- The Washington Times - Thursday, August 26, 2004

For many reasons, you may wind up owning a real estate note. A note is a financial instrument by which the owner of real estate borrows money against the property.

Most times, the note is referred to as a mortgage. A homeowner can have several mortgages on one property. Sometimes these total more than the value of the property with some programs. However, in most circumstances, the note is only a portion of the value of the property. For instance, the property may be worth $200,000, but the mortgage is for $180,000.

The first mortgage is usually held by a large lender, such as a bank or investment firm. Second trusts can be held by large companies, but it’s not unusual for individuals to hold a second trust on a property.

In some instances, the seller of a property will offer to hold a second trust to enable a purchaser to buy the property. Sellers often make such an offer for several reasons.

The buyer might qualify only for a smaller mortgage, so the owner-seller takes on a second mortgage so the buyer can qualify to purchase the house. For instance, the buyer might put down 5 percent in cash and take on a mortgage for 75 percent of the value of a house, and then the owner creates a note for the remaining 20 percent to make the deal work.

The owner can hold this note and receive payments over time, or the note holder could sell it and get cash upfront but at a discount.

It’s like either taking $120 over the next year at $10 per month or taking $60 now. Many note holders would rather take the lower amount of cash than hold out for the larger amount over time. This impatience can work in the best interest of a bargain-hunting note buyer.

Let’s say a home sells for $200,000. The buyer puts down 5 percent ($10,000), the owner provides a 20 percent second trust at $40,000, and the bank loans the buyer the rest ($150,000).

If the second trust is to be paid back over 15 years at 9 percent, the monthly payment would be $405.71. The total amount paid to the note holder would actually be $73,027.80 — quite a bit of money.

However, let’s suppose the note holder gets into financial distress in year five. He has the option to sell the note for some quick cash. At this point, after 60 payments, the note is worth $31,861. To make it worth the note buyer’s while, the note owner would most likely sell it at a discount.

By discounting the note, the actual return on the buyer’s money is more than the original 9 percent on the face of the note.

For instance, if the buyer purchases the note for $25,000 and continues to receive the payments of $405.71 over the remaining 10 years of the note, he’ll receive a return of 15.15 percent per year on the note. If the seller is really desperate and sells the note for $20,000, the return balloons up to 21.43 percent.

But it hasn’t been so bad for the seller by letting the note go for just $20,000. Remember, he’s received 60 payments of $405.71 ($24,342.60) and then a final purchase price of $20,000, totaling $44,342.60. The drawback is that over five years, he’s received only a cumulative 10 percent return.

The new owner of the note will receive a total of $48,685.20 in payments on his $20,000 investment over the next decade — not a bad return. What’s more, the investment is secured by real estate, not paper or the last quarter’s performance.

So how do you purchase or sell these notes? There are plenty of places online to find those who want to buy notes, but look to the local mortgage industry, settlement companies or real estate investment club to start.

Your first contact would be with either a mortgage broker or banker who wants people with a bit of cash who are looking to buy seconds at the table when the property is being settled. Also try a Realtor who works with investors to help buyers who need creative financing.

There are plenty of ways to invest in real estate. Buying paper can be one of the cleanest alternatives out there.

M. Anthony Carr has written about real estate for more than 15 years. Contact him by e-mail ([email protected]).

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