Ringo was really his name. He had a $22,400 note that he desperately needed to sell. He insisted that we meet in the next hour, which I reluctantly agreed to do. He came to my office in his auto mechanic’s clothes.

He brought a copy of the note, deed and closing statement. The documents showed that Ringo had sold his house a year ago for $250,000 with a $225,000 first. The closing statement showed that the buyers had put down $25,000 cash and they got a bank loan for the $225,000.

It was a "hidden second"

Ringo, it turned out, was holding a “hidden second.” This means that somehow the bank thought that the buyers had made the cash down payment. However, after escrow closed the second note Ringo was holding was recorded against the property, and the sellers had bought the house with only $5,000 down.

Ringo was holding a note with practically no equity. It had a 98% “loan to value.” The terms of the note were $22,400 note at 12% “interest only” all due in one more year. The monthly payments were $224.00. This note was so risky it should have had a warning label and skull and crossbones on it. But for the clever note buyer there may be a way to buy these types of notes.

Clever note buyers buy "partials"

Counting myself a “clever note buyer," I did several things. First, I told Ringo that I only wanted to buy a part of the note since it was so very risky. I pointed out to him that the chances of the note being paid were about same as Anita Hill marrying Clarence Thomas. I ask him what the smallest amount of cash he needed. He reluctantly admitted he needed $10,000 as soon as possible.

Second, I told Ringo I needed to talk to the payors. He agreed, and gave me their phone number. 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.

Lower the interest rate and "pop" the balloon

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 $414.98 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 paid $15,000 nine 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:

Note Amount:	22,400
Interest Rate:	10%
Term:	72
Payment:	414.98
Balloon:	0

Buying only "part" of the note yields 41%

I then met with Ringo and proposed that I would buy the next 52 payments on this note for $10,000 if he would add additional collateral and guarantee the note. He said he had some equity in his house, and agreed to add that as additional security that the payors would pay their new monthly payments.

Then I told Ringo when I had received the 52 payments, I would turn the note back to him and it would still have a balance due of $7,615.15. Ringo was thrilled. He got $10,000 now and a note with 20 payments of $407.57 remaining and a $7,615 balance due.

We opened escrow, I funded the note and ended up the following:

My Investment:	10,000
Interest Rate:	10%
Term:	52
Payment:	414.98
My Yield:	41.19%

If anyone thinks that 40% is an unconscionable yield consider:

1. We get paid for what we know, and should not apologize for making a profit on our knowledge.
   
   

2. Ringo had no other place to go. He was lucky he found us, and thankful he did.
   
   

3. This is still a risky note, and no reasonable person would buy it with less than a 40% yield and the extra collateral.

The lesson is that many “bad” notes can be made into “better” notes if you can talk to the payor and restructure the terms and collateral.

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