Mortgage Notes and How to Structure Them

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As noted in my article last month, collecting payments on a mortgage note is not the same as collecting monthly interest on a savings account.  Whether you’re a mortgage buyer or a property owner, the processes and paperwork before, during, and after the sale need to be done by certain standards to maintain the legality and enforceability of your contract.

Down Payment

The most important part of the sales transaction is to get as large of a down payment as you can, with a minimum of 10% for residential and higher amounts for other property types.  There are three reasons for this.  First, and most importantly, is that you’ll want to have an equity buffer in case the payer defaults and does not leave the property in good condition.  You will need the money to make repairs and to foreclose before you resell the property.  Second, the payer should have his own money committed to the house so that he suffers financially if he walks away.  Third, if you ever sell the note, you’ll get a higher price for it if there is a strong equity position.

Good Credit

Before you commit to selling a property or buying a real estate note, get a current credit report on the payer(s).  Go beyond just looking at the credit score, and check the details of any past defaults and late payments.  If the payer has excellent credit, it indicates a higher chance of them being responsible payers for you.

Expert Help

Unless you are a professional with expertise and experience in real estate notes, work with an attorney or title company in setting up the documents.  These will include such items as the promissory note, deed of trust or mortgage, closing statement, etc.  The mortgage note should reflect items like the interest rate (get at least market rate), term of the note (best if at least five years unless the note is quite small), the payment amount, and the due date and grace period for payments.  When the transaction has completed and both parties have signed the appropriate documents, the title company will record the deed, which makes it a matter of public record that you have a financial interest in the property.

During the term of the note, consider having an outside party service your note.  In case there are issues with late payments, unpaid taxes or the like, they should be able to help you in resolving those issues.

And finally, if the payer defaults on the note, enlist the help of a competent attorney right away.  In the wake of the housing bust, states have become stricter about the process that lenders and real estate note holders must follow.  If you deviate from their laws, you will often delay getting the property back and may even be penalized financially.
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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.

6 Comments

  1. A few months ago I attended a lecture given by a bankruptcy attorney who also works with people in foreclosure. Basically, he helps people cheat those they owe money to. An interesting point he made was that it’s much easier to foreclose on an LLC than on an individual. If I were to invest in notes (right now I’m looking for investers to hold notes on my properties) I would make sure I’m lending to an LLC.

  2. Amy,

    Sounds like an interesting lecture, though for all of the wrong reasons. People like this end up hurting everyone in the long run except the scumbags.

    When I buy a note, I still prefer a personal guarantee, and most investors will give a higher price on notes with personal guarantees. Plus, if you would only buy notes where the payer is an LLC, you would have very little business.

    Thank you for your comments.

  3. Right on the money Alan. Thx for the post. I am a banker and I teach investors how to review cash flow notes and make small real estate loans SECURED by marketable collateral. Investors are amazed how easy collecting an interest check is when they learn the information you have spoken about in your blog.

    Lee Carney

  4. Amy
    As a Private Lending Coach, I always ensure my loans are made to a LLC and guaranteed by the actual live-person borrower. Why? Because in most States, and only if I need to, I can foreclose LLC and still be able to seek a summary judgment against the guarantor. Mind you, in my 15 years of commercial banking, I have never had to do that, but I always make sure it is an option.

    Lee Carney

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