It’s no secret that I love notes. And since my book just launched, I wanted to tell you the biggest reason why.
Whether you buy a performing or non-performing note, create it via seller financing or by lending hard money, the goal is for that note to perform. And when it’s placed with a servicer and it’s performing, I would argue it’s better than almost any property that cash flows the same amount.
Here’s why: it’s passive. And when it’s passive, things get easy. Or rather, they stay easy. There are no calls in the middle of the night from tenants, there are no townships hassling you, and there’s no property being slowly worn down until the day your tenant moves and you have to renovate. In fact, with institutional notes, if a borrower moves, they still have to settle the note, whether it’s by selling the property or renting it out.
Now if you’ve read any of my previous articles, you probably already know that. But what you may not know is that when you have a passive investment that’s a debt instrument like this, it makes paying debt with debt an interesting idea.
Related: An Introduction to Note Investing
College for a Fraction of the Cost
The more I mention this, the more people want to hear about it.
When I tell people this story, I often say, “Think back to your first note.” This provides context that we can all relate to. For some people, it was their car loan or their mortgage. My first note was my student loan, and that’s the same case for my son—only when he got to college age, I had already started in the note business and figured out that if we were to employ two different investing strategies together, we could pay for his college tuition with a fraction of the money.
So instead of my wife and I just writing a check, both my son and my wife took out student loans. The main reason we did this was because student loan interest can be deductible, and if we could use the borrowed money at approximately 6–7 percent to pay for tuition and our money stayed invested at approximately 12–18 percent, that alone would offset the cost of his tuition. But it gets better than playing the float with a higher yield paying investment.
For some loans, there’s a deferral period—something like six months after graduation—usually put in place so the student can find a job by that time. In our case, this gave us even more time and more money to earn and gain more arbitrage. But again, that’s not all. The second part of the strategy has to do with the timing.
Right before payments on the student loan came due, we purchased a re-performing note with a similar monthly payment and a term that had a longer time frame than the student loan. We purchased this note for a significant discount. Keep in mind, a re-performing second lien can be purchased for anywhere from 40–60 percent of the payoff amount. So the payment we received from the note could be used to pay the student loan payment. And guess what? It still pays us even today! We managed to pay for roughly $100,000 worth of college tuition with just under $40,000! Pretty powerful stuff!
“Free” Insurance With Notes
And don’t think it can only be applied to college. I’ve even been able to obtain free or low-cost insurance by employing this same strategy. And it’s pretty simple.
1. Over-fund your permanent life insurance policy
2. Borrow the money out to buy a note (at 4–5 percent interest on the loan from the policy)
3. Buy a performing note with a 10–18 percent return
Then it’s just a matter of using that spread, or arbitrage, to go toward the loan payments, interest, and premium payments. And there you have it; notes will buy you “free” (or at least very low-cost) insurance! “Free” insurance and paying for college at a fraction of the cost is really just the tip of the iceberg in terms of what you can do with notes. What I love more than anything about explaining these strategies is when investors come back to me with new spins on the same idea.
Before you get started in the note business, it’s important to ask yourself: Are there things in my life that I can pay for with notes?
What in your life would you like to pay for with notes?
Let’s brainstorm strategies below!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.