This is a transcription of part eight of our video series, Investing Mortgage Notes. In this video, we discuss alternatives to investing in mortgage notes and the advantages and disadvantages of those investments.
Hello again and welcome to the eighth episode. In our series of investing in private mortgage notes. Today we’re going to be talking about what happens if the borrower sells a property during the term of your investment. And also a little bit about nonperforming notes and what those are. So in simple terms, if the borrower sells the property and or just simply decides to refinance during the term of your loan, you’re paid back whatever you are owed at that time. So as we have mentioned before, let’s say a typical $30,000 note, and you’re 10 years, I’m sorry, yeah, 10 years into that note. And you’re supposed to be, your entire investment is 12 years. Well, at that point, I would expect that out of the $30,000 you probably, your principal or the amount that you had invested would probably have been decreased down to say maybe $28,000 so you would only be short $2,000 of your initial investment.
So, what the borrower or servicer would do is they would tell the borrower what the unpaid balance is. And at that time, his new lender or the title agent, whomever is handling the transaction would pay that amount to the servicer and then they would in turn pay that to you. So you’d be totally paid off and your entire investment would be returned. Then you might say, “Well, I’m losing my investment.” Well, you’re not losing your investment. You got all your money back. You have to decide then what you’re going to do with it. So you’re basically starting all over. You could reinvest that money if you have it already in another note or some other investments or keep it for whatever purpose. But the main point that I’m trying to convey here is that you do not lose any money in case of any sort of early repayment or sale of the property.
Next thing I want to talk about a little bit is what happens with a nonperforming note, because some people prefer to buy nonperforming notes. I typically don’t sell them. I don’t I recommend them if it’s something that you really want to get involved in, but you have to know that they are an active versus a passive investment. One of the things that I’ve tried to tailor here is a passive investment for you the borrower, I’m sorry, you the lender, where you can collect your fees and be happy and not have to worry about it. With a nonperforming loan, you have to decide whether or not you want to foreclose on the borrower, because you are buying it when it is already non-performing. It can be a very good way to gain a property at a very low loan to value.
So, it might be a $60,000 property that you get for say $20,000 or $25,000. And if the property is in really good shape, you can turn right around and either sell it yourself and maybe create a new note. Maybe you have nothing more than say a year holding period and your investment was $25,000 on a $60,000 house. You turn around and sell the house, the borrower gives you $10,000 for your investment, for their down payment and you get to carry back at that point a $50,000 mortgage. That’s a pretty good return if you think about it. Your investment was $25,000 you got back $10,000 within a year’s time and a note for $40,000. I’ll take that any day. They don’t all work out that way. The nonperforming note market is rather tight these days, but I think it’s actually going to loosen up here as we go along in this current economic cycle.
It will slow down eventually and there’ll be more opportunities to buy nonperforming notes, primarily maybe from flippers who have not been able to get out of their properties once they have renovated them. And they have somebody who from their self directed IRA has given them money, equity money to invest or some hard money lender, and it’s a good way to give them some relief and basically to get them out of that investment. So the advantages though of investing in the type of note that we have discussed up to this point is that it’s consistent and stable and pretty much a hands off. With the rare exception you have to work with a servicer or to figure out what’s going on and make sure the payments are made and that type of thing. With the nonperforming note though, you are very active. You’re having to go in actively foreclosing the property, knowing that upfront, dealing with the state foreclosure laws, perhaps having to get the property renovated and everything of that sort.
And while they can be very good investments, you just have to know that it can be time consuming and you have to have that time to put in there and devote to that type of project. So that’s it for our installment today. We will be concluding with our next episode and we’ll talk a little bit about these investments in general. As always, if you have any immediate questions, please don’t hesitate to call me. Richard Thorton at (510) 918-9001.
Missed our previous installments of this series? Click the links below to view them.
Part 1: Investing in Mortgage Notes
Part 2: Notes Vs. Deeds, Land Contracts, and Subprime Mortgages
Part 3: Buy & Broke Mortgage Notes
Part 4: Alternatives to Investing in Mortgage Notes
Part 5: Mortgage Note Underwriting
Part 6: Mechanics of Investing in Mortgage Notes
Part 7: What to Do When Your Borrower Defaults