Real Estate Notes
Often referred to as promissory notes, these are documents that state the amount owed, interest rate and years to repay a debt; they are usually accompanied by a mortgage or deed of trust that pledges the property in the case of nonpayment. Notes are loans you can buy or originate with IRA monies. To buy a note, consider contacting banks, lenders or brokers. You will want to have the property value appraised, examine the borrower’s credit, complete a title search to check for liens, purchase title insurance, and find a collection agency to receive the payments. Banks and other lenders often sell notes at a discount, so they are usually low risk and offer a good opportunity to earn profit.
If you want to originate loans, real estate companies, mortgage brokers, newspaper ads and builders/contractors associations are great sources. Be clear about your goals (short-term profit, stability, 12% growth, etc.) and any restrictions (location, type of property, borrower’s credit, etc.). If you originate a note, it is usually because the borrower has problems with credit history or overextended credit. You may want to ask for a credit report, current bank statement, and a written explanation of credit problems. To make this investment safer, consider these ways to lower your risk:
- Ask the borrower to add more collateral with additional real estate
- Have the borrower find a cosigner for signature strength
- If other liens exist on the property, it is advisable to take the first or second lien position by loaning the borrower sufficient funds to pay off these debts. Assuming a third or fourth lien position makes collecting very difficult if foreclosures is necessary. (Keep in mind that foreclosed homes usually sell at a discount, so by the time payments and penalties are paid off to the first and second lien holders, there may be nothing left for those who follow.)
- When the borrower has bad credit, have him sell part of the ownership to another backer creating a tenancy in common
Notes have the potential to offer investors the benefits of real estate without the burden of maintaining a rental property.