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[illuminati @thmoneycircle]

In depth lesson on note (mortgage) investing:

What is is, why I do it, how you are protected, etc

Yesterday was a rough overview, this sucker is gonna be in depth. Turn your TV off, tell your fat wife to leave you alone for 5 min cause school is in session...

First things first, what is a 'note'? It's a loan (in our case, on real estate)

It has two pieces:
1) Promissory note, this outlines the terms (amount, rate, repayment, balloon, etc)

2) Mortgage or Deed of Trust. Depends on state, look up 'Is [insert state] a mortgage or deed of trust state'. Some are both. Anyways, these instruments secure the promissory note. It says if Jim doesn't pay me back according to promissory note I get to foreclose on the property

Now that we know the legal bullshit, we need to know the two types:

Interest only & amortized

Interest only, well, you only get paid interest and the principle is returned at the end of the loan in the form of a balloon

Amortized (your traditional 15/30yr bank notes) is where the balance gets paid down with every payment

Now that you know the technical definitions, we should go into the math, and figure out how these can make us $$$

amortized loans get safer over time, the LTV decreases which in turn, increases your cushion...while interest only keep the same balance throughout the life of the loan

Why do people (including me) buy these?

- We get one of two things, consistent cashflow or the property

- If you buy correctly, they are pretty passive. You can hire a servicer to deal with all the bullshit

(As a general rule of thumb, if you wouldn't be okay owning the property for the amount you lent on it, don't lend on it)

What kind of returns can they offer?

it depends...you can get anywhere from 0% to 40%+ in some situations. though typically i'm seeing ~8, 9, 10% being pretty common for a performing handsoff note

the one below is a 15.78% return (from my quick math...could be off)

SO HOW DO WE CONTROL OUR RISK?????

1) COLLATERAL

This is VERY important. It is what the loan is secured by...

let's go through two situations:

1A) you lend $500,000 on a $500,000 house

2A) you lend $500,000 on a million dollar house

which one would you rather do? probably no. 2. Nothing changed except the collateral. this is the biggest lever in making sure our capital is protected

2) Let's talk about our next variable, LTV (aka loan to value)

How much did we lend / property value

$50,000 loan on a $100,000 property = 50% LTV
$30,000 loan on a $100,000 property = 30% LTV
$70,000 loan on a $100,000 property = 70% LTV

*typically* the lower the LTV, the lower the risk.

as an example, i just bought a note that pays 10% IO on a $135,000 property. it has a balance of $62,500. 46% LTV. So im protected, while getting a bangin' return

3) BORROWER
The person/entity borrowing the money matters (a little, i guess). I personally don't give a shit. If the LTV is good (and true) and the terms look good, i don't care about the borrower...but i guess you can

Now look, the borrower still matters. A borrower with stable income and a history of making payments is obviously preferable.

Personally, I care a hell of a lot more about the collateral and the LTV than I do the borrower's credit score. If I have a low LTV on a solid property, I know I have multiple ways to get my money back if things go sideways.

now we can get into some more 'advanced stuff'?

lien position...what in the fuck is that???

its the order in which (if something goes wrong) that creditors get paid

so if you are in 1st lien position, you get paid first from the sale proceeds

let's give an example:

$250,000 1st position

$100,000 2nd position

$50,000 3rd position

house sells at auction for $360,000

1st and 2nd position get all of their $$$ back ($350,000) while 3rd position only gets back 20% of their original investment. I personally only buy firsts unless the second is REALLY (and I mean REALLY) appealing.

So, as an exercise, let's evaluate the note below (happy to look at anything you guys need help w too, fyi)

We have a $32,000 balance at 12% on a 6yr amortization schedule. We get a monthly payment of $625.61/mo for the next 72 months. We can buy this note for $29,000.

So we discount it:

At $32k it provides a 12% yield
At $29k it provides a 15.78% yield...wow

yield is good, now what about the rest of it??

we have to protect our money, let's make sure that's done....it's secured by a house renting for $875, though we don't know the value i'd assume it's atleast $50,000. That puts our LTV at 58%. That's safe enough for me. Usually anything under 70% i'm happy with

lien position: 1st, so we are 1st in line to get paid in event of default

borrower? we don't really know but probably fine...they will pay the $625 cause they don't want to lose the house paying $875

another bonus, it's amortized so the balance gets reduced every month, this does two things:
1) returns capital every month
2) decreases loan balance every month (which reduces risk)

so you get one of two things:
1) $625.61/mo for 72 months
2) the property (worth $50,000+)

overall, not to shabby

i hope ya learned something. for most people, notes are a GREAT idea (atleast if you hate the sound of sourcing, fixing, managing and financing deals)

[Option chain @TraderGang704]

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