Some Due Diligence Basics on Note Investing

[Chris Seveney]

Recently, been seeing more and more online posts of performing mortgage notes on the secondary market as one-offs with a rise in individual investors presenting "anticipated returns". The numbers invited a closer inspection, leading me to share some key insights for those of you involved with performing mortgage notes. Here are some critical considerations:

1. ROI: While it may seem attractive initially, remember that your asset, the note, loses value as the principal goes down. Take for instance a loan with a balance of $12,000 at 0% interest, paying $500 monthly for two years. Despite an ROI of 50%, you'll net no profits after the two years. The solution? Understand the yield or the internal rate of return (IRR).

2. Monthly Payments: Be cautious of sellers basing returns on monthly payments. This can be misleading as it often assumes no fees. In reality, you will at least have servicing fees, which can consume up to 10% of a payment, particularly for loans under $500/month.

3. Loan Constant: It's crucial to grasp this concept. The lower the interest rate and longer the term, the more you'll need to discount the loan, yielding a lower loan constant. To reach their targeted return, investors might discount the loan further. Keep in mind, a higher loan constant translates to a higher loan value.

4. Yield/IRR Variations: With lower balance loans, yield/IRR can be misleading due to its potential for large variations. Always consider the absolute profit - a difference of $1,000 can significantly change the yield.

5. 0% Loans: Avoid these at all costs. If the seller defaults, they have no incentive to pay since there's no accrued interest. Moreover, any fees you advance won't collect interest. Your only exit strategy would be to wait until the property is sold or you manage to sell the loan.

[Jay Hinrichs]

Quote from @Chris Seveney:

Quote from @Jay Hinrichs:

Quote from @Chris Seveney:

Recently, been seeing more and more online posts of performing mortgage notes on the secondary market as one-offs with a rise in individual investors presenting "anticipated returns". The numbers invited a closer inspection, leading me to share some key insights for those of you involved with performing mortgage notes. Here are some critical considerations:

1. ROI: While it may seem attractive initially, remember that your asset, the note, loses value as the principal goes down. Take for instance a loan with a balance of $12,000 at 0% interest, paying $500 monthly for two years. Despite an ROI of 50%, you'll net no profits after the two years. The solution? Understand the yield or the internal rate of return (IRR).

2. Monthly Payments: Be cautious of sellers basing returns on monthly payments. This can be misleading as it often assumes no fees. In reality, you will at least have servicing fees, which can consume up to 10% of a payment, particularly for loans under $500/month.

3. Loan Constant: It's crucial to grasp this concept. The lower the interest rate and longer the term, the more you'll need to discount the loan, yielding a lower loan constant. To reach their targeted return, investors might discount the loan further. Keep in mind, a higher loan constant translates to a higher loan value.

4. Yield/IRR Variations: With lower balance loans, yield/IRR can be misleading due to its potential for large variations. Always consider the absolute profit - a difference of $1,000 can significantly change the yield.

5. 0% Loans: Avoid these at all costs. If the seller defaults, they have no incentive to pay since there's no accrued interest. Moreover, any fees you advance won't collect interest. Your only exit strategy would be to wait until the property is sold or you manage to sell the loan.

on the zero interest loans I think when your originating them you can put a default rate in that will solve this issue..  I have done oh at least 20 25 zero % seller carry backs ( getting rid of some dogs ) and the payments have been 100% perfect Reason:  the buyer builds equity so fast they dont want to lose that equity.. mine were all 24 to 48 months  ..

I have seen posted on BP  buyers offer 10 and 15 year zero %  for those loans I totally agree way to long.

 Yes I agree on default interest. The ones I am seeing do not list default, and many are contract for deeds that also do not list ability to collect legal fees etc. These are poorly written land contracts primarily on vacant land that someone bought at tax sale and are selling off the assets seller financing then selling the loans. 

my dad literally did thousands of those deals back when land game was super hot in the mid 60s to about 80.  bought at tax sale sell on contract.. Now there are guru's charging money how to do it. We came up with the zero % financing in the Carter 20% interest years..  we looked at what a note investor would want on a yeild and lo and behold 30 months zero interest had the same PVM as a 7 year note at 15% interest  we killed it with our zero percent program..  Nissan / Datsun was the first to come out with Zero % for cars and we mirrored them.