Understanding Discounted Notes

There so many false beliefs about note investing. Let’s clear some of them up.

 

Today let’s talk about everybody’s seemingly favorite topic in investing, discounted notes secured by real estate. First of all, we have to understand what a note really is. All it is is a promise to pay. You’re going to sign a piece of paper that lays out how much you’ve borrowed. It’s going to have how much interest you’re paying, when the payments are due, how long the loan lasts; is it fully amortized, that is, does it just pay off a little bit each time and each month until its paid off no balloon payment? Is there a balloon payment, where all of the sudden you owe a whole bunch of money? We don’t know until we look at the note itself. Now real estate loans, the notes have something called security, which is the real estate. The evidence of that security is what’s called either a trust deed or a mortgage. Different states have one or the other but they’re essentially the same thing. They’re the evidence that this piece of real estate is the security for a note that it alludes to. It’s the trust deed or the mortgage that is then recorded at the local county recorder’s office. What that means is, you can go to your local county and you can find out if the trust deed, that you signed when you borrowed money to buy your house or a piece of investment property, was properly recorded. It will have been. You just want to make sure you can see it. You can also check on other property, see who owns it, but it’s going to be evidenced by the deed of title and you’re going to see if there’s any debt on it. It’ll have a trust deed or a mortgage recorded on that property. Now when you buy a note, and they say well we’re buying a note at a discount, all that means is so much money is owed on a particular note and you’re paying less than that amount owed for that particular note. So if that note is for $50,000 and you paid $40,000, that means you got a 20% discount on that note and yet, you’re receiving interest based on $50,000 even though you only have $40,000 in it. What does that do? That ups the yield. So if you were making, if that note called for 5% interest but you only have $40,000 invested, clearly you’re making more than 5%. So when you’re buying notes, and you’re buying them for your retirement income, there are many things you want to look at. One of them is what position that note possesses against that property. Now they have first position notes, those are the notes that I recommend. All first position or second position or fifteenth position means is that was the order, chronologically, in which that particular loan was recorded at the recorder’s office in that county. So if you borrowed money to buy the house, and later on you borrowed got a second trust deed loan on that home because you wanted it for investment or whatever reason you might have had, that trust deed is now recorded but since it recorded chronologically after that original loan that you got, it is now known as a second deed of trust. That’s all it is; it’s the chronology of recording. Whatever order it was recorded in compared to the other liens that may be against the property, that’s the number in line that it will become. The reason why I like you to invest in first position notes, for the most part, is that when you have to foreclose sometimes on a note, what that means is when you’re done foreclosing, there will be no other loans in front of you that you’re having to take over as would be the case if you had a second position or a third position. All those after first are called junior liens. They’re junior to the senior lien which is what we call the first position loan; the senior lien. Now, anybody that tells you “well if you buy these notes right and you do your due diligence, you will not have to ever foreclose because you did it right the first time” it’s like they think it’s like the carpenters rule of thumb; measure twice, cut once. That’s just not true and let me tell you why. You could have done all the research in the world, and there’s a first position note down the street from you, you know the property, you know everything. You are completely comfortable with it. Not only that, you know that the guy that’s paying on that note is very well employed. His monthly payment is only one sixth of his earnings and his FICO score is 815. There was a survey done recently and you know what they found out? When you lose your job, you can’t make your house payment with your FICO score. Remember that next time somebody tells you you’ll never foreclose if you do your homework. You will foreclose if you’re investing consistently in notes over a long period of years. Anybody that tells you otherwise either thinks you are naive, or they are. That’s all there is to it. We’re going to continue this series on notes, but I think that’s enough for today.

Back to Top