In its simplest form, my first note was a student loan that I took out to go to college. You could also say my first note and mortgage was the one I took out to buy an owner-occupied duplex that I still own today. But my very first note investment, where I took on the role of the bank, was a private money deal I did for a wholesaler friend.
When it came to preparing to take out my student loan, I pretty much just relied on my school counselor and the financial aid office at the college. Looking back, it was the classic “fox guarding the hen house” situation, as I just knew I wanted to go to college, and I wasn’t too concerned about the terms of my loan or what the true cost of college really was. I was just operating on faith—faith in myself to get a better job when I finished school so I could pay back the loan.
When preparing to buy my first property, it was different. I was confident. As a real estate agent, I understood the advantages and the cost of buying a property with an FHA mortgage, and I felt that I knew what I was getting into, especially since I was handy as well.
By the time I decided to use debt as an investment, I had something between blind faith and total confidence. So, where was I on this spectrum, and what did I do to prepare myself? Better yet, how can you prepare yourself to use debt as a wealth building tool?
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Preparing to “Be the Bank”
When I decided to “be the bank” for my wholesaler friend, I felt somewhat comfortable with the process. I was aware of how hard money worked, so I mimicked many of their requirements. Since I was a partner in a title company at the time, I understood the paperwork as well as how the collateral would secure my investment.
Here are some of my typical private lending suggestions:
- Use a note and mortgage. Hire an attorney or title company if needed to do so.
- Use a deed in lieu of foreclosure in the event of non-payment (non-owner occupied, commercial only). You can also require a personal guarantee and/or confession of judgement.
- Know the estimated after repair value (ARV) by getting an appraisal (paid for by the borrower). Be sure to have a scope of work and possibly a draw schedule in place, as well as proof the borrower has the resources to complete the project.
- Be named insured on the homeowners’ policy on the property.
- Know the borrower. Some things to look at are creditworthiness, experience level, skill set, portfolio of past projects, etc.
- Check and require title insurance, as you want to ensure you’re in first position.
- Know the property and the area. You may end up owning it someday.
Besides meeting the lending conditions above, I also prepared myself to invest in notes through education.
I would attend workshops, and I networked with investors in the note business, as well as others who were doing private money deals, either as borrowers to grow their portfolios or as lenders to increase their yield and cash flow.
All of this helped me gain a better understanding of notes in general before finally pulling the trigger.
Buying Institutional Notes
Preparing to buy my first distressed institutional notes was much more difficult. Although my private note experiences helped a lot, at the time there wasn’t much info available on non-performing notes, nor were there many people to ask or groups to join, and there was a very high barrier to entry. It was tough, especially starting out with second mortgages. Things were different then as well, with much less regulations and licensing requirements.
Related: The Investor’s Guide to Performing Due Diligence on Real Estate Notes
We just started out by taking baby steps. We purchased a few high equity second mortgages with our own money and hoped things would work out—and they did.
My best advice for starting out in notes besides learning as much as you can and joining groups is to start out slow and easy until you have more experience. Maybe start out with a performing note at first. Or joint venture or partner with someone else who has more experience. You could even shadow someone else’s deal. Or maybe try participating in a note fund. My point is there are many ways to limit risk until you have more experience. It’s just taking that first step that matters most.
Now that I shared how I prepared to do my first note deals, how are you preparing to do yours? If you’re investing in notes already, what advice do you have for newer investors?
Weigh in below!