When you made the decision to invest in real estate, you began gathering a ton of information on market conditions, financing for flips and how to maximize your returns on different types of investment strategies. Those in your circles talk about finding distressed properties, finding value properties to rent and even development. You may hear about private mortgage notes, but this seems like a mysterious investment instrument. If you can master how mortgage notes work in Chicago, you open a door to a lucrative investment niche.
How Did I Become a Bank?
A lot of private mortgage note holders never initially intended to become a private lender? Many investors find themselves the owners of a private mortgage note by virtue of doing business. You have bought a property and fixed it up. However, the marketplace isn’t a hot sellers’ market. As you market the property for sale, you realize you need to think about all contingencies to get cash flow and be able to act on the next deal.
A buyer approaches you, unable to qualify for a traditional bank loan. They went through a divorce, which killed their credit but they do have cash and a good payment history on their last rental property. Evaluating the numbers, it makes sense to take a $50,000 down payment on a $200,000 home with a five-year term at 10 percent. This gives you a good chunk of cash and consistent cash flow still backed by the value of the property. The buyer agrees and you complete the paperwork for your first private mortgage note.
Seeking Out Notes to Buy or Hold
Once you have a note, you might decide that buying more creates an interesting mix of cash flow with note maturities. Think of having a ladder of certificates of deposit paying monthly interest but maturing at different calendar dates. There are notes you can buy often marketed via real estate investment clubs or private lenders. You can also advertise in local Chicago offering private financing. Check usury laws to ensure you are not exceeding IL’s regulations for interest terms.
Remember that you assume the risk on the note if the property buyer goes into default. While you can foreclose, that might lead to high court costs and rehabbing a property again. Therefore price the note for a comfortable return. When serving as a private lender, the note might be anywhere from three to ten percent above standard loan rates. When buying a note from an existing private investor, consider the remaining term and whether the risk has declined. Offer anywhere from 50 to 90 percent of the note’s remaining value based on your risk assessment and desired return on investment.
If you find that you have a need for cash for any reason, you can liquidate the mortgage note. Obviously, you are at the other end of the negotiation table as you were when you were the buyer. Keep in mind that a good negotiator might buy a note for a deep 50 percent discount on the note, adding it to a portfolio of notes that you turn around and sell as a package. This is similar to big lending banks that sell notes almost immediately after underwriting to servicing banks.