His name was really Ringo Jones. He had a note that he desperately needed to sell. We agreed to meet at my office, and he would bring a copy of the note, deed and closing statement. He insisted that we meet in the next hour, which I reluctantly agreed to do.
The documents showed that the house Ringo had sold for $249,000 with a $227,000 first mortgage. The closing statement showed that the buyers had put down $22,000 cash and gotten a bank loan for the $227,000. Ringo, it turned out was holding a “hidden second.” This means that somehow the bank thought that the buyers had made a cash down payment, but after escrow closed, the second mortgage that Ringo was holding was recorded against the property. The effect was the sellers had bought the house with no money down. Ringo was holding a note with no equity in the property; and the buyers of the house had no cash invested in the house.
The terms of the note were 12% interest only all due in two years. The monthly payments were $220.00. The note was a year old so it was only one year from the balloon. This note is so risky it should have had a warning label and skull and crossbones on it. However, for the clever note buyer there may be a way to buy these types of notes.
Counting myself a “clever” note buyer I did several things. First, I told Ringo I only wanted to buy a part of the note since it was so very risky. I pointed out him that the chances of the note being paid were about same as Bill Clinton marrying Monica Lewinsky. I asked him what the smallest amount of cash he needed. He reluctantly admitted he needed $10,000 cash. Second, I told Ringo I needed to talk to the payors. He agreed. Third, I ask Ringo to guarantee the note on a piece of his own property. He agreed.
I met with the payors the following day. The payors were a young married couple and the wife’s brother. They were all working and all lived in the house with two young children. I suspected they were worried about the balloon payment due in a year, and I was right.
I proposed the following. First, I would lower their interest rate from 12% to 10%, second I would amortize the note over 6 years and eliminate their balloon. In return, they must agree to raise their payment to $407.57 per month, and add some other collateral to the note, to insure they would pay it.
They owned a small lot in Shelter Cove, California for which their parents had $15,000 9 years ago. They agreed to add this property plus the subject property to a blanket deed of trust. They were very happy with the new deal, and I had a much better note.
Their new note looked like this:
N I PV PMT FV
72 10% $22,000 $407.57 $0
I then met with Ringo and proposed that I would buy the next 52 payments on this note for $10,000. When I had received the 52 payments, I would turn the note back to him and it would still have a balance due of $7,479. Ringo was thrilled. He got $10,000 now and a note with 20 payments of $407.57 remaining for a $7,479 balance due.
We opened escrow; I funded the note and ended up the following:
N I PV PMT FV
52 40% $10,000 $414.98 $0
If anyone thinks that 40% is an unconscionable yield consider:
♦ We get paid for what we know, and should not apologize for making a profit on our knowledge.
♦ Ringo had no other place to go. He was lucky he found us, and thankful he did.
♦ This is still a risky note, and no reasonable person with buy with less than a 40% yield and the extra collateral.
The lesson is many “bad” notes can be made into “better” notes if you can talk to the payor and restructure the terms and collateral.
by Jon Richards
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