Most of the notes that aren’t purchased are because of unacceptable LTV or “Loan to Value” ratios. Few note buyers realize the alternatives, so we will look at a few today.
1. Example One – Leveragectomies
A “Leveragectomy” is to un-leverage a property. Many times a note can actually be split from one “bad” note into two notes (One good – one bad).
For example, let’s look at the following illustration. Lets say that a property was sold for a low down or went down in value to the point where there is a note with a 100% LTV.
Current property value = $100,000 Seller held first = $100,000 Equity = $0 LTV 100% Potential buyers = 1 (me)
A leveragectomy here would mean split the one $100,000 note into an $80,000 first loan and a $20,000 second loan. Now, who wants the first? – everybody! Who wants the second? – Just me or the seller. The second can be free, extra profit for me or I can let the seller keep it. The first now would be very marketable. Here’s a couple ways to go about it.
A – The Even Split – Let’s say this $100,000 loan has payments of $1000 per month at 10% interest. We could divide it evenly by creating an $80,000 loan with payments of $800 per month and a $20,000 loan with payments of $200 per month. Both at 10% for 216 months. Value of this 80k note would be $51,191 at 18% yield.
B – The Uneven Split – This note can also be structured by directing the entire $1000 payment to the 80k note which would then pay off in 132 months. At that time the payment would be directed to the second. This makes the first more valuable = $57,379 at 18%.
As I’ve mentioned before, any change in the note requires all parties to the note. The payor is going to need some incentive, like a trail of ten dollar bills to the title company, but there is plenty of profit to be able to share some with him. I might even give him a couple thousand dollars – written off of the back of his loan. What does that cost me? Very little.
Example Two – Collateral Conversion
The collateral for the note isn’t written in stone. You can change the collateral. For example, what if the payor has another property that could act as better collateral? Change it. Again, another trail of ten dollar bills may be needed. What about adding this other property as additional collateral? How about fixing up or improving the property that acts ac collateral? All are examples of ways to improve the collateral. In fact, the seller of the note has a need for cash. The note isn’t the only way to get it. I have had sellers of notes offer to add their own properties in as collateral. We can also create a note against the “note sellers” (not the payor’s) property that mirrors his unsalable note except for the fact that it has a better Loan to Value ratio.
Example Three – Partial Purchase Subordination
Purchasing a partial means buying a piece of the note instead of the whole note. When purchasing a partial, it is usually structured so that the interest that the note seller retains is “subordinated” to that of the note purchaser. This means that the note purchaser gets paid before the note seller in case of default. In a case like this you are looking at the “Investment to value” ratio, which is the ratio of what you have invested to the value of the property – instead of looking at the total amount of the note in question. Many buyers will weigh this ITV ratio heavily, yet not all will. You’ll need some legal advice on the first one or two of these that you do. In addition, there are many ways to do partials. Some are smooth and easy and some have some inherent pitfalls. We will talk more about partials in a special article on the subject. An example of a partial in this situation would be buying 93 payments for $50,000 which would then yield 18%.