The Paper Game
PAPER GAME:
As Buyer/As Borrower:
1. I’ll exchange you, the foreclosing lender, one of my seasoned and well-secured mortgages on another property for the one you’re foreclosing. Most people don't like foreclosures. This way your income stream would be restored and I can do the dirty work. This puts you in the same position as above, but without the use of cash. Now YOU can control the foreclosure and have a priority position in negotiating with the owner.
2. I’ll give you part cash and will finance the balance. The note can be security for the loan or another note on your property as additional security.
3. If you agree to give me a loan on my paper/house that I am buying, or own already now, I’ll agree to buy your re-possessed stuff or buy your X. Get a“must loan” commitment.
4. How can I use a CP to Create a "Collateral rental?" I’m going to rent someone’s collateral, but not need cash. Say you are the Collateral Parter (CP) with your equity to utilize. We go to a seller together and negotiate buying Seller’s house at 80 cents on the dollar with cash now, and financing the balance but it is secured by the CP collateral property\, not the subject property. No cash is needed from CP. Just a signature owing say $270K to a Seller at 9%. At closing, the collateral partner (CP) gets a **better** Note from ME for a SPREAD (say 12%, so 3% spread) secured on the subject property in 1st position. CP agrees to subordinate his so we can pull $40-60K out of the property via refi as immediate profit. We use that money to make the payments to CP (and keep as cash reserves) and get our down payment back. As we go buy new notes, we agree to release parts of the CP’s Note owed to seller (and moved to the new notes) so CP has less liability going forward. Now… let’s say we get the investor out of the picture because we paid him off by releasing his collateral to new notes. Those new notes were bought via refi on the subject property. Those new notes are still collateral to the SELLER in the original deal. But as those notes get paid off early, we still have the right to SUBSTITUTE new collateral and not pass that payoff onto the seller. It’s only collateral IF we defaulted on the original payments. So if we get paid off at full face value, say $75K, we can go buy another note **at discount** to use as continued collateral to our seller agreement and pocket the difference (say $25K cash). This gives us the cashflow to pay the payments on the subject property each year and going forward.
Say you’re a developer. You offer your land as collateral for me to go buy a single family house that needs work. Seller gets the note on your land. I have the house now free and clear. I can do the same thing, pull a line of credit on the home and go buy discounted paper at or equal to the face value of the note on collateral.
Hypothecation The idea behind hypothecation is that I pledge another asset to secure my performance on what I’m buying from the Seller (House A). This “other asset” could be another Note somewhere, created by a Partner. The note promises say 9% interest to the Seller. Then the underlying note that I owe the partner (secured in 1st position to the House A I’m buying) is for 12%, so he makes a spread in the middle of 3% but has NO cash in the deal and is better-collateralized for it (1st position on House A).
5. Always look to BUY BY PREPAY (BBP). If you have $2000 to invest and want a 16% rate of return, you could arrange to buy (pre-pay) the first 25 payments. Also, using the analogy above, I could buy the first three years of payments and have a 39.44% yield. It's a simple concept to sell. You owe $10,000 over 15 years. You pay one fifth of the principle balance ($2,000) for one fifth of the payments (3 years or 36). This technique is simple, logical and profitable.
Both:
Consider balloon alternatives. Instead of a balloon could I graduate the monthly payment? Or how about the loan goes to shorter amortization? Or a partial balloon is now due? Or a rollover to next year if certain financing isn’t available?
Break notes into several. Could we create several notes instead of one large one, which will make them easier to sell or hypothecate?
Did I include an Exculpatory Clause? This clause states "The property is the sole security for this note." This means that there is no personal recourse on a note.
Did I include Substitution of Collateral? A sample clause that can be used in an earnest money receipt and offer to purchase (an offer) is "collateral for this note may be substituted at any time before or after closing with sellers approval." After closing refers to being able to replace the collateral at a future date. Before closing gives an out so that the same contracts may be offered on more than one property at one time. A similar clause should be included in the note.
Did I negotiate large pre-payments? Can I lower my monthly payment by making a large principal payment (re-amortize) unlike with a typical bank?
Did I include an Assignment of Rents? This clause provides for the ability to take over the management and income of a property (within state laws and practices) during the foreclosure process.
Did I include a Subordination Clause? This clause provides that a note can be subordinated to another loan. This means that another note takes priority to the one that is subordinated. An example might be when a seller takes a note and agrees that at a later date he will allow the buyer to put on a new first loan. The seller then ends up with a second instead of a first that he had. This clause would be used on a property where there is remodeling or some other major cash outlay and a new first or second loan may be needed at a later date.
Pre-payment Penalty - This clause provides for a penalty for the early payment on a note. You would generally not want this clause in a note, unless it is a wrap-around note that you don't want paid off early. Most holders of seller financing would love to be paid off early. A clause providing a penalty could discourage a potential early payoff.
Pre-payment Discount - A clause like this is one that you would want in a note you are paying on. It could provide for a discount of a certain amount or percentage if you pay off the note early. This clause could make a note less saleable for the note holder.
First Right of Refusal - This provides for the payor on a note to have the first right to buy the note if it is offered for sale. It usually provides that the payor has the right to buy the note for the same price that someone else provides a written offer for it.
Consider splitting the sellers notes into one that is up to 80% LTV, and the rest higher than that, so it’s easier to sell off.
Ensure the seller is named as an additional insured on the "Hazard Insurance Policy," in case of fire or other covered disaster.
Taxes - Thousands of note holders out there are unaware of their legal responsibility to provide tax information as to the interest received. A 1098 form needs to be filled out each year.
If you’re stuck apart on price, lower the interest rate you’re paying on the seller 2nd and come up in price to meet his asking.
Can I build in step-rate financing (1% increase per year) into my note to entice the seller and get him greedy?
Instead of *ever* paying off a Note… Ask for a Must-Lend or Rollover: If the noteholder/old seller likes their monthly income and doesn’t want their principal back, then you ask them to rollover their note to the next asset you are buying, and their funds stay in escrow at the title company until it is completed. Offer a cash incentive (toward principal of the note) to get them to release the old collateral and move to new collateral.
The subordinate “shift” on what you already have: Keep in mind that you can use subordination to draw cash on properties you already own. If you purchased a property with seller financing, simply ask the former owner to subordinate his mortgage to a new first. This may require you to give the seller some incentive, such as additional cash or pay down of the principal. Either way, subordination is an excellent way to finance a purchase or draw money out of existing properties.
If the market won’t support the seller’s asking interest rate, you can SPLIT it into two Notes to the Seller. The first is a standard mortgage at a more affordable interest rate. The 2nd is the amount (approx.) of the interest that is NOT paid (think a flat $6K which is the difference between 14% market minus 9% attained over 5 years) due as a single payable note in 5 years. You might also offer to charge interest on that 2nd note amount at a smaller amount (like 5%). Then you can go back and offer to buy out the 2nd note (since it’s so small) at 50% of it’s value, and you’ve wiped out your interest on the deal down to nothing.
Let me buy the balloon payments (heavily discounted to me since it’s so far off) but I’ll do that in a rising market where it’s likely the loan will get refinanced earlier.
If I don’t want to foreclose on the people that are in default but have equity, I could buy the property now (Deed in Lieu) at fair market value FMV with easy terms. The down payment is the note that is owed to me or whatever lender needs my help (forgiven) and the balance of the seller's equity is taken back in a note with easy terms. This note is secured not by the subject property but by something else like my personal residence. I then structure a lease for a fair market rent that runs for the period during which the current owners had planned to stay. I then refinance the property and get my cash back and cash left over to invest in discounted mortgages and receive a tremendous cash flow.
Sell the discounted note BACK to the payor. You might buy a note at a 40 percent discount and sell it to the payor at a discount of 25 percent. You would think that the first person that the seller of a note would contact when he wants to sell his note would be the one paying on it, but most of the time they don't. They assume that if they could pay off the note that they would have already done so or that if they had any interest they would have already contacted them.
* LOWER THEIR MONTHLY PAYMENT
* LOWER THEIR LOAN AMOUNT BY $2,000
* PAY OFF THEIR LOAN IN THE SAME AMOUNT OF TIME
* PUT $500 CASH IN THEIR POCKET
* AND YOU'LL MAKE $1500 IN THE PROCESS
Pre-pay a partial to double your yield. Let's say you are paying on a "private" mortgage loan. The reason a private mortgage would be important here is because there is some negotiation involved and institutions become faceless entities where no one can make a decision (or cares to) when it comes to negotiation. We apply the same concept of buying a partial to a loan we are paying on. It may be that the individual we are paying could use a little cash and would allow a partial pre-payment discount. If the rate were 8% and I want a 16% yield, I am going to need some discount. For example, let's say you are paying on a $10,000 mortgage at 8% over 15 years with a payment of $95.57 per month. If you have $2000 to invest and want a 16% rate of return, you could arrange to buy (pre-pay) the first 25 payments. Also, using the analogy above, I could buy the first three years of payments and have a 39.44% yield. It's a simple concept to sell. You owe $10,000 over 15 years. You pay one fifth of the principle balance ($2,000) for one fifth of the payments (3 years or 36). This technique is simple, logical and profitable.
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As Lender/Note Holder:
- I’ll make you a deal so I can get paid off EARLY. Convince your borrower to take a cash incentive to refi me off early, or a discount. Or I’ll help him refi by co-signing OR taking title, refinancing, and selling back to him on a WRAP. Borrower might be able to get some extra cash in the pocket from a cash out and keep payments about the same. Convince borrower to invest the extra cash and buy another note to subsidize his payments further.
2. Accept a partial early payoff if you can’t get the full thing. For example, the borrower agrees to cash-out refi $50K in proceeds to you but you subordinate the balance owed to 2nd position on a nice 55% LTV mortgage he gets in 1st. An easy loan to get, and he gives you some of the proceeds. In exchange, you could also offer him a better interest rate or lower payments on the balance he owes you.
3. Avoid foreclosure, be sure to propose all my Restructuring ideas with borrower:
Lower interest in return for raise monthly payment.
Lower interest in return for graduating and/or higher payment.
Eliminate or extend balloon in return for graduating and/or higher payment.
Shorten amortization in return for graduating payment.
Provide cash loan in return for a new wrapped loan balance.
Fix terms or clauses that are causing problem.
Where can I go get immediate financing to get cash out? Consider banks, institutions, a single investor, selling several fast partials to a network of syndications, etc. They will lend.
Learn the “Paper Trade at Face” where I TRADE my notes for other real estate, property, or other notes? I can buy the notes at a discount (50%) to face value and then trade the note for FULL face value for real estate, and you’ve effectively bought real estate at a 50% discount. Or trade it for personal property. You can also trade your good note for a bad note (at significant discount). Or for example, to get cash out: I will trade you a note at full face value (that I may have bought discounted) on your free and clear home. You get the note with income stream, I get the home. Once I buy the home, I can immediately refi it at 70% and get a wad of cash out.
The Paper Trade The "Paper trade" in it’s simplest format is buying notes at a discount and then trading them at full face value for real estate equities. I buy a $100,000 note for $70,000 (30% discount) and then use it as collateral to buy a $100,000 house. I end up buying the house at 70% of market value. Most of the time the "Trade" takes the form of using the note (or notes) as collateral - a term called "hypothecation."
So I pledge a Note as collateral at full face value (the one I bought at a discount anyway) but get the new asset free and clear. Then I refi the new asset at 70% and get my cash out.
Where do I get the Note though? From an investor with equity – we create the note. So investor B has a home with plenty of equity and creates a $70K note that I use to buy the house.
- How to Deal with Underlying loans, as the junior Wrap Holder:
Re-instate them and re-wrap to the borrower
Loan money to the borrower and re-wrap the underlying
Buy underlying
Negotiate discount on underlying and then refinance them off, re-wrap to borrower
Try to refinance underlying PLUS your cash into the note back out, sell on wrap
Negotiate a partial payment (via refi) on the underlying in exchange for lower interest rate or pmt, try to get some cash out yourself
7. When holding, Index your notes to inflation or allow yourself to convert to equity position or share in appreciation. When this loan can be indexed to inflation, or be convertible into, or share in, the equity at the option of the note holder, it might be written for a couple of percentage points less. At 95% loan to value ratio, a plain vanilla level payment, fully amortizing, 30 year first mortgage note might be written at 7.0% or so.
Other ways to fix up flawed notes are too numerous to mention or to give details on, but here are a few examples.
INCREASE THE SECURITY - A note seller brought me a note once that had a 100% loan to value ratio and was signed by a corporation only (no individual recourse). I told him the two problems with the note, that I thought were incurable. A few hours later, I received a call from the payer of the note. He was willing to double the security (now a 50% loan to value ratio) and sign the note personally. All of a sudden an un-marketable, undesirable note has changed (ugly duckling to a swan).
IMPROVE THE SECURITY - Move the note to more desirable security or even fix up the security that is presently there. How about using some money which would be paid for the note to improve the property? Subordination to a new small hard money loan to raise fix up capital?
IMPROVE THE RATIOS - How about splitting a note with a bad loan to value ratio into two notes? Then instead of one large un-salable, undesirable note there are two notes - one that is salable.
IMPROVE THE CASH FLOW - Could you work with the property owner on refinancing underlying loans to raise the cash flow on the wrap? There are dozens of ways to change the terms and cash flow on a note.
SELL the lower yield to an investor, POCKET the monthly cashflow difference. FINANCE 100% of your purchase of the note with OPM, no different than a house. Security for their loan is the note as collateral. Find one or more investors that would be happy with a safe, secure 16% rate of return. In this example we will use two investors. They will receive a monthly cash flow secured by real estate.Buy the Trust Deed Note with the money from the investors and secure their investment with a note you are buying. Their note is secured by the Trust Deed Note which is secured by the real estate. The total monthly payments to the investors will be $172.35 and the payment coming in will be $220.22 per month.
OVERLEVERAGE AND GET FREE CASH: Finance the amount the cash flow will cover instead of just the cost (which is less). At the rate of 16% over 240 months, a payment of $220.22 per month would amortize a loan amount of $15,828.86. Subtract out your purchase price of $12,388.16 and that leaves $3440.70 cash to fill any empty space in your wallet. On top of that, you have equity in the note of $4171.12. That means you have BEEN PAID over $3400 cash to buy a note that you'll have over $4100 equity in.
Great way out of an upside down property…Move it! At all times you should look to MOVE the Note off a troubled or property in default (at the approval of the lender who is interested in finding better collateral) and find BETTER collateral - specifically instead use a Note(s) you buy at a DISCOUNT. No need to use houses as collateral if you can use Notes. Then you can finance the property now that it is free and clear.