Selling Note Creates Instant Cash for Seller, Profit for Buyer

There are many reasons why you may find yourself as the owner of a real estate note. A note is a financial instrument by which the owner of real estate borrows money against the property. Most times, the note is referred to as a mortgage. A homeowner can have several mortgages on one property – totaling more than the value of the property with some programs. However, in most circumstances the note is only a portion of the value of the property. For instance, the property may be worth $200,000, but the mortgage is for $180,000.

The first mortgage is usually held by a large lender – such as a bank or investment firm. Second trusts can be held by large companies, but it’s not unusual for individuals to hold a second trust on a property. In some instances, the seller of a property will offer to hold a second trust to enable a purchaser to buy the property. Sellers often make such an offer for several reasons. Most times it’s because the buyer may only qualify for a smaller mortgage, so the owner/seller takes on a second to enable them to qualify to purchase the house.

For instance, the buyer may put down 5 percent in cash, take on a mortgage for 75 percent of the value of a house, and then the owner creates a note for the remaining 20 percent to make the deal work.

The owner can hold on to this note and receive payments over time or the note holder could sell it, get cash upfront, but at a discount. It’s like either taking $120 over the next year at $10 per month or taking $60 now. Many note holders would rather take the lower amount of cash than hold out for the larger amount over time. This impatience can work in the best interest of a bargain-hunting note buyer.

It works like this. Let’s say a home sells for $200,000. The buyer puts down 5 percent ($10,000) and the owner provides a 20 percent second trust at $40,000 and the bank loans the buyer the rest ($150,000).

If the second trust was to be paid back over 15 years at 9 percent, the monthly payment would be $405.71. The total amount paid to the note holder would actually be $73,027.80 – quite a bit of money. However, if the note holder got into financial distress in year 5, he has the option to selling the note for some quick cash. At this point the note is only worth $31,861 (after 60 payments) and to make it worth the note buyer’s while, the note owner would most likely sell it at a discount. By discounting the note, the actual return on the buyer’s money is more than the original 9 percent on the face of the note.

For instance, if the buyer purchases the note for $25,000 and continues to receive the payment of $405.71 over the remaining 10 years of the note, he’ll receive a return of 15.15 percent per year on the note. If the seller is really desperate and sells the note for $20,000, the return balloons up to 21.43 percent. But it hasn’t been so bad for the seller by letting the note go for just $20,000. Remember, he’s received 60 payments of $405.71 ($24,342.60) and then a final purchase price of $20,000, totaling $44,342.60. The drawback is that over 10 years, he’s only received a cumulative 10 percent return on the money.

Now – the new owner will receive a total of $48,685.20 in payments on his $20,000 investment over the next decade. Not a bad return. What’s more – it’s a guaranteed return on the money – not a hopeful return like most investors face with stocks. In addition, the investment is secured by real estate, not paper or the last quarter’s performance.

So how do you purchase or sell these notes? There are plenty of places online to find those who want to buy notes, but the best place to look is to your local mortgage industry, settlement companies or real estate investment club.

Your first contact would be with either a mortgage broker/banker who is looking for people with a bit of cash who are looking to buy seconds at the table when the property is being settled. Another contact would be with a Realtor who works with investors to help buyers get into properties who need creative financing.

There are plenty of ways to invest in real estate – buying paper can be one of the cleanest alternatives out there.