Promissory Note Investing – Buying a Note
Posted on 30 March 2011 | By Lawrence Tepper
only smart people–the money goes where they go.
As a promissory note investor you have two basic approaches that will put a note onto you books:
You can buy an existing loan that has already been closed—and is completed;
You can originate a new loan—that requires you to complete it;
In this article we will be examining the process of buying an existing note rather than originating a new note.
Let’s first look at the advantages of buying an existing note:
You will not have to create any new loan documents. The only time that you will have to spend prior to receiving the payments is the time and effort required to examine all of the existing loan documents.
You may receive a payment history if the loan has been in existence for awhile.
You will not have to negotiate the loan terms with the borrower.
The disadvantages of buying an existing note:
You will have to accept or reject the loan documents as they now exist; you will not be able to modify any of the existing language or clauses to fit your preferences.
If certain loan documents that you deem to be important are missing, or were never completed, you will have to decide if their absence presents a reason for you to not buy the loan.
You probably will not be able to meet the borrower before closing the purchase because of privacy laws.
Why is the loan being sold?
When purchasing any promissory note, a reasonable and very important question to be considered is “why is the loan being sold”? Essentially, it is probably being sold for one of three reasons:
There are problems relating to the loan itself
There are problems relating to the borrower
There are problems relating to the seller
A savvy note buyer will figure out the answer to this question before proceeding. If the reason it is being sold relates to the seller, then that is a green flag—proceed. But, if the reason relates to the loan itself, or to the borrower, then that is a red flag—do not proceed with the purchase until you discover exactly what the problem is. Once the problem is uncovered and understood it can be evaluated in order to determine if it is a fatal problem, or merely one that requires special attention, but can be accepted.
Examples of problems
There are many names that are applied to “sub-performing loans”. They are often called a high maintenance, slow pay, irregular pay, etc. These loans require a tremendous amount collection effort in order to keep the tardy borrower current with their payments month in and month out.
In some cases there may be accumulated late payments–back payments already added to the outstanding principal. Or, an existing Forbearance Agreement exists between the lender and the borrowers to stave off a foreclosure. Or, there may be a Modification Agreement in force that overrides the original loan documents.
This type of loan happens where attempts to collect it have been unsuccessful and the loan 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. These problem loan accounts are a financial drain for the lender in both time expended and in money lost.
For astute, experienced promissory note investor these difficult loans present an excellent business opportunity. An experience, capable note investor can create an excellent profit by acquiring these problem loans at a discounted purchase price and then cleaning-up the problems.
In essence they can make lemon-aid from of a lemon.
But, for an inexperienced promissory note investor, this type of loan should be avoided.
The loan documents needed and the steps to be taken when buying an existing mortgage loan
The necessary loan documents required when purchasing a real estate secured promissory note are essentially the same whether you are purchasing from a private note seller, an estate, the Bankruptcy Court, or from a commercial bank. Listed below are the steps to be taken and the loan documents required:
1. Determine if a Modification Agreement is in force
On many bank owned loans that are being sold today, the original loan documents have been Modified or changed in an effort to help the borrower maintain ownership of the property. The new, Modified terms now control—they over-ride the original loan documents. Obtain a signed copy of the Loan Modification Agreement if one exists.
2. Verify the outstanding loan balance
Verify the outstanding loan balance due on the note and the actual repayment terms of the note or the Modification Agreement. You must review the actual documents that were executed!
3. Obtain a Payment History of the loan
Verify with the seller of the note that the interest and principal have been paid through a specific date. Verify when the next payment is due.
4. Determine that the mortgage (or trust deed) is a FIRST lien position loan
Ascertain that the mortgage (or trust deed) has an insured FIRST Lien position; get a copy of the Mortgagee’s Title Insurance policy. Review the Mortgagee’s Title Insurance Policy. Usually, a Lender’s/Mortgagee’s Title Insurance Policy was issued when the loan was originated.
5. Determine the status of the property taxes
You want to establish the status of the property taxes–whether they are current or delinquent– and determine if an Escrow/Impound account exists; if it does, it should be transferred to you. Often property taxes and fire insurance premiums are paid monthly by the borrower into a separate Escrow Account/Impound Account. It is your responsibility to have that account transferred to you if one exists.
6. Determine the status of the property hazard insurance
Obtain a copy of the hazard insurance policy. Later, after completing the loan purchase the policy will have to be endorsed to show you as the new Loss Payee.
7. Confirm the value of the property that secures the note
Confirm the value of the collateral real property that secures the note—the current market value. Obtain a current real estate appraisal of the collateral property; or, you can do your own evaluation; or, hire a competent Realtor to do a broker price opinion report—“BPO”.
8. Have the actual mortgage (or trust deed) assigned to you
Get the actual mortgage (or the trust deed) assigned to you. The assignment, once executed and recorded, will accomplish this and will transfer all rights, title, and interest in the instrument to you.
9. Have the original promissory note endorsed to you
Have the original promissory note endorsed to you–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 document called an allonge that is then attached to the promissory note.
10. Have physical possession of the promissory note given to you
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. It is very important that you have physical possession on the note. The promissory note is a negotiable instrument. If lost it can be forged and sold. If you have to do a foreclosure, you will be required to show the original note to the court or to the public trustee.
11. Have an estoppel affidavit executed by the borrower if possible
You should try to obtain an estoppel affidavit from the borrower. That document affirms the actual balance and terms of the note and verifies that there are no disputes or set-offs existing. It will be very useful if a dispute with the borrower should arise.
12. Prepare “Notification Letters”
Prepare signed notification letters to both the borrower and fire hazard insurance agent notifying them of the transfer of the loan to you. These letters are often referred to as “Good-By Letters” (from the loan seller to the borrower), “Welcome Letters” (from you to the borrower), and “Notification Letters” (to the insurance agent requesting a new Loss Payee Endorsement).
Do not attempt to buy a promissory note loan without professional help
As you can see, this is a multi-step, technical process. This process can be easily handled for you by specialists who are well trained and very familiar with the process and the documents. It can be botched-up easily by an untrained person. No one is born knowing how to buy a promissory note. Everyone has to learn—and learning can be very expensive. Don’t pay tuition with your life savings!
Promissory Note Specialist and Attorney
At the very beginning of the purchase process engage a reputable promissory note specialist as your advisor, and also engage a reputable attorney who has specialized experience in the promissory note area. The few hundred dollars that you will pay these two will save you thousands of dollars and many, many sleepless nights.
Once you own the actual loan there are a number of options available for you to pursue in an attempt to collect or get the note instrument performing. Some of these options will be covered in a future article.