All Forum Posts by: William "W.J" Mencarow

It means the terms of the note a seller "carries back," a.k.a. seller financing.  The terms include the interest rate, number of payments, balance, etc.

Hi Trevor,

I've been investing in single family houses since the '80s.  I've learned most of what I know from John Schaub (I've learned  most of what NOT to do by screwing up).  His book "Building Wealth One House At A Time" is full of great advice, as are his home study courses.  In fact, I just went to his live course in Sarasota.   

There are a lot of get-rich-quick crooks claiming to teach real estate.  Anybody who spends most of his time giving seminars doesn't have time to actually be doing real estate.  Avoid anybody who upsells you, charges thousands for "mentoring" or "coaching" or "boot camps."  Generally in real estate education, the higher the price the less valuable.  

I hope this helps.  Feel free to email me if you have questions.  I'm easily found in a web search.

Bill

Hi Christian,

Since nobody has responded, I'll give you my 2 cents.  I've been buying and renting SFHs since the '80s, first in the Washington, DC area, now in central Texas.   I'm a buy and hold guy, not a flipper.

I never buy a house I wouldn't live in.  That goes for the neighborhood as well, even if I like the house.   I don't mean the house and neighborhood has to be ideal for me, but in a pinch I could live there and be OK.  If I would worry about my wife being alone in the house, I don't buy it. (Since she does some of the rehabbing, she's often alone in houses we buy.)  If the house and neighborhood passes those tests, I know it will attract good tenants.  And attracting good tenants is THE goal.

I've learned by trials of fire in buying houses in all kinds of neighborhoods (except the worst slums) --  all the way from trashy houses in low income neighborhoods to one I own right now, on a private golf course.  My best rentals, both from good cash flow and fewer tenant headaches, are in middle income to higher middle income neighborhoods. 

High-end houses tend to have tenant turnover, which can kill your profits and even put you in the red.  People who rent high-end houses usually are doing it because they are waiting to buy a house and will move out in a year or two.  There are exceptions, of course (as is the one I have now), but that is one of the risks in expensive houses.

What do I look for in a neighborhood?  Kids playing, mothers pushing strollers, mowed lawns, cul-de-sacs, off major roads, little traffic (so kids can play outside), good school district, walking distance or a short drive to shopping.  I walk the neighborhood and talk to people, tell them I am interested in buying in the area and ask them how they like it.  John Schaub taught me to also ask them if they know of anyone who might be selling but hasn't listed yet (www.johnschaub.com).  

What do I look for in a house?  3/2s with garages.  I don't want more bedrooms because I don't want an army of kids destroying my house.  I want a garage because tenants often fill them up with stuff, a workshop, etc., and that means moving would be a huge deal for them (so they are likely to stay when the rent goes up).  I LOVE to see my tenants have to park in the driveway because of all the stuff in the garage.  New or newer roof and AC compressor.  Brick or other siding that doesn't need paint.  Tile floors, ideally everywhere.  A yard for kids and pets (upkeep is tenant's job).  Yes, I allow pets if there are tile floors, because I can get more rent

I have owned  houses in bad neighborhoods and paid less for them.  The cash flow was great -- when the renters paid, which wasn't often until I hounded them, and when there were no major repairs, of which there were many, and when there were no vacancies, which there were many of, and when I could find desirable tenants, which was rare, so the houses sat vacant for weeks and even months between renters.  

Bottom line:  If you are looking at houses in a neighborhood and you think you would be more comfortable if you had a gun, don't buy there.

The other MAJOR issue with bad neighborhoods is drugs.  The government under civil forfeiture laws can seize your house if your tenants are convicted of drug dealing/manufacturing. Yes, of course that could happen in nicer neighborhoods, but the chances are less.  That's why you need to visit your tenants every so often no matter the neighborhood.

Maybe slumlords do well with those kinds of properties, but I am not and do not want to be a slumlord.  I buy nice houses in nice neighborhoods, fix them up to the max, spend a little more to make them over the top, and rent them to nice tenants who appreciate the house and appreciate me as their landlord.  As a result my average tenant stays for years; one stayed for 18 years, and she'd still be there if I hadn't sold the house.

I hope this helps a bit.

George, I just ran across this article that appeared in my newsletter The Paper Source Journal.  It's by Lorelei Stevens, president of Wall Street Brokers in Seattle.  She's a third-generation note investor, done it exclusively all her life.  Her company buys notes, including unusual notes like divorce liens, all over the country:  www.WallStreetBrokers.com (I can't get it to paginate well, sorry.)

THE DISADVANTAGES OF  A SELLER CARRYBACK

The fundamental risk is that you may not get all your money. The following problems are examples:

Foreclosure: If  the mortgagor stops paying, and you’ve tried all practical means to get things back on track, you may have to take legal steps to get your money or get the property back. You will need professional help to handle a foreclosure. Foreclosure is a last resort that costs time and
money.

Economic Slump: Although property values usually rise over time, they can decline because of an economic downturn. In a severe downturn, your mortgagor may owe you more than the value of the property and decide it’s not worth continuing to pay you. They might offer to give you the property, ask you to reduce the payback amount, or decide to just walk away, which means you may have to take the property back.

Mortgagor Problems: They could suffer from a lost job, a divorce, addictions, illness that piles up medical bills, and other personal adversity that stops payments to you.

Uninsured Damage: Although a prudent note investor will always require the mortgagor to obtain fire/hazard insurance on the property, some types of damage may not be covered by the policy.
Damages that might not be covered could include floods and earthquakes. If the property sustains
uninsured damage, the buyer may lose incentive to pay, ask you to accept less money, or even
abandon the property, again leading to foreclosure.

Mortgagor complaints: The mortgagor might find some defect in the property after taking possession, such as a leaky roof or rotten siding, an environmental violation such as heating oil residue, or a zoning or building code violation – and stop paying until you fix the problem.

Irregular payments: This is more an annoyance than a deal-breaker. Some mortgagors may fall a
month behind and stay that way for several payments and then slowly catch up, while others may
completely skip a payment or two and then quickly bring their payments current. You can
sometimes detect a potential problem mortgagor in advance – while you’re checking out their credit and ability to pay – but not always. It’s a good idea to include penalties for erratic payment, but even then some may still push the limits.

Sudden need: You could find yourself under pressure to get fast cash and decide to sell your
note or contract for deed. Investors are available to buy them, but they customarily buy at a
discount, meaning you will receive less than the balance owing.

Great question!   Finding good notes is the major difficulty.  Most successful investors (and note brokers) I know spend most of their time marketing for notes.  

Note investors need to make sure the note and note seller isn't violating Dodd-Frank. In short, if you want a seller-carryback note created on or after January 1, 2014, if it is a private individual, trust, or estate, then ask them to sign an affidavit saying that they have not done more than three in a 12-month period and how many of them had balloons. If the note seller is an entity, an LLC, or a corporation, etc., ask for an affidavit saying how many it has done and how many of them had balloons.

Here's part of an interview I did with Ric Thom, who has been one of the major advocates before Congress and regulators representing the note and real estate industry:

Dodd-Frank applies to seller carryback notes created on or after January 1, 2014.

THE ONE PER YEAR CATEGORY

The CFPB broke seller financing into two different categories. One category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence.

Let me repeat that, because there has been so much misinformation circulated about it: this category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence. For them:

* You can have a balloon in your note with the buyer.

* You do not have to prove or document their ability to repay.

* The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning.

That’s probably going to affect all but three to five percent of individuals who carry back notes.

Remember that these restrictions only apply to seller-carryback transactions on properties

that have a dwelling that the buyer will use as their primary residence. A transaction on a lot or vacant land is exempt (even if the buyers plan to build a primary residence).

If the property has a dwelling, but the buyer is not going to use it as their primary residence —say they’re going to rent it or use it as a second home — then none of this applies, and you can offer seller financing with no restrictions.

Commercial property and multifamily that is five units or larger is also exempt from the restrictions.

Again, the one seller carryback transaction per year category applies to individuals, trusts and estates. It does NOT apply to corporations, LLCs, partnerships or other legal entities. In that case the second category applies (below).

Again, these rules only apply to what the CFPB refers to as a residential mortgage loan where the note is secured by a dwelling or residential real property that includes a dwelling.

Most people only carry back a note once in their lifetime, when they sell the big house, retire and move somewhere else. Some might do it a few more times. Even many real estate investors only do it once a year. These regulations are not a huge change for most people.

THE MORE THAN ONE PER YEAR CATEGORY

The second category applies to individuals, trusts and estates that do more than one seller carryback transaction per year when the buyers will use the dwelling as their primary residence.

It also applies to any seller-carryback transaction — even one — where the seller is a corporation, LLC, partnership or other legal entity and when the buyers will use the dwelling as their primary residence.

* The note cannot have a balloon.

* The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year after the fifth year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning. This is the same restriction as the first category.

* You must determine the buyer's ability to repay.

* If you do no more than three seller-financed transactions per year you do not have to become a Mortgage Loan Originator (MLO).

* If you do more than three you must become an MLO -- or find an MLO who is willing to be the go-between.

Just as in the “one per year” category, these restrictions only apply to seller-carryback transactions on properties that have a dwelling that the buyer will use as their primary residence.

If you have a rental house and the renters want to buy the house to use as their primary residence, and you want to carry back a note with a balloon (and you don't do more than one seller carryback transaction per year), and that rental property is in a corporation, LLC, partnership or other legal entity, you're going to have to move the property into a trust or into your personal name. Otherwise, you're going to fall into the second category which says you cannot have a balloon unless you are an individual, trust or estate.

If you think about it, not having a balloon but being able to do an adjustable rate almost serves the same purpose. Let's say you start out with an interest rate of 6% on the note and then after five years it goes to 8%, then it goes to 10% and then it goes to 12%. That’s a huge incentive for the buyer to refinance out of the property and pay you off. If they don’t, then you’re rewarded for your risk in carrying that paper; you’re now getting 12% for holding that paper, and there is no balloon.

ABILITY TO REPAY

The second category requires you to determine the buyer’s ability to repay, but the rules and the regs don't specify any standards for doing it (such as the qualified mortgage standard, a 43% debt to income ratio, etc.). You don’t have to do any of that; you can just ask them if they have a job, can you see a paystub, can you see their tax return (which they may or may not give to you). All you are required to do is to make some good-faith determination that they’re able to afford that payment, and you do not have to document it.

It would be prudent to have some documentation in case there’s a default and the buyer's attorney says "where’s the documentation?" and tries to create a legal defense against paying you. But there is no requirement that you have to document. All it says is that you should determine the buyer’s ability to repay.

I asked an attorney at the CFPB about how one should determine the buyer’s ability to repay. He said that if you fall under category two you have to determine the ability to repay, but he admitted that there are no set guidelines. You just have to show that you used good faith in determining, for example, that the buyer has a job, his rent was $1,000 per month, but the payment on the note is $900 a month and you think in good faith he can afford this property because he could afford the rental house he was in before.

WHEN YOU’RE BUYING A NOTE CREATED ON OR AFTER JAN. 1, 2014

You're going to be able to tell from the note if the mortgagee is a private individual or an entity. If it is a private individual, trust, or estate, then ask them to sign an affidavit saying that they have not done more than three of these in a 12-month period and how many of them had balloons. If it's an entity, an LLC, or a corporation, etc., ask for an affidavit saying how many it has done and how many of them had balloons.

If there is a balloon in that note that you're buying from an LLC, corporation or partnership, etc.,you know there's not supposed to be one (again, if that note was created on or after January 1, 2014).

You’ll have to have the note modified to remove the balloon before you buy it. Otherwise at some point the mortgagor could use the fact that the note was not in compliance when it was written as a defense against paying the debt or foreclosure. 

Check out NoteSmith.com

A friend closed a six figure seller carryback note purchase late last fall thru Drake Chandler, Esq. Obenschain & Chandler, L.L.C. 7000 Central Parkway, Suite 1450 Atlanta, GA 30328.   Phone numbers can't be posted here, so PM me if you need it.  If you contact him, please mention that Reliant Financial / Danette Ferguson referred you.

George, I've been investing in notes since the early 1980's, so I'll try to answer your questions as best I can:

1.  In addition to the Paper Source (full disclosure:  that's my company), I suggest Peter Fortunato's Basic Paper Course (www.peterfortunato.com) and the materials at noteinvestor.com.  Jeff Armstrong has excellent materials at armstrongcapital.com for both note investors and note brokers (and those who want to be).

Avoid any event where they upsell you.  And if you're at one, leave when they start doing it.  

And certainly don't fall for paying thousands for a "boot camp," "coaching," "mentoring" etc.  That kind of price is a huge red flag.  So many people through the years have told me how they were ripped off that way.

2. That is "possible," but I wouldn't recommend it, esp. for an under $20K property. Add an NPN (non-performing note) to that mix and you are just asking for headaches.

3.  I haven't read the "alarming threads" about the "huge risks," but if you buy notes with your own money, and you are not selling notes, the main risks are financial, not legal. I wrote a guide on the risks of notes some years ago.  Let me know if you want it, and I'll send it to you.

4.  In my 7-part introductory e-course on notes I recommend that you don't buy any notes until you have brokered so many that you know exactly what you are doing.  

I used to know a guy who was part of a touring group of get-rich-quick "gurus."  After he quit in disgust, he told me some backstage stories about some of the speakers.

He said one of them had an introduction that went, "Ladies and gentlemen, now presenting XXXXXXX, who has made millions with what he is about to reveal to you."

All the gurus laughed at that intro, because the inside joke was -- and the guy being introduced wrote it that way with this in mind -- that what he made millions on, what he "revealed," is how to buy his $25,000 "coaching" and "boot camp."

He also told me of another con man named (oh, how I wish I could name him, but I don't want to get sued).  This guru switched from pitching home study courses on real estate and notes to "subliminal" audio downloads and CDs on a variety of self-help topics:   losing weight, getting to sleep, kicking alcohol and drugs, etc.  The subliminal messages were buried in soft static.

He asked him why he switched from real estate, and the guy confided, "Simple.  I don't have to do any work at all.  The downloads and CDs are just a bunch of static."

BTW James, I've been in real estate and notes for 30+ years, and most of the gurus are like the crooks I just described.  There are only a few with the heart of a teacher and who have earned the right to teach by practicing what they preach.   And they charge a fraction of what others charge for far better information. (When it comes  to real estate and note education, my working principle is, the more they charge the less it is worth.)  

I, along with thousands of others, heartily recommend John Schaub (who, with his partner the late Jack Miller, taught the first seminars on single family house investing) and Peter Fortunato (the undisputed master of creative finance -- as Jack used to say, "Pete is the comet and we're just trying to hang on to the tail.")