Selling Part of a Note: How Partial Notes Work

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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.

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About Author

Alan Noblitt is a nationwide note buyer and a licensed real estate broker in California. His business, Seascape Capital Inc., started in 2002.

7 Comments

  1. 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

  2. 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

  3. Mike Hartzog on

    Hi Alan,

    I realize this is one of your older articles but it is touching on an area of note investing that I would like to understand more completely. What I want to know, in the case of a partial, is how the remaining principal is divided between the front-end owner and back-end owner when the note is paid off early. When you buy or sell the a number of payments on the front-end of a note, is a principal amount designated for the purchase or is the principal due the front-end owner based on the amortization schedule of the note?

    Regards,
    Mike Hartzog

    • Mike,
      There are at least three different ways of calculating the split of the proceeds from an early payoff — often referred to as schedules A,B, and C. The details are too extensive to go in to here, but you can see the various calculations in a book called “More Calculator Power” by Jon Richards. Those pages would also answer your second question.

      Alan

      • Mike Hartzog on

        Alan,

        Thanks for the response and the book recommendation. I will check it out. I found one example online. Schedule A is the note as purchased, Schedule B is the front half and in that example, they used the present value of the payments purchased as the principal due. Schedule C is the back-portion, and the principal assigned is the remaining principal from the original note, i.e., PV of schedule A minus the PV of schedule B. That approach makes sense to me.

        Mike

  4. Alan,

    I understand that there are a number of different ways that one can purchase partials, including the purchase of a fraction of each of the remaining payments, or a fraction of a series of payments. I’m sure you get what I’m saying, but for the purpose of clarity: If the total monthly note payment is $800, and there are 36 remaining payments, then the parties could agree to a partial note purchase in which the investor pays the seller a lump sum for the 36 remaining payments, and then collects $600/month, while the seller receives the remaining $200/month.

    Now then, given the above scenario, how would you go about legally structuring/executing this kind of deal? Obviously, there would be a partial note purchase agreement involved, which would outline the payment splitting arrangement, intentions, responsibilities, obligations, etc. of the parties. Then, I’m guessing a partial assignment needs to be recorded, correct? Would the partial assignment specify the fractionalized interests of the parties, similar to how a fractional interest note is done? And finally, once the loan is boarded with new servicer would they just send out two checks, each month — one to the investor ($600) and one to the seller ($200)?

    I apologize for the long question, but I’m just trying to understand how best to structure these kind of deals. Thank you!

  5. Anthony,
    There are a number of ways to do partials, including those for scenarios like you painted. We usually refer to those as split partials, which are less common than partials where we buy a certain number of whole payments and leave the rest to the original note holder.

    We do not ever fractionalize, as we take full assignment of the note. The legal language in the agreement protects the original note holder, as it specifies exactly what we are to receive and what happens in case of certain scenarios like default, early payoff, etc. The contract gets recorded as a full assignment, as partials are too confusing for many title companies.

    When we do split partials, the payer sends the full payment to us, then we cut a check to the other party. That way, we can fully track the note balance and what has come in.

    I hope that helps.

    Regards,
    Alan Noblitt

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