May 19th, 2014 7:13 PM by Gregg Mower
I see investing in Notes and Deeds of Trusts as the future for Real Estate Investors. Wait a minute you say, people have been lending their money to other people since the beginning of time. You would be right, however, over the last several decades we have let the banks lend out our money for us. We have let the banks receive the interest on our money all the while we have been suffering with low returns on our money in the banks. Seems weird that we believe the Banks can do a better job at lending our money to people we don’t know than we can. But it is too complicated to lend money in today’s world some might say. A little known fact that exists in Real Estate law is that there is no usury law for those individuals who lend out their own funds. In other words there are no limits to the amount of interest you can charge on a private note. This may sound a little farfetched, but it is the law, and we are supposed to live by the law of the land. Private money lending has been around since money was invented as a means of commerce. In fact, in the 1930’s movie “It’s a Wonderful Life” with Jimmie Stewart, arguably one of the best Christmas Movies of all time, Jimmie Stewarts character George Bailey was a Mortgage Broker who would lend the town’s folks money out for Real Estate in Bedford Falls. There is a scene in the movie where the “Great Depression” hits and there is a run on the banks and George Bailey is forced to give up his honeymoon and give his savings to the town’s people who wanted their money from the “Building and Loan” (The Bailey Brokerage). He convinces the investors, in the movie, not to take all their money out of the Building and Loan as it is invested in everyone’s homes in town, and that it would be impossible to do so, and that if they insisted everyone would lose as the Building and Loan would go bankrupt. This is a great scene where he explains in layman’s terms how the lending and banking system works.
This is still true in today’s Private Money Lending and Banking world. The law states you can lend your money to others for Real Estate up to 8 times a year without the services of a Licensed Broker. However most would choose to use the services of a Broker as they will be more protected by using a Broker, as the Broker must adhere to a strict set of rules when handling other people’s money. The system is easy with no costs to the lender to use a broker and the yields are far greater than that of a Bank.
What you need to know when deciding to invest in Notes and Deeds? First is the terminology, there are many new words that you should get comfortable with. The first of which is what is a Note and a Deed of Trust. The Note, or Promissory Note, is the written paper or contract between the Lender and a Borrower stating the terms of the loan and how it will be paid back. The Deed of Trust, in California, assigns a trustee, or a Third party to be in charge of foreclosure proceedings and as is the document that is recorded at the county that secures the Note legally. Sounds like a mouthful, but to keep it simple the Deed of Trust secures the Note and are the legal instruments that bind the Borrower and lender together until the loan is paid in full. A Real Estate Broker like MAE Capital Mortgage can prepare these documents and make sure they are legal binding instruments and that they are handled correctly.
The next thing you need to know is how the system works. The system is generally pretty easy. Once you have decided to invest some of your money, you need to know who to give your money to and how it will be handled. The very first thing I would suggest is that you do not give your money directly to a Broker and ask them to invest it. This is very important, as you should be advised of the investment you are making before giving any money. Your Broker should furnish you the RE 35 (Investor Booklet) and RE 870 (Investor Questionnaire), to determine your financial situation as an investor. Then when a Broker presents you with an investment opportunity they should also provide you the RE 851 (Individual loan information form) that spells out the qualifications of the Borrower and the terms of the transaction. Your Broker should also provide you with the loan application, appraisal, and preliminary title report, and credit report and the purpose of the loan. The risks of the transaction should be outlined by the Broker as well, such as the Loan-to-value of the transaction or the equity position you would have if the loan went to foreclosure. Generally, the higher the risk to the Lender the higher rate of return the Lender should have. Conversely, the lower the risk the lower the return, and as an investor your risk assessment will become obvious to a good Broker who deals with this type of lending. So once you have determined that this is an investment for you, and the terms of the transaction are acceptable for your return objectives, the Broker will draw up the legal document for you and the borrower to sign. A good Broker will insist on using an Escrow company that will issue title insurance, to protect you, as well as act as a disinterested third party that will bring Buyer, Seller, Lender, Broker together in a neutral setting at different times. Once the buyer has signed all the legal documents you as the Lender will be instructed by your Broker to wire funds directly to the Escrow company, again your Broker should not have direct contact with your money. At this time your Broker has made sure the Title Insurance is correct on your behalf and that there is a hazard insurance policy in place in case of a catastrophe. Before the loan has funded you, as the Lender, can choose if you want to service the loan or have the Broker (if capable) service the loan for a fee for you. Servicing the loan means the collection of payments and the dealing with the borrower throughout the term of the loan. If you choose to have the Broker service the loan on your behalf there will generally be a nominal fee to do so in addition to a “servicing spread” that the Broker probably built in the loan to receive. For example; a servicing spread is the difference between the interest rate collected from the borrower and the rate of interest paid to the Investor/Lender. If the Note was written at 11% and the Lender was promised to receive 10% the 1% difference is the servicing spread paid to broker every month. To break it down even further as a Lender you agree to the terms from the Broker upfront so there are no surprises. If the loan is a $100,000 interest only at 11% the annual interest collected would be $11,000 and the Lender’s agreement was to collect at 10% the lender would receive $10,000 annually leaving $1,000 for the Broker in servicing spread. Generally, there is a small fee for the Broker to perform the servicing on top of the spread and that generally runs $15 to $30 a month taken out of the payment from the borrower for postage, phones and personnel. For that monthly fee the Lender will get a check every month from the Broker and will never have to deal with the Borrower directly the Broker will. In addition, any late fees collected from the Borrower will be split between the Lender and the Broker and they will generally run up to 10% of the payment, in the example above the monthly payment would be $916.67 a month so the late fee would be $91.67 if the borrower makes a payment after the 10th of the month.
So with the Stock Markets bouncing up against record highs with nothing but downside potential for the next few years and Real Estate Values flat for the most part and rents staying steady where do you put your money to make a 10% or better return? For the savvy Investors they might just be looking at lending their money and acting as a bank and getting the big returns themselves. Another little known vehicle is the Self Directed IRA where you can legally lend your money from your retirement account for a Note and Deed of Trust. I know this works, as I have done just that with my personal retirement account realizing that the returns and fees on my IRA in the Stock Markets have not been acceptable. The allusive 10% return on investment may be only realized if you become your own bank. We would love the opportunity to help you through this maze of opportunity. As always you can leave your comments on this or any of the blog posts or contact us directly for a personal education on this opportunity.