Raising Capital through Note Hypothecation

[Lupe Santiago]

Hi! I am looking to raise capital from some family / friends for my real estate lending business. I am an unlicensed hard money lender (legal in my jurisdiction - no broker license needed for non-owner occupied) and have a substantial sum of notes that I have lent upon.

Problem: Need to raise more money to continue lending w/ current clients, but probably can't sell the note via assignment of note & deed of trust because I'm not a broker. I operate as an unlicensed sole proprietor.

Here's my idea: Say I have 10 notes, each with principal at $100,000, with properties my borrowers purchased for $125,000 securing each note. Now I want to raise $90k from a friend so I can continue lending to my borrowers. Therefore, I would execute a note in favor of my friend for $90k, then pledge one of the notes of principal $100k as security. Upon an event of my default on the $90k note, the note & deed of trust would automatically vest in my friend, and he would step into the shoes of the lender to my borrower with the $100k obligation and property - friend is ultra secure and is basically getting 90 / 125 LTV based on not the market value, but the purchase price of borrower. That, in a nutshell, is how it would work.

Question...

1. My friend wants to be damn sure that he's the only person who has a claim on that note. How can I assure him of that when there doesn't exist an equivalent, well-established land-title recorder system for notes? How does he know I didn't already hypothecate it to someone else?

2. Any other issues or does anyone have experience in this area? I'm still trying to figure out how it would legally and operationally work!

Thank you very much!

[Dave Van Horn]

Lupe Santiago I think I can answer all of your questions. What you're after is what is called a Collateral Assignment of Note and Mortgage. Just to give a quick definition: a collateral assignment is the transfer of ownership rights of an asset from a borrower to a lender (e.g. one investor to one note), in exchange for the granting of some type of loan.

I was in your same situation in 2008 and I started doing Collateral Assignments on a one off basis and later on as a private offering. Since then I've done over $2 million of these both individually and as a private offering. When doing one of these on a one-off basis, it only requires 2 documents, a promissory note with the new lender and the Collateral Assignment of Note Mortgage doc (including a legal description of the property that is tied to the note).

1. You're NOT recording the note, you just record the Collateral Assignment of Note and Mortgage document. This includes a legal description of the underlying property, the original mortgage origination date, the original lender, the original loan amount, county and state where it was recorded, book and page numbers or ID number. This recording (recorded in the county the property behind the note is located) perfects the collateral (your performing note) for your friend's loan to you. The recording date is what will assure him of priority over other liens, so he will see he has the first claim to the note. And if he REALLY didn't trust you, he could do an encumbrance report on title because that would show no other collateral assignments would have been recorded. If you want a copy of my Collateral Assignment, just message me with your email and I'll send it over.

2. Word to the wise: Since I went from doing it from a one off basis to a higher quantity, my securities attorney recommended that I start a private offering. Most offerings are only worth it if you're raising $1 million or more. It looks like you're starting to get to that point with your 10 notes. Setting up a Private Offering could cost up to $7-$10K to set up, but it might very well be worth it, it was in my case. I also have a copy of our private offering as well, so you can message me if you're interested in seeing it.

ANOTHER TIP: I would also be sure to include a substitution of collateral clause in your promissory note. In case the original homeowner wants to refinance or sell, you would then have the right to substitute another note of equal or like value instead of paying your lender back early.

*ANOTHER BIG TIP*: When you go to record your Satisfaction of Collateral Assignment of Note and Mortgage, MAKE SURE the recorder's office doesn't mistakenly satisfy the actual mortgage instead of the collateral assignment.

And just to be clear a Collateral Assignment of Note and Mortgage has nothing to do with mortgage origination or a transfer/escrow of an assignment because the original owner of the note is still maintaining the rights unless there is a default.

Hope this helps,
Dave