Note Course Bonus-What Makes A Safe Note? Pt. 1
Published: Tue, 06/10/08
What makes a "safe" note? I asked some of the most active investors
this question, and in this mailing I'll give you their answers.
Whether you are primarily an investor or a broker,
I think you'll learn a great deal from these answers.
Even those who broker everything and never invest must know
how to recognize a good note!
Cheers,
W. J. Mencarow
The Paper Source, Inc.
www.PaperSourceOnline.com
www.cashflows.org
BLOG: http://papersource.wordpress.com
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Here is the question I asked some of the top national note
investors:
"Of course there are no guarantees, but what in your
opinion are the priority characteristics of a residential
mortgage note that a private investor should look for in
order to have as safe an investment as possible?"
"The Lower the Investment-to-Value Ratio, the Safer the Mortgage"
"An investor in mortgage notes in the secondary market has
one objective...that is, to earn a targeted return on investment.
Although in purchasing such notes we evaluate the seasoning,
the down payment, the payor's credit scores and other elements,
ultimately the most important factor is the value of the
property relative to the amount owed.
Just because a borrower has paid promptly for a period
of time or has good credit or put up a sizable down payment
does not assure that he or she won't run into future cash flow
problems and an inability to make required payments. As mutual
fund operators always caution, "past performance may not be
indicative of future results."
However, if an investor holds paper with a low balance owing
relative to the value of the property, the investor has a very high
probability of "coming out whole" and realizing its targeted
return either through receipt of the promised periodic
payments, or, if for any reason the payments are not made, through
realization of an equivalent amount through foreclosure on the
property. The lower the investment to value ratio, the safer
the mortgage." -- Rick Gordon, Director - Transactions, Florida
Asset Financing Corp.
"How Much Will It Cost To Foreclose?"
Determining what makes a "safe" mortgage is all a matter of
preference in what you are looking to experience.
How much pleasure? How much risk?
We've purchased high-risk notes that have paid off early
and made a handsome profit. We've purchased "safe" investments,
and lost our asses.
However, with experience being the best teacher, what any
private investor should look for must be measured by how much risk
he/she is willing to endure in the event of the need to foreclose,
either for non-payment of either the monthly payments, taxes or
"waste" of the property. It as much depends upon who the investor
is, their own characteristics, as what the secured property is, the
creditworthiness of the payor, and the amount of equity and
seasoning in the property.
All of the following comments overlay large brushstrokes in
generalities, so please accept the concepts and not the specifics.
For example, an aggressive, young, energetic, "I want to
foreclose and fix the place up and sell it for a profit" kind of
investor will purchase a higher risk note hoping that he/she can
get the place back, and make a killing. A more passive investor
does not want the risk of loss and is looking for a note securing a
property where the payor has good credit, perhaps some seasoning,
definitely some substantial equity, and a property type and location
that is in the mainstream. This is the case to minimize
the risk that something will go wrong. And if it does, so that if
they have to foreclose, there is something worthwhile to work
with that, even if from a distance, can be fixed up relatively
inexpensively, and resold in order to cover the financial exposure.
Personally, my major issue is determined by whether I
think I'm going to get paid, and if I am not:
a) how much is it going to cost me to foreclose, i.e. is it
an easy to foreclose state, such as a Deed of Trust state where it
only takes a few months to get a property back, or am I secured on
a Contract for Deed, that is to say, where I don't have to go to
court to foreclose? If I have to go to court to foreclose,
such as in New York, Florida, New Jersey, etc. (I live in
California), I am less likely to personally buy the note. And the
truth is, I've had many successful purchases in these states. The
question is, however, what my first considerations are, and that
is always the first one.
b) What kind of property is it? This is mainly for
the purposes of determining my risk upon resale.
c) How much equity is in the property so that if I have to
foreclose, there is room to cover all my costs, legal and repair,
time since having any payments, and the value that can be gained
by expending these dollars? This also takes into account whether it
is a 1st or 2nd, and if I will have to carry the 1st in the event
of default, and whether it is worth it to do so.
d) Yes, I always look at credit scores. Very important.
What I also look at in the credit scoring is how much debt
there is on the credit cards and accounts versus the amount
of credit available. Someone with good credit can be charged
up to the max, which might be an accident waiting to happen.
e) Seasoning is not my type priority, except from the
standpoint when any of the other factors above are weak.
f) My sense of smell, and history of eating a lot of
terrible properties around the country, that apparently were
underwritten properly, but went bad anyway. There is absolutely
nothing more valuable than experience.
MORE TO COME!