Making the Most of Your Real Estate Note

How to Avoid the Biggest Mistakes Note Holders Make:

Protect your investment. A real estate note is an important investment and needs to be treated as such. Many real estate note holders are unaware of the precautions they can take to ensure that their note continues to perform up to expectations.

Check your investment regularly. Drive by occasionally. Is the current owner maintaining the property? If you don’t live nearby ask a friend or real estate agent to drive by and send you photos.

Check the taxes. If the property taxes are not current on the property it can be sold at a tax auction and wipe out your note completely.

Verify insurance coverage annually. If the property is destroyed by fire, for example, will the current owner be able to rebuild. Tip: ensure the insurance coverage at least covers the balance of the mortgage. Also, make sure you are listed as a mortgagee on the policy so that you can get paid in the event the property is destroyed.

Check the borrower’s credit. This is often cited as the number one mistake note holders make. Many note holders mistakenly believe their real estate agent or escrow company will do this for them. They won’t. You need to review the borrower’s credit. This will also help you determine the interest rate and terms you will approve for the buyer. If you ever decide to sell the note, the investor will need an updated copy of the borrower’s credit report. Tip: If you did not receive a copy of the borrowers credit report at the time you negotiated the note it’s not too late. As a creditor you are entitled to review it periodically.

Don’t Sell The Property At A Discount. Price, terms, condition and location help sell a property. You are offering great terms and should charge a premium for that.

Charge an Appropriate Interest Rate. I have been guilty of not charging a high enough interest rate myself in an effort to get a property sold. However, the fact is, if the buyer could obtain a traditional loan with a lower interest rate, they would. You are talking all the risk as well as offering a valuable service and you need to charge for that through the interest rate. As a general rule you should not charge any less than 9% interest for owner occupied, residential property with good borrower credit. The interest rate should increase from there depending on the property value, type of property, down payment and borrower’s credit. Tip: if you want to lower the monthly payment use a longer amortization period and include a balloon payment. This will not lower the value of your note as much as charging too low an interest rate will.

Get a Down Payment. Not getting a large enough down payment or any down payment at all significantly devalues your note. The borrower needs to have a vested interest in the property; otherwise you are taking all the risk. The larger the down payment, the more the note is worth.

Good Record Keeping. As with any business or investment good record keeping is essential.
Maintain a record of the mortgage payments you have received. Tip: consider opening a separate bank account for these transactions. In the event you want to sell the note it will be much easier to show the payment history.

Keep your original documents in a safe location such as a safety deposit box or a fireproof safe at home. Your real estate note is a negotiable and transferable document. In the event you want to sell your note a copy will not work, you need the originals.

IRS reporting. The IRS requires that you provide the mortgagor a report of the total interest paid in the proceeding year no later than January 31st. Of course you must also include the interest you received on your tax return.

Act Swiftly. If a payment is received late immediately contact the borrower and inform them that you will be charging a late fee pursuant to the terms of the note. If it was an oversight, great, but you don’t want to give the impression that paying late is ok. If the borrower has missed a payment or payments don’t just hope they will catch up, you will need to act quickly to discuss options with the borrower. Tip: this is a good time to run the borrowers credit to make sure they have not been falling behind on other commitments. If you plan to sell your note, this is the worst time to do it.

Courtney Self

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