Profits From Discounted Mortgage Notes


Many sellers and businesses have taken back first and second mortgages on property they have sold. This was often necessary in order to sell the property due to the then existing high prices and interest rates. These "notes" as they are called are often sold to raise cash. These notes have a FACE VALUE, an INTEREST RATE at which the note is being paid and a TERM (length of time left before it is paid off).


The "time value" of money assumes that a dollar today is worth more than a dollar in the future, so these notes are sold at discounted prices - usually at 50-80 cents on the dollar. To find such notes, network among those who would know who has such notes - CPA's, tax attornies, financial planners - even Realtors who may know sellers who took back notes when they sold their homes.


Why would someone sell a mortgage worth, say, $100,000 for as little as $70,000 or less? Because cash today, in one lump sum, is more valuable than a monthly trickle of income. This is why many lotteries - including Powerball - only pay half the jackpot if the winner chooses the cash option. If they choose the annuity option, they get the full amount of the jackpot. The "Time Value of Money" in action.


Remember - over time the dollar continually loses value due to inflation. If a dollar that you collect in 10 years is only worth 80 cents when you collect it, why would you pay a dollar now for the privilege of collecting 80 cents later? If you pay 80 cents now for a dollar you collect in ten years, you waited a long time to break even. So, if you are going to wait a long time to get your money back, these factors - plus a fair profit for you, the investor - must be taken into consideration. Therefore, these mortgages are worth between 50-80 cents on the dollar today, in cash. If you invest a big chunk of cash today, you expect it to be worth more in ten years, not less.


Mortgages are a "structured settlement", so to speak, giving off a predetermined income stream over a predetermined period of time. To exchange those small, regular payments for cash in hand today, the owner must give up some of the face value.


Let us see an example of how we can benefit from this without the need for cash or credit.


Let's say you find a property valued at $200,000. The seller is retiring and owns the place free and clear of any liens or mortgages. He wants to buy a condo in Florida for $80,000. You suggest that he invest the balance of his equity into seasoned mortgages worth $120,000 and paying 8% interest (or the going rate in the current market), with monthly payments of about $1000 per month to supplement his Social Security. This income will not affect his Social Security. The interest rate being offered by such a note is much higher than that on CD's, so the seller agrees.


Now, locate one or more mortgages with a total $120,000+ face value, at 8% (+/-) interest with monthly payments of at least $1000. Offer the mortgage holder $85,000 or so, to be paid in cash at closing. The note is to be placed into escrow along with a signed copy of the agreement, notarized.


At closing, your bank (if YOU are buying the property) or your buyer's bank (if you are reselling to a third party) puts up the money for a first mortgage of 90% of the price, or $180,000. From this amount:


1.) You pay $85,000 for the note. The note seller goes home, happy, and you own the $120,000 note


2.) You pay the seller of the property $80,000 cash for his condo and give him the $120,000 in mortgage(s). He goes home, happy


3.) There is $15,000 left "on the table". This belongs to you, along with $20,000 in equity in the property (the difference between the $180,000 mortgage and the $200,000 value).


If you bought and sold simultaneously at a double escrow, you would walk away with $35,000 cash - in other words, the $15,000 left on the table and the $20,000 equity you sold to your buyer (his down payment).


You have just plucked $35,000 cash out of "thin air", without having put up any cash or credit. You even arranged to buy the notes with no cash of your own (the note is purchased only at closing). This is wise investing using OPM - Other People's Money. A wise investor always seeks ways to use Other People's Money, Other People's Time and Other People's Talents.


Another example:


You are buying a $160,000 property. The first mortgage on the property is held by the previous owner. The mortgage has a current face value of $108,000. Without telling the mortgage holder that you are buying THAT particular property, offer $72,000 cash for his mortgage, to be paid at closing. Your agreement and the note goes into escrow. If he knows you are buying the property the note is on, he will not sell you the note - he will wait for the sale and get the entire $108,000.


If you are buying this as your own personal residence, you would get a first mortgage from your bank in the amount of $132,000 - $72,000 to pay for the note seller's mortgage on the property, $52,000 to pay the seller his equity and $8,000 to cover closing costs. You now own a $160,000 home for which you paid $124,000 plus $8,000 in closing costs. You now own $28,000 in equity (the difference between your new $132,000 mortgage and the $160,000 value of the property), you made no down payment and even the closing costs have been taken care of. It doesn't get much better than that.


Once you have built up some cash reserves, look for more mortgages to buy at about 65-70% on the dollar. With these in hand, go to the owners of these properties - those who are paying on these mortgages - and offer to sell his mortgage back to him at 80-85% on the dollar. He can refinance the property to eliminate a pesky payment and save thousands on his mortgage - a very good deal for him. You make a quick 15-20% profit for a few hours work.


Or, with a few of these notes, say, $40,000 face for which you paid $28,000, you can offer them as a $40,000 down payment on your next property, which gets your money back and saves you another $12,000 to put in your pocket.



Simple Man's Guide to Real Estate