Real Estate Note Safety... Part Two

This is Part Two of my two-part post on real estate note safety...

Note Safety—Storage

It is important to keep your original note in a safe place such as a safe deposit box or a fireproof safe in your home. Make a photocopy to keep with your trust deed and other escrow papers.

There are two reasons for this precaution. First, the note is not recorded in the county recorder’s office. The deed of trust/mortgage is. If you lost your deed of trust, you could simply get another copy at the recorder’s office.

Second, your note is a negotiable instrument that means it can be endorsed on the back like a check. You wouldn’t keep an uncashed check lying around, so think of your note like check and take good care of it.

Many people guard their original grant deed on a property with their life. The fact is anyone can get another copy of their grant deed from the county recorder’s office, just like they can a trust deed.

Maximizing Note Value—Payment Records

Keeping a detailed, well-organized and legible payment record showing the date each payment was received, and a breakdown of the principal, interest and late charge for each amount received is important to maintaining the value of your note.

If you ever decide to sell your note, you will be required to show the payment history to a prospective note buyer so the note buyer can verify the payment patterns of the note payor.

If the payments on a “seasoned” note, which is a note with a payment history over an extended period, have been made consistently on time, the value of the note will be greater than if the payments have been late or delinquent because the perceived risk of the note is lower.

Use the payment record sheet or ledger to keep track of all the payments you receive. Also, print out an amortization table for your loan amount. Go to www.bankrate.com to obtain a printable amortization schedule.

One thing many note holders neglect to do is to keep copies of the checks they receive. Make sure to make a copy of every check you receive and keep the envelope it came in if it was mailed to you. This kind of record keeping only adds value to your note as an asset because you have written proof that payments are being made on time.

Conversely, if you are receiving payments late or not at all, you again have proof in the form of good record keeping. Please use this tool!

Note Problems—Late Problems

If the payments on your note are late, it is important to call the note payor and find out why the payment is late and when it will be sent. Most note payors don’t like to receive these kinds of phone calls, and just by calling you will improve your chances of receiving future payments on time. Be courteous but firm about the need to receive the payments on time.

If your note calls for a late payment charge, be sure to collect it. Many note holders have a late payment charge built into their note but do not collect it. There are two reasons to collect the late charge besides the obvious one that it is more money in your pocket.

First, you will again improve your chances of receiving future payments on time if you collect the late charge.

Second, if you don’t collect the late charges regularly, you may not be able to collect them later in the event of a foreclosure because you demonstrated that you do not enforce that part of the note contract.

Note Problems—Delinquent Payments

If a payment is more than a month overdue, it ceases to be late and becomes delinquent. If you have talked to the note payor when the payment was merely late, you have taken the first step toward solving the delinquency problem because you have established communication with the payor.

The worst action you can do when the payments stop is to break off communications with the payor and start a foreclosure. Foreclosure may eventually be necessary, but it should definitely NOT be your first option.

A non-judicial foreclosure takes approximately four months if there are not postponements of the trustee’s sale. In many cases, there are multiple postponements that could further prolong the process. Usually one or two months have passed without payments before the notice of default is filed, which means that six or more payments may be in arrears before the foreclosure sale takes place.

In order for you to recoup your investment in your note, someone must bid high enough for the property at the trustee’s sale to cover the remaining principal balance on your note (and any underlying notes), all the back payments and late charges, and the trustee’s fees and attorney’s fees.

The amounts bid by the bidders at a trustee’s sale will be well below the market value of the property. If the loan-to-value ratio of your loan is not low enough, no one will bid high enough at the trustee’s sale to purchase the property. In this case, you will end up with the property back and may not be able to sell it for enough to get your money back out of your note.

If the note payor declares bankruptcy, this could incur further delays and costs. Even though the court may eventually rule that the foreclosure may proceed, these additional costs could mean you might end up with the property and not be able to sell for enough to recoup your investment in the note.

Another problem with foreclosure occurs when you have to take the property back. You must report the remainder of the realized gain that has not yet been reported.

In other words, you must complete the tax reporting of the installment gain from when the property was sold. If you are not able to sell the property in the same year that you receive it in a foreclosure, then you must pay taxes on the gain even though you have received no cash. Then if you sell the property in a subsequent year and take a loss you can only deduct $3000 of the loss per year.

It is best if you can get the note payor to make up the delinquent payments, but sometimes this is not possible because the delinquency may have been caused by the payor’s loss of a job and other loss of income during a period of several months.

Many times a payor can resume making payments but cannot make up the missed payments.

If this is the case, it is an excellent opportunity to restructure the note so that you have a more valuable note. The payor will usually go along with a restructuring because it solves his problem also. In other words, you agree not to foreclose if the payor agrees to restructure the note.

Restructuring a note requires some special expertise and you should only do this yourself if you feel confident you know what you are doing. If you want help restructuring a note, call us at 1-800-264-1056, Ext.101.

If the payor is not able to resume payments, you have two options... start foreclosure or sell the note. Sometimes you can still work with the note payor to restructure the note after the foreclosure has been started.

To start a foreclosure, notify the trustee of the default and request a foreclosure.

If you sell the note when payments are delinquent, but before a foreclosure is initiated, you will not receive as much cash for the note as you would if payments were not delinquent, but probably more cash than you would if the foreclosure is already in process.

This is because if you sell the note before the foreclosure process is started, the new buyer of the note has the time to try to work with the note payor to restructure or refinance.