being a landlord, go into making this decision.

Below are some options, out of many, available to you.

Investors who want to deal only with paper (“paper” is another word for loan, mortgage, etc.), not properties, want to get out of the house as quickly as possible, usually through a foreclosure auction or trustee sale.

Hold and Rent
A note investor may want the rental income from a property to diversify cash flow. In this case, the investor will keep the home, renovate it, then rent it out.

Fix and Flip
To realize a high profit in the short-term, the investor may rehab the home and sell it at retail. Again, this could be very profitable due to the cost of the discounted note.

Research the home’s market before deciding on an exit strategy. Fortunately, the fact that we purchase notes at a discount gives us many options.

Having so many options is one of the reasons this business can be so profitable.


What other exit strategies do we have?

There are more ways to earn income in this business than what we have already covered.

What other exit strategies do we have?
One of the most attractive aspects of the note business is the multiple exit strategies available to the investor who buys at a discount.

Whether the borrower defaults or starts paying again, we have a variety of strategies to choose from to exit from the deal profitably. Let’s look at some of the strategies at our disposal when we have a successful workout.

Mod and Sell
The first is a simple purchase, modify, markup, and sell. As discussed earlier, when we can turn a non-performing loan into a re-performing loan we can sell the loan for a much higher price than we paid.

The “mod and sell” strategy is a very lucrative business model.

Brokering is a method where a note seller wishes to sell a note, and you find the buyer. The buyer tells you what they will pay, and you offer less to the seller. The difference between the sale price and the accepted price is your profit.

Brokering is the best way to generate income with no money out of pocket.

Selling a Partial
“Selling a partial” refers to selling part of the income stream of the note. The note holder sells a portion of the payments (usually a set number of payments from the front-end of the loan) to another investor at a price that will result in an agreed-upon yield for the investor. After the investor receives all his payments, the payments revert to the note holder.

With partials, you get the best of both worlds–you get your money back so that you can buy another note and at some point in the future, you continue to receive payments from the note.

You can see the power of buying at a discount.

Can this get any better?

It can!


How can we use the benefits of our IRA?

You can invest in notes from a self-directed IRA, have all the profits returned to the account, and enjoy the tax benefits of the IRA.

How can we use the benefits of our IRA?
There are some great IRA custodians in the business that can give you answers to any questions that you may have about investing in notes using IRAs.

Two well-known custodians are:

Quest IRA
Phone: 855-FUN-IRAS (855-386-4727)
Equity Trust
Phone: (855) 621-9859
Below is some information from the web site of Equity Trust:

“Self-Directed IRAs

A self-directed IRA puts you in the driver seat of your financial future, giving you the freedom and control to invest in assets you know and understand best. The power of a self-directed IRA comes from the almost endless investment options.
You are not limited to just stocks, bonds or mutual funds – you can invest in real estate, promissory notes, tax liens, private businesses, precious metals, etc. Plus you reap the asset protection and all of the tax advantages that come with government-sponsored retirement plans.”

Feel free to contact us with your questions. We find this area fascinating and enjoy sharing it with others.