There are all sorts of ways to buy and sell a mortgage note. A common question that note sellers ask me is how a “partial” works. A partial is simply when a mortgage note buyer like myself offers to buy part of a note. Instead of buying the entire note, the mortgage buyer purchases just some of the payments or the payments and part of the balloon.
Why would anyone want to do a partial?
Let’s say that you sold a house one year ago to a buyer for $100,000. The buyer gave you a $5000 down payment, and you agreed to carry a note for the other $95,000, with payments amortizing over the next 30 years. If you went to a note buyer about selling your full note, they would probably only be willing to give you $80,000 to $85,000, and that assumes that the payer on the note has good credit and that everything about the note is positive. You may not want to take a $10,000 to $15,000 haircut on a note that you consider to be strong.
What if you only needed $30,000 to put your kid through a year of college, pay off bills, or make another investment? It would not make sense to sell the entire mortgage note. You could sell the next six years of payments to the note buyer instead to get that $30,000. For you as the note holder, this solves your cash flow problem while allowing you to keep most of the note and taking a smaller discount than you would have if selling the whole note. You could also sell additional payments in the future if you needed more cash.
The mortgage buyer benefits because he is keeping a large equity buffer on the note. Thus, if the payer ever defaulted, the note buyer would have a better chance of recovering his investment.
The disadvantage of a partial for the note holder is that he is in a junior lien position and thus less protected if there was ever a default. However, with most investors (including us), the original note holder has the option of buying out our interest and then pursuing whatever avenues that he chooses. Even if that is not feasible, a reputable mortgage buyer will try to protect both parties during the default and foreclosure process.
In the current economic environment, and with real estate still getting pummeled, partials are often the only decent solution. For my company, about three-fourths of our note purchases are partials. Most of those notes would have been too risky to pay out a lot for the full note, so the partial saved the deals. If you have questions about partials or note in general, feel free to contact me.
{ 2 comments… read them below or add one }
Greetings Alan,
Can you explain how you structure a partial note sale? Is there a way to grant joint first position? Or must there be a junior and senior position? Do you pool money for a partial note sale into a separate entity, like an LLC or LP? Just curious as to how this works as my company may benefit from this technique.
Thanks,
Joey
Joey,
You could hold joint first position with the original note holder, but I don’t know why you would want to nor do I know of investors who will do that. When we buy part of a note, we are in 1st position to receive those x number of payments. After we have received the designated number of payments, then we assign the note back to the original note holder.
Most investors, including us, buy notes (partials or fulls) in the name of our corporation or LLC. We do not set up a separate LLC for each note. There could be some advantages to doing that, but it would be an expensive and time consuming way to go.
Hope that helps.
Regards,
Alan Noblitt