Buying Back Mortgage Debt for Bonus Profits
When I first began buying real estate, I had no idea that I could buy back my own debt, let alone how to make it happen. The very first time I made money doing it was completely unexpected! The mortgage holder asked if I’d be willing to pay off my mortgage, immediately, if he reduced the amount I owed him. I said, “Yes.” He knocked off $16,500— and I was never so pleasantly surprised in all my life. What an easy way to earn $16,500, I thought!
Quite by accident, I had stumbled into my first discount buying experience. I quickly realized I was onto something big! I remember thinking to myself, “If I can make $16,500 on just one medium-size mortgage, how much could I make if I had a hundred mortgages to work with?” That’s when I began to realize that the more private notes or mortgages I could assume when I acquire the property, the greater the odds of buying some of them back for a discount.
Strategies that go far beyond the simple wisdom of acquiring properties below market values can double and triple your profits, even after you already own the property. If this sounds too good to be true, believe me, it’s not!
We’ve already discussed wraparound financing and the opportunities to buy back underlying mortgages at substantial discounts. However, buying mortgage debt is not limited just to wraparound mortgages when you sell. It can work anytime when you own properties and are making mortgage payments to private parties. Let me show you how this is done.
Setting the Stage for Discount Profits
If you want to make big bucks buying your own debt, you must locate and acquire the kind of mortgage debt that creates an opportunity for discount buying. The more common institutional financing—the kind of mortgages that banks and savings and loan lenders make on properties—is not what you’re looking for here. Newer properties (non-fixers) are almost always financed by institutional lenders, rather than by sellers who carry back a mortgage. Therefore, if you insist on acquiring newer real estate, chances are this lucrative opportunity will not be an option for you.
Older properties are where you’ll find the private notes or mortgages. Since many banks will have nothing to do with financing older properties, especially nonconforming, multi-unit rentals, it means sellers of these types of properties are forced to carry back the financing themselves, in order to sell them. Quite often these properties will sell every few years, with each seller, in turn, creating a new mortgage or promissory note for a portion of his or her equity. I have personally bought properties with as many as seven personal notes secured by a property. Three or four seller carryback notes are not the least bit uncommon with older rental properties like we’re discussing here.
Look for Property with Private Mortgages
Your first step is to buy the right kind of property, one with the potential for adding value like I was able to do at Hillcrest and with other properties. It must be securing one or more private mortgages or promissory notes.
To illustrate, let’s say we locate an older rundown apartment building and discover it’s had three owners during the past few years. Further research reveals that with each of these sales new owner carryback mortgages were created to facilitate the transactions. These mortgages, commonly called owner financing or purchase money notes, are long-term and they are assumable to a new buyer.
The seller is asking $300,000 for the building, a price that seems reasonable based upon the income. The seller will take $30,000 cash down payment (10%) and allow the buyer to assume the three existing mortgages with remaining balances of $85,000, $50,000, and $35,000. To complete the transaction, the seller is willing to carry back another mortgage for the balance of the sale price. The new purchase money mortgage will be for $100,000, secured by the apartment for a term of 20 years.
These are excellent terms for a buyer. Obviously, the seller must be fairly motivated to make this deal. In most cases, the properties I find with these kinds of terms have been “milked”—that is, allowed to run down because the owner is not willing to spend any rent money for routine upkeep. High expenses and management problems are top motivators for selling, I’ve found.
I realize I haven’t presented a complete picture of this apartment building—things like deferred maintenance, bad tenants, and the location. However, I’ve told you the rents are reasonable for the asking price. That’s really all you need to know to move forward. Don’t negotiate too much over the asking price, if it’s reasonable.
Here’s where you need to spend your time and efforts. First, ask for copies of all three existing notes (mortgages).
One of the things you’ll want to find out about each of the notes or mortgages is the face amount, the amount when it was originated. For example, let’s say the note with the current $50,000 balance started out at $57,500. That means $7,500 of the principal amount has been paid so far. Having copies of each note will also give you the names of the buyers and sellers, the exact amount of the payments, interest rates, remaining time until payoff, and any special provisions you should know about. Private party notes can have a wide variety of provisions. Always read them very carefully.
I once had a note that stated, “The Beneficiary may increase the interest rate from 9% to 11% beginning January 1986, if the duplexes are not properly maintained.” I seriously doubt if it’s enforceable, but it’s still one of the terms stated in the note. The only way I would ever know it’s there is to see the note for myself. Notes drawn up between private parties often contain very unusual terms. My advice is to get copies and read them several times! The term you don’t want to see is a due-on-sale clause, meaning you would have to pay the note or mortgage off if you sold the property.
Let’s continue with the apartment example. It’s the right kind of property, because it’s property that’s been around for many years, long enough to have been sold multiple times. So, it has multiple notes (mortgages) secured by it. Newer buildings are less likely to have accumulated these notes from multiple sales.
Let me clarify. I’m not talking about notes or mortgages where cash money was borrowed against the property. Those are often called hard-money loans—and you can forget about discounting them.
Purchase money notes are the kind we’re looking for. These are notes where no money was actually given to anyone. They’re a form of credit extended to the buyer to facilitate the sale. These are the kinds of notes or mortgages that can earn you big money! And, this is where having knowledge about the players (beneficiaries) can earn bonus profits for savvy investors. The more you can learn about the folks who receive the payments, the better your chances for plotting a strategy that will hit pay dirt!
Most Sellers Would Rather Have Cash
Let’s say, for example, Mr. Jones is receiving monthly mortgage payments from the sale of his apartment building. Jones sold the apartments several years back, because the tenants were about to drive him completely bonkers. In a moment of weakness, Jones rented to a rock band that played loud music all night, slept all day, and paid rents only when Jones stayed up late enough to catch them! Jones is now 67 years old and retired. He sold the apartments and carried back a note for $90,000, which now has an unpaid balance of $85,000. Jones is scheduled to receive payments of $780 per month for 25 more years.
Jones would have preferred a cash sale for his apartment building. He wasn’t keen on financing the deal himself. However, because he got behind on the maintenance and suffered rent collection problems with the band, there was only one buyer who showed any interest in purchasing his property. So he pretty much had to take the offer or forget the sale. Jones took a small cash down payment and carried back the balance of his equity on a note for $90,000. It’s the only way he could get anywhere near the price he was asking!
When and How to Talk about Discounting the Mortgage
Life expectancy for Jones is 73 years. That’s only six years from now and his note will still have 19 more years of payments. If you’re trying to purchase the property, the time to talk to Jones about discounting is after you already own the apartment and have assumed the note. If you attempt to discount the note during negotiations, Jones is quite likely to insist on more cash, because he feels he has more bargaining power! Waiting until after you own the property before asking about discounts will generally get you better results.
I always like to meet with most mortgage holders at their homes. You can learn a great deal about people by seeing how they live. For example, you’ll be able to answer questions like “What kind of cars do they own?” Are they old junkers?” and “What’s the condition of their furniture? Is it expensive?” and “Do they have college-age children who cost extra money?” This information helps me determine their needs. If I can learn what they might need or want, then figure out a way to give it to them, I will nearly always come away with a sizable discount. This personal information can be very valuable, believe me!
Jay’s Red Mustang Strategy
I always like to tell the story about my red Mustang transaction! It illustrates the importance of understanding human nature and how it can be used to make big money in this business.
Susan and her boyfriend unexpectedly inherited my mortgage when Susan’s mother passed away. The balance was $48,000 and my payments were $441 per month. The note had 11 years to go before the balance would finally be paid. I learned of the mother’s death when I received an address change for mailing the payments. Shortly after that, I contacted Susan with an offer to buy the note.
I explained that I could refinance my property, but would only be able to net out about $25,000 after expenses. So, that’s what I offered. Susan’s boyfriend was a typical deadbeat who always needed cash, but, surprisingly, he didn’t like my offer. Reducing my debt by $23,000 was a little more than he could stand to see me get; otherwise, I think Susan would have gone for the $25,000 cash. However, they stuck together and refused my offer.
If at First You Don’t Succeed, Try Harder
Quite often your first offer won’t be accepted. Don’t give up—just try a little harder! The day I drove by Susan’s apartment and saw her boyfriend’s junky Subaru sitting on wooden blocks with the engine missing, I knew how to redo my offer. Human nature being what it is, I knew that young people living in a tiny one-bedroom apartment with no transportation will soon self-destruct! When I saw them again, they were a lot more motivated and willing to talk about selling the note. They were on the couch watching TV when I drove up in a shiny new red Mustang convertible.
My credit union had already agreed to loan me $20,000 so I could pay cash for the Mustang. It was a beauty! My loan payments would be $381 per month. The dealer also gave me a trade-in allowance for my 21-year-old pickup. Had I purchased the car on a regular installment contract from the dealer, the total cost would have been around $25,000, including the $2,000 credit for my pickup.
I left the motor running when I went to the door and knocked. When it opened, they both saw the car at the same time. It was love at first sight. They both immediately fell in love with my shiny new red Mustang convertible.
I let Susan drive around the block a couple of times and squeal the tires. When she got back, she wouldn’t get out! It was as if she were glued to the seat. “Anyone can own a new Mustang convertible,” I told her. “All you need is $25,000 and they’ll deliver it to your door.”
As we talked, I was watching the boyfriend. Several times he glanced over at his jacked-up Subaru, then back to Susan, who showed no signs of getting out of my car. I could tell by now, the boyfriend was hooked! “Can we both take a ride?” he asked. I agreed, but only around the block—one time!
Reeling in the Big Ones
Marketing folks call it “the hook.” Others use the term “setup.” But the name doesn’t matter. I will tell you this much—if you can figure out how to structure your proposals in a manner that will fit the wants or desires of a particular client, you can “hook” clients with a remarkable rate of success!
Susan and her boyfriend needed a new convertible like they needed a hole in the head. But once they saw the car, they wanted it very badly! Seeing it in their own driveway, holding the keys, and then finally driving around the block was a bit more temptation than either of them could stand.
In less than 24 hours the deal was done! They had traded the note to me for much less cash than my original offer. You recall my offer was $25,000 cash. The deal they finally accepted was this new convertible and $3,000 cash. To me this deal was much more attractive than my original cash offer, because there were no appraisals, no points, and no new deeds on my property. I paid $20,000 cash to the car dealer with money borrowed from my credit union, so the only out-of-pocket cash I needed was $3,000 to close the deal.
Here’s the bottom line. My $48,000 debt is gone, along with the $441 monthly payments scheduled for the next 11 years. Instead, I now have $381 monthly payments for only six years. If you forget the payments for a moment and just consider the trade itself, it cost just $25,000 ($20,000 borrowed funds, $2,000 trade-in, and $3,000 cash) to buy back $48,000 worth of long-term mortgage debt.
Where Your Negotiating Skills Will Earn the Biggest Profit
I’m sure you can see for yourself that buying the right kind of properties— like the kind we’re discussing here, with private party notes attached—can offer some exciting high-profit opportunities, once you get the hang of using this technique!
I recall being a part of one particularly long and drawn-out negotiating battle where the sellers and I exchanged four or five counteroffers back and forth. We argued for weeks over a $4,000 difference in the selling price! My offer was $146,000. The seller wouldn’t budge below $150,000.
Let’s suppose this property had three $25,000 private notes attached, all of which could be assumed. Say we finally purchase the property and eventually are able to buy back the debt, with something on the order of my Mustang deal (about 50¢ on the dollar). That means three $25,000 notes (mortgages) discounted by 50% would be $37,000 worth of discounts.
When you match this kind of potential profit against the small $4,000 difference in the seller’s asking price, you can begin to see where your negotiating skills will earn the biggest profits.
Again, let me emphasize—you must buy the right kind of property. You obviously won’t be able to do what I’m suggesting here if you purchase property with the normal 20% cash down and finance the balance with a bank loan. There’s simply no room for this kind of creativity in deals like that!
Timing Is Critical: Buy Back the Mortgage After Purchasing the Property
We’ve discussed buying the right kind of properties—the ones with good assumable debt. I’ve also told you that you can best use this strategy after you become the new owner. Quite often I’m asked, “Why not buy the existing notes (mortgages) at the same time you buy the property? For example, during the escrow period, couldn’t we simply negotiate with each mortgage holder, asking if they would be willing to sell their notes for a cash discount? It seems reasonable that if the note holders would agree to sell while the property is in escrow, we could wrap everything up in one glorious transaction! We could buy the property, obtain our discounts, and close the escrow all at one time! That would save a lot of time!”
Remember what I told you earlier about human nature? Real estate knowledge is not what makes this idea work. It’s much simpler than that. It’s the human nature factor inside all of us!
I well remember trying to do everything in one glorious transaction, as stated in the question above, and it turned out a horrible mess! I told the seller I had just enough money to pay 10% cash down for his property. I then contacted both private note holders who had mortgages on the property totaling $78,000 and got their approval to sell me both notes for $53,000 cash. My plan was to refinance the property to get the payoff money. Everything was moving along fine until the seller got wind of my $53,000 cash offer. He demanded a bigger down payment—plus he told me, “Since you plan on refinancing my property anyway, I’d rather not carry back any mortgage myself.”
I’ve never made that mistake again! The lesson I learned was to nail down first things first, then move on to the next step. Remember: there are many sellers out there who are perfectly content to accept your 10% cash down offers. They’re willing to carry back all of the financing as well—unless they get the idea you’re holding back on them. If that happens, greed takes over and you may lose the entire deal!
Factors That Motivate Sellers to Give Discounts
I keep a file on every private note holder I’m making payments to. I can’t tell you exactly what this information is worth, but a modest guess would be about $50,000 a year. In other words, that’s the amount of profit I expect to earn annually from buying back my own debt. My files contain information on every beneficiary (the folks who get my payments) including number and ages of family members and when children will be ready to start college, so I’ll know when to start sending them letters pitching my $35,000 cash tuition plan!
One of the best opportunities occurs when note holders pass away. My Mustang deal is perhaps the best example. Through my beneficiary files, I had been tracking Susan since she was only 13. You saw the results! Most people who inherit valuables, like mortgage notes, tend to lust for cash instead. Keep a good eye on the obituaries. I always cut out the notice when one of my beneficiaries dies. Then I make it my business to find out who will inherit my payments.
Joint note holders who divorce are naturals for substantial discounts. Keep good track of them too. Divorced folks seldom want payments. Most often they need cash—and quickly!
It’s also good business to send note holders a Christmas card around November 30. Lots of good discount deals pop up when people are in the mood to buy gifts or take a winter cruise. Of course, you must spell it out—paint them a picture when you send out your cards. Let them know you have cash available, usually about half of what you owe!
I hope you’ve got the picture by now. Next time you’re negotiating to purchase a property, take a good hard look at the various ways you might profit from the deal. You never want to miss the opportunity to deliver a Mustang. The experience can be quite exhilarating, believe me!
The Top Reasons Why Mortgage Holders Sell for Discounts
Why in heaven’s name would anyone sell their mortgage for less than the unpaid balance? Why would the former property owner be willing to accept a lot less money now than he or she previously would take when selling the property? Obviously, there is no end to the list of answers, but here are some of the most common reasons I’ve found.
1. Note (mortgage) holders want cash instead of monthly payments, for
many reasons. Perhaps they wish to …
a. Purchase a car, boat, or recreational vehicle.
b. Take a vacation.
c. Buy something that requires a lot of cash.
d. Start up a business venture.
e. Send the kids to college or help them buy a new home.
2. Partners break up and separate or divorce.
a. Partners need to split the money and go their own ways.
b. Divorce often creates a need for immediate cash.
Investors who sell rundown properties often carry back the mortgage to facilitate the sale, but they would rather have received cash.
Lifestyles change—health or death of beneficiary.
a. Older mortgage holders may want cash for “one last fling.”
b. The mortgage holder suddenly needs cash for the hospital or a
retirement home.
c. Younger relatives who inherit mortgages often want cash immediately, instead of payments over time. Many folks are impatient just like Susan and her boyfriend.
Finding the Right Mortgages Is Well Worth the Search
If I could pick an ideal property to purchase, it would be one that has at least four private-party purchase money mortgages that I could assume. Purchase money mortgages are the kind that result from sales where the seller carries back the financing. They’re different from mortgages where cash is loaned against the property. As I mentioned earlier, they’re an extension of credit. No cash is dispersed.
Here’s a typical example. An owner sells his $100,000 property on terms. Both parties agree to a $10,000 cash down payment and a seller carryback mortgage or promissory note for $90,000 at 10% interest, with monthly payments of $800 (interest and principal), until the balance is paid.
The $90,000 mortgage or promissory note is a purchase money mortgage—the kind of mortgage you should be looking for. First of all, it’s a long-term note: it will take about 28 years to pay it off, which means you will have many opportunities along the way to contact the holder (or his or her heirs) about selling the note back to you for less than the balance owed, more commonly referred to as a discount.
Naturally, the mortgage should not contain a due-on-sale clause in the terms! However, most seller carryback notes do not have due-on-sale clauses. They don’t have prepay penalties or late fee charges, either. This makes them weak in terms of their value as commercial paper. Mortgage brokers and professional note buyers want these kinds of terms when they purchase notes for cash.
A $90,000 note with 25 years of payments remaining, no due-on-sale clause, and just three years old with only a 10% down payment is almost unmarketable. The cash amount anyone would likely pay for such a note (soggy paper) would not make the note holder very happy. In reality, the person most likely to pay the highest price for this weak note is the mortgagor, the property owner who is making the payments on it.
Don’t Throw the Gold Away with the Sand
New investors have told me they won’t buy properties with more than two mortgages on them! If there are more than two, they insist that the mortgages be consolidated (paid off), leaving only a single loan or mortgage when escrow closes. They claim that having just one mortgage payment simplifies everything, as there’s only one payment and one lender to worry about. It makes a nice, clean manageable transaction, they say.
Well, I must tell you that having clean and manageable transactions should never mean tossing your money or profit potential out the window! If it does, you’re in for big trouble as an investor! Never lose sight of the target or you’ll be passing right over some hefty profits that could easily be yours for the asking. It’s much like having big gold nuggets in your pan, then throwing them out with the sand because you fail to recognize them!
Note-Buying Strategy Requires Detective Work
My note-buying strategy is based more on events and circumstances in the lives of my payees than on the yield charts. For example, when I locate a property I’m interested in buying, I always make it my business to see copies of the promissory notes to determine if they are good candidates for my future buy-back strategy. Notes are not public information like recorded deeds, so you must ask the sellers to produce them.
After I determine that the terms are acceptable, I try to dig out information about each of the beneficiaries, using my “Detective Columbo” techniques. I want to know if they’re rich or poor, young or old and, if they have kids, how many and their ages, especially if they’re about the right age for college. To do this right, you must force yourself to be a little “snoopy,” but it will pay off over time, believe me!
Jay’s Christmas Letter Generates Profits Year-Round
Let’s imagine that I discover that a note holder is an average family man, with a 10-year-old car and three teenage kids. I’ll send him my “special Christmas letter,” as follows.
November 15, 2002 Dear Mr. Andrews:
My, how time flies! Only six more weeks until Christmas. As you know, I’ve been sending monthly payments to you since I bought your property on Ugly Street nearly two years ago. Today, I just received word that I’ll be getting a substantial cash distribution from my late Aunt Lucy’s estate. It’s not quite as much as the balance I owe you ($56,570 as of 11-02), but I’m writing to everyone I make mortgage payments to, in order to find out who might need the extra cash. According to the terms of our promissory note, I still have about 15 years of payments left until it’s finally paid off.
In the past, several people I send mortgage payments to have asked me if I could pay them cash, instead of monthly payments. Naturally they are willing to reduce the amount I owe them in exchange for immediate cash! Because my income is mostly from rents, I seldom have enough cash to take advantage of their generous offers, but I do appreciate them offering, just the same. Naturally, I’m happy to pay cash when I have it.
The way things look, I should have my money a couple of weeks before Christmas, but certainly not later than January l. If you have a need for extra Christmas cash or perhaps for Jimbo’s college tuition this coming spring, now would be the time to let me know, before I spend the money on something foolish! Also, if you could let me know how much of a discount you’ll give for cash, I’d appreciate it very much. The best way for you to determine the true value is to call several professional note buyers in the yellow pages or newspaper ads. They will give you a quick estimate of the value—free of charge. I’ll assure you, I’m always willing to pay more than professional mortgage buyers because I don’t have a fancy office or the overhead to pay—and, of course, there are no fees dealing with me!
Sincerely,
Fixer Jay
Value, Like Beauty, Is in the Eye of the Note Holder
There are many books written about buying notes at discount, but the business of buying and selling notes is not what we’re discussing here.
We’re discussing buying back debt on properties we purchase without much regard for the standard yield computations. I know I’m going to hear from a few note buyers, but let me just say this anyway: I am more than happy to buy back my own mortgage debt and pay a little more money than most professional discount mortgage buyers would pay—and you should be too!
Investors Need a Healthy Financial Diet
Once you get a taste of buying back your own notes or mortgages at whopping discounts, you might just decide to expand your note-buying business and leave fixing toilets to someone else.
Before you sell your toilet auger, however, let me remind you that income earned from buying notes is not the same as income from rentals. For one thing, you will get no depreciation or capital gain treatment. In short, you won’t get any tax shelter—and tax shelter has been a big part of my fortune-building strategy. My suggestion is to do both. Operating real estate and buying notes make excellent bedfellows. Check out the tax treatment with your local advisor.
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