Whether you’re buying Mortgage Notes from a broker or performing your own due diligence careful underwriting is always prudent. Working with a seller you know and trust lessens the need for in depth investigation. However, if you’re working with a seller or broker for the first time you should always verify the critical information to the best of your ability. Years of training is required to deeply understand the risks associated with investing in notes. But understanding the simple factors presented below will help ensure the quality of your investment.
There are three elements that are essential to any note purchase, they are:
Mortgage Note Investor’s Checklist — Essential Items
These are the MOST important because, if they’re not understood, each could individually ruin your investment and leave you with little to no ability to correct the situation. Let’s discuss each one.
- Blight – If a home is in a neighborhood with high crime, abandon houses, broken down cars, etc. you can’t fix it. While you may be able to rent the housed if the borrower defaults, prospective tenants will be low quality and your ability to sell the house limited.
- Taxes – Are the taxes current? Are there any outstanding utility liens or judgements against the property? Discovering tax bills or other liens after you have purchased a note can ruin your return. Your ability to sell the note without taking a loss will be very limited. The liability may even exceed your investments value.
- Title – Does the seller actually own the property? Do they have the right to sell it? Is there a clear chain of title showing past owners and their releases from their ownership?
Factors to Consider When Investing in Mortgage Notes
While you MUST have positive answers to the questions above you should also check the items below. You can adjust the order that you address each, but you should consider each factor.
- Property Photo- What does the house look like? Is it well maintained? Is the yard clean?
- Loan to Value – What is the ratio of the loan amount to the houses value? In some cases, the mortgage amount can exceed the current market value. When this occurs, the note needs to be devalued to the market value.
- Investment to Value – This ratio is actually more important than the loan to value because it defines the cushion the investment has should market values decrease or the note holder default.
- Payment History – How consistently has the borrower been making his payments and for what period. The longer the history you have the higher the likely hood that the borrower will make his future payments.
- BPO – This stands for “Broker Price Opinion” which an indicator of the property’s value. It’s not a full appraisal but is a good indicator.
- Crime Rate – What is the area’s crime rate? We mentioned it before in the Blight section but it’s important to note because it limits your ability to rent or sell the property if needed.
- Neighborhood Rent – One of the exits investors have is to rent the property. Local rents for similar properties should be approximately twice the mortgage payment being collected.
When underwriting a note investors need to have answers for the questions presented above to determine the likelihood of receiving the anticipated value of their investment. It’s always beneficial to determine the exit plan before you buy. Unlike stocks and other investments, a good note will have at least three possible ways to recover a potential loss. They are as follows:
- Sell the property – The lower the investment to value the better chance you will have of selling the property for more than you have invested.
- Rent the property – If local rents are high enough you may be able to rent the property to continue receiving payments.
- Sell the note – Many note buyers specialize in buy nonperforming notes. It’s possible that your note could be sold for an amount equal to the value of your remaining investment.
Investing in mortgage notes is an excellent way to build long term wealth. By diversifying your portfolio with stable consistent returns, you can create the financial freedom you desire. If you have more questions don’t hesitate to call us at 800-508-5212.