Is it ethical (or legal) to suggest a borrower refinance a PN?

18 Replies

I bought a performing note which has been plugging along with prompt payments.  However, I could use a chunk of cash more than monthly payments right now. Rather than sell the note, would it be unethical or illegal to have someone contact the borrower about refinancing?  The property has built some good equity through appreciation and rates are low, having one payment might be attractive to the borrower, and with a nudge I could get cashed out.  Thoughts?

Originally posted by @Micki M. :

I bought a performing note which has been plugging along with prompt payments.  However, I could use a chunk of cash more than monthly payments right now. Rather than sell the note, would it be unethical or illegal to have someone contact the borrower about refinancing?  The property has built some good equity through appreciation and rates are low, having one payment might be attractive to the borrower, and with a nudge I could get cashed out.  Thoughts?

Not  only is it legal, it's the way the business works. The average mortgage is paid out by a refi or sale in under 10 years. Not only is it ethical when it's a better deal for your borrower, it's just the right thing to do.

I specialized in obtaining good notes from seller financed deals then refinancing them to better loans as quickly as they qualified. Look up the term "velocity of money". An example: If I were to buy a 65K note for 50K then got 10K back in under 90 days, I can make 40K in a year off of my 50K! I'd spend 5K on the refinancing or giving the borrower an incentive to get a better loan! Sure beats trying to find other note buyers to sell at a discount that in this example would be less than 10%!

You need to be aware of the issue of forgiving debt as that becomes income to the borrower. So, if you pay loan costs tell the borrower to see their tax advisor.

Several techniques to use, pay new loan costs, discount the payoff, refi less and take an unsecured note for the change, payoff other debts to help them qualify or buy down the interest rate on the new loan. While all of these can create a tax liability to a borrower, their cost is their tax rate, that's much better than them paying the full costs of a new loan, so it is a deal for them.

I brokered my loans and originated the new loans as well, that was easier for me to just give them a discount in the origination of the new loan, avoiding tax issues in many cases, while actually paying off the entire balance of the old loan. If you have a broker or servicer who services your notes, they may be able to charge you a release or processing fee as the note holder and offer a much better deal to the borrower in an origination. The broker makes the same thing, you have a cost in the transaction, the borrower gets in much cheaper or with better terms. The tax pot is correct.  There are ways for a broker or servicer to charge a note holder for services rendered and lighten up on the cost of borrowing in a new loan, all playing within the rules, legally and ethically!

I have no idea why people get so involved with NPNs with all the brain damage and risk compared to working good notes to a more profitable end, whatever..... :) 

Originally posted by @Micki M. :

@Bob Malecki

 I'd prefer to get the full value rather than sell it on at a discount. Do people buy full price notes?

Well that depends on the interest rate, equity, location, etc. Typically a performer will sell for 90% or less LTV on average. You may want to consider selling a partial which will give you a chuck of cash while still owning the note and remaining payments. Here is a basic article on partials, you can Google around for "note partials" and find more info:

http://www.biggerpockets.com/renewsblog/2011/11/18...

Everybody wants to go to heaven but no one wants to die!

@Micki M. Who's more motivated here, you or your borrower?

I think you have a couple of good suggestions, however you are balking. Your hesitation tells me you are in the wishful thinking mode, not the taking action mode. Perhaps you can demonstrate I am wrong.

Are you willing to sell a portion of your loan in order to pull the cash you need without "killing the cow" ?

I've been investing in CA notes for nearly 30 years. My typical yields are 12-15%+ and LTV 1st's.

What can you offer me that is comparative risk/yield? 

Thanks @Bob Malecki this is my first note so I didn't even know you could sell partial (although it's a pretty small one to begin with.

@Rick H. haha, I've never been accused of not being an action taker, you'll have to get to know me better.  I have no problem holding onto the note for the long term gain, but if I could realize my cash now I'd be happy to encourage the borrower in that direction. Now I've got even more options to explore.  Let me get 24 hours past my post before it's considered "balking"  :) 

@Bill Gulley

 I've read several of your posts in which you've mentioned the buy a note (or contract to buy a note), have the borrower refi in a short amount of time, and "smoke your calculator" when calculating the return. I remember you laid out the formula on how to find these seller financed notes in a previous post but I haven't been able to find it. I wish I had saved the info.

I think you suggested that a note investor could go to the recorder's office in their own backyard and search for deeds of trust that were recorded 18-36 months prior. You explained that many sellers used seller financing to sell an unwanted piece of property because that was the only way they could do it at the time. After 18-36 months, most sellers are open to selling their note because they really wanted the cash in the first place. You said that these sellers are more likely to sell at a discount than an institution for a variety of reasons. Once you buy the note at a discount, you work with the borrower to refi at the UPB and get a really nice return that "smokes your calculator." Did I get the gist of that right?

I didn't really understand the concept that much the first time I read your post but the OP brought the subject back to mind. The popularity of NPN's brings with it increased competition as more people are looking to be involved with them. It seems like there'd be a lot less competition going after 18-36 month old seller financed notes (or maybe I'm wrong...)

@Andreas Mirza

You got it, good memory! No idea where that post is. As to competition, I get letters all the time about buying notes, they go to file 13 quickly, guess they don't really know me, LOL, thinking they can make more than I can....

But, no, you can shorten that time of seasoning to a year. I was saying look 3 years back and at 18 to 36 months you should find some.

Newbie note types really should begin in their own backyard, they have the court house, can find an attorney, they have their boots on the ground, they can drive by the collateral and sleep better.

Miki, you mentioned wanting full "value" for a note. The concept of buying notes is governed by the "Time Value of Money", a dollar today is worth more than in the future. The value of receiving $10,000 over ten years is not $10,000 unless the interest demanded in the market is being paid on the money and alternative investments carry the same risk. This isn't the case with notes held or created by individuals as they don't create notes that meet institutional guidelines, in those cases a note may sell at above the UPB at a "premium". So, the "value" is what the market will bear and private notes are simply not seen at the same quality as institutional notes to begin with, for many reasons.

And yes, the highest price you may get is by guaranteeing the note with an assignment, more like borrowing against it or selling part of the payments and retaining the responsibility of the note's performance, with recourse.

BTW, looks like Rick aged 20 years after his previous post, it shouldn't been that hard to mention that Rick....  ;) 

@Bill Gulley

While I was looking for your earlier post yesterday, I came across this one you wrote and I loved the analogy:

"Buying a NPN is much like buying a wrecked car, can you really fix it, buying from a broker where the note is reinstated and performing is buying a wrecked car that has been rebuilt to pass inspection. Both are still wrecks, the value of both are less, the mentality of the borrower has already been tainted and in a different mindset than a more credit worthy borrower. You can make money fixing wrecks and selling rebuilt cars, you may be better off just starting out selling used cars that haven't been wrecked.

Bill G."

My near-future plan is to get involved in buying and selling junk cars (under the advice of a qualified mentor) but you've got me thinking about these used (pre-owned?) cars.... 

Starting out, make life easier and the learning curve shorter, after you gain expertise then move on to bigger challenges.

Beware of some of these note mentors, they may be teaching you how to buy the wrecked car after it has been repaired but not really how to buy it damaged and how to fix it.

Again, note modifications are the new extension of credit just as originating a new note, just because you own the note doesn't give you a license to originate new notes or extend credit.

May be I should run a note fax service and get a fox as a logo, LOL. :)

Here is a website that I found very useful when I was looking at the various ways you can sell a note.

http://www.dancikcapital.com/why_sell_your_note.php

A mention of Matt G.'s link above. No affiliation or endorsement of that site.

If you find someone to work with you, there are other ways, actually endless variables to design variable cash flows from a note or portfolio.

Think of having a pot of cash available to you at any time by assigning a note, you take some cash out and the note covers the withdrawal until it is paid by the note. A secured line of credit type arrangement without declaring principal received for taxes!

You can also assign a note to provide staggered lump sum payments, you need some cash now, in 4 years you know you need some more Bobby's college fund, 5 years later you know you'll want to payoff your lake house....whatever.

A note is an annuity income, that income stream can be designed by "borrowing" against that pot of cash. Taking future dollars later on will cost you less than taking it out today.

Simply waiting later can expose you to interest rate risks, investors may require higher yields than today, but you can "lock in" the discounted yield today and avoid market changes. 

You can use that cash without receiving a lump sum of principal to pay taxes on.

Think outside the box! :)   

To the topic of the OP and for the sake of the newer folks.

A Mortgagee may not force a Borrower to refinance.  A Mortgagee may not force a Borrower to use any specific Lender or Broker to refinance.  It is not a bad idea to have a disclosure of Affiliated Business if a new loan does happen.  (each of you should consult counsel)  A Borrower has certain privacy rights, just handing off even their top line data (name, address, phone) can be a violation of that privacy.  Certainly a concern if even great data is shared with no prior approval from a Borrower like credit, income or asset information.

Do not accept money for the lead from a lender or a broker.  Do not accept any type of fee other than your payoff if the loan funds.  Just don't do it.

In any sales environment a "warm hand-off" is a better way to execute a sale.  In this environment it is no different.  It will also help you ensure you stay on the right side of compliance.  Sometimes you can give incentive to your Borrower by giving a principal discount.  Other times you can simply suggest "Billy Borrower, you should look into getting a new loan to lower your rate.  I can give you a firm we have worked with before or you can find your own." - type thing.  

I will say, it can be a double edge sword.  If the Borrower gets excited and then does not qualify that can stress the relationship between the two of you.  Also note, not all originators are made equal.  Some will be forward with reasons a Borrower does not qualify and others will not.  Understand, you as a Mortgagee are not entitled to any of that information.  The Borrower is only entitled to the standard denial letter.  

The moral of the story here, is yes, a Mortgagee can work with and encourage a Borrower to refinance but there are limitations and proper ways to conduct yourself.  As was pointed out above to some extent, the benefit should always be to the Borrower not the Mortgagee/Investor.  The Mortgagee/Investor can always sell the loan if they really need/want to get out of it.  

Originally posted by @Bill Gulley :

I specialized in obtaining good notes from seller financed deals then refinancing them to better loans as quickly as they qualified. Look up the term "velocity of money". An example: If I were to buy a 65K note for 50K then got 10K back in under 90 days, I can make 40K in a year off of my 50K! I'd spend 5K on the refinancing or giving the borrower an incentive to get a better loan! Sure beats trying to find other note buyers to sell at a discount that in this example would be less than 10%!

Wow this is great. 

How do you get around roadblocks such as rising interest rates or the borrower not being worthy of a refi with institutional standards?

Is this where you spending (or more technically "forgiving"?) the 5k difference comes into play? The borrower would have no costs or at least a lower loan balance at the end of it all with you still getting paid out the 10k difference?

Converting or paying off seller financed or private loans usually involves notes with higher rates than the current secondary market rate. Commercial seller financed notes are generally higher than the bank's portfolio rate.

You can also "buy down" the rate to make things better for the borrower.

No roadblocks for me, I owned the mortgage company. I know if a borrower will qualify for a refi before buying a note too.

Many if not most just run to a broker to find a note, they try to deal with what they are offered. Not me so much. I can find notes locally, I can sure contact a borrower before speaking with a note holder, no law against that. I can work the deal with a borrower from both sides of the fence. Trick is, getting the borrower to talk to you but most do if they think they can save some money.

Then I can ask the note holder if they want to sell the note, if they do, work a deal.

If you already know a note holder wants out, I can contact that borrower before I contact the note holder to see if I can save them some money. I don't have to tell the borrower his note is being sold. Must you tell a tenant the landlord is willing to sell the property....no!

Dion brings up good points about privacy and the information you are entitled to. Usually, brokers are holding the cards close to their chest to control the deal. They ask that you not contact a borrower and probably should not, or at least be breaking the news to them that their note is being sold. Some go into shock or just payoff what the lender will take.

So, you line up the note deal in the direction you need to play the hand, the horse can push or pull the cart.

Once you have a business relationship with a note holder or a commitment you are entitled to every document in the loan file, credit reports, all borrower information, as at that point you are an interested party with a pending transaction.....not like just opening up loan files for public viewing. I'll bet many brokers don't disclose all the loan information, all most like selling a car without letting someone sit in it or drive it.

What most seem to be doing in notes as an investor is really following the heard, the broker with the bell on his collar leading the investors down the path they want them to go. Doing your own due diligence or setting up your own transaction seems taboo by those getting investors to "buy in".

Investors probably have more notes in their own backyard than they can possibly buy, but that's not what the note gurus or brokerages are teaching them.....obviously. Good luck :)

@Bill Gulley makes a point that is good about a broker trying to sell a loan but that was not my point.  I will assume the mass will wade those waters as they do.  My point of concern is the liability that may arise from a holder of a note trying to work with a loan originator to refinance a borrower and how all that comes into being.

As the Mortgagee you are bound by certain privacy restrictions the origination documents may have put in place on top of customary privacy restrictions for such things.  In an example, I could see an investor who holds a couple of notes send over some Borrower data to a mortgage originator (broker or direct lender) to allow the originator to see who may or may not qualify.  With no permission from the Borrower, that would be a no, no.  

Most loan sale brokers do not hold files and generally do not control file access unless you are involved in more an institutional sale.  Same sort of liability from the holder goes on there, you do not know what the loan sale broker is going to do with the data which might breach privacy.  

All good stuff.  Good luck.

Ah, yes, good point Dion.

I have received copies of mortgage files with the names, account numbers and address blacked out from banks wanting to know if I could refi that borrower, a bit different than sending information to a broker to simply sell the note. Full package from a 1003 to the HUD to the servicing records, but I'd have no idea of who it was until I said yes, I can get this one done. Then the referral begins and that is another tactful matter.

Absolutely, loan information is sensitive data and must be held in confidence on a need to know basis as well. The insurance guy in a bank has no business looking at a loan file, information is controlled, or should be. :)

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