- The Washington Times - Thursday, August 19, 2004

There are plenty of ways to invest in real estate, and one of the cleanest ways is to lend money to buyers who need cash to purchase a property.

For most individual investors, this loan would be based on a promissory note — an instrument by which you loan someone money and they promise to pay it back in certain terms and at a certain interest rate.

It sounds easy, and the process actually is pretty simple. There are plenty of sample notes on the Web, and Microsoft even has some templates for this type of document at its documents site. I’ve used it several times.

The tough part is the risk factor. After all, you’re handing over thousands of dollars to someone and hoping, praying, they’ll pay it back. If they do, great. You’re making more than market interest on your money. However, if they don’t, you may have to foreclose on the property, which can get pretty messy.

If the person signing the note (the borrower) is a trustworthy person, then there’s no fear. That’s why you want to complete a financial background check on anyone to whom you would consider issuing a promissory note. Assuming you’ve completed this process, then your next task is looking at the terms of the note:

• Start date and finish date

• Loan amount

• Length of loan

• Interest rate

• Payment plan

• Recourse for nonpayment

• Location to which payments are to be sent

• Name of who will receive payment

• Name, address of borrower

There are several ways to figure repayment. If this note is with a family member and you’re just loaning the money but don’t really care when it’s paid back, then you can be a bit more flexible on the payback requirements.

If you are receiving a loan from a family member, you definitely want to use a promissory note. It removes any question about the intentions of both the borrower and the lender.

I’ve seen plenty of bad blood boil over. If the borrower gets into financial stress, it gets more uncomfortable and distressing between the family members and can ruin what should be a nurturing relationship.

However, a promissory note takes away the flexibility of “Just pay it back when you can.” The payback can occur several ways:

• Amortized. This is how most loans are paid off — a payment that includes interest and principal over the term of the loan.

• Balloon payment. Let’s say you can afford only $100 per month, but you still want to pay off the mortgage in five years. Over 59 months, you’d pay $100 per month, but the balance of the loan would be due at month 60. You can figure this with simple interest or compounded interest.

• Interest only. On a simple plan, a loan of $10,000 at 7 percent would cost the borrower $58.33 per month for 59 months (7 percent per year divided by 12 monthly payments) and then a balloon payment of $10,058.53 on month 60.

• Single payment. This is how many promissory notes are structured — “Here, Johnny, take this $10,000 and pay me back with interest in five years.” Johnny would pay back the $10,000, plus 7 percent interest — $3,500. It could even be compounded interest.

There’s a lot of information out there about promissory notes. Before you either issue one or take one, read up on the risks and benefits.

M. Anthony Carr has written about real estate for more than 15 years. Contact him by e-mail (manthonycarr@erols.com).

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