A note by definition is a promise to pay, also referred to as a promissory note. If you take a $100 bill out of your wallet at the upper left-hand corner, it describes what you are holding as a federal reserve note. US currency at one time was backed by gold, and in the body was called a gold certificate, then it was changed to a silver certificate meaning that our money was backed by silver. What gives a note power is when it is backed by a hard asset Like Real Estate. When this is done, it is called a mortgage. At closing you sign your name on a promissory note that was backed by the real estate you are buying. This is how you give teeth to a promissory note by giving it a hard asset as security for payment.
The note business is one of the most interesting subsets of the real estate investing business. Most real estate gurus never talk about it because they either do not understand it or maybe they just don’t want you to know about this wonderful industry.
All of you should have seen on television advertising over the years, that I might add, is low-quality advertising with marginal actors talking about structured settlements. A structured settlement could be, for example, there was a car accident. Let’s say you were paid out $5000, every five years for the next thirty years, that is a structured settlement. You can sell a monthly or yearly payment stream even once every five years for a lump sum of cash up front. The structure of these settlements is when real estate investors are buying a property, they may not have enough money or will not qualify for the entirety of the mortgage. So, they give the seller a second mortgage, that could be a balloon. Knowing that it will or could balloon in five years, or it could be a balloon note in six months, it could even be monthly payments for fifteen years, it could be any structured pay out overtime.
This industry for people that have notes can be bought and sold. The buyers are looking for a yield that they can earn on their money. As an example, if the interest rate on the note is 5%, the note buyer may want a yield of 12%. So, they will buy the note at a discount to add space value that will give them an annualized rate of return, called yield of 12%. Financial calculators are set up to give you the information you need on how to calculate it. There are individuals that make an amazing amount of money simply brokering the notes. Since you are not creating the note, the note was already created, you don’t need to be a mortgage broker to work in this field. People that create notes are required in most states to have a mortgage brokers license.
Another aspect of the note business is called factoring. As an example, let’s say you have a small business that does flooring. You have payroll that you have to meet every Friday. You have a large job and you have ordered $50,000 worth of flooring and you have gone past the credit level that the manufacturer will give you. You can sell the contract you are holding for the job so you can get paid and have the cash flow to survive. Some of you would say go to the bank. A lot of banks will loan money to people who don’t need the money, the people that need the money don’t always get it. So, factoring in a nutshell is simply selling your accounts receivable so that you have cash flow to stay in business. Obviously, this is a brief overview of the two industries they are like twin sisters, that work exactly the same way. But really understanding this industry can help you put real estate deals together, help you stay in business, and help you to minimize the negative effects of running a business where you need weekly cash flow.
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