Whenever you buy a discounted note, you should be thinking about how you can work with the payor to “fix up” the note. I have written several times about restructuring notes to increase their present value. This article will explore the procedure on a more general level.

The following discussion suggests ways to get your payor to pay-off his note or increase his payments, all with the idea of helping you get your money back more quickly. But this is to no avail if you have no place to put the extra money.

For example, if you own a note paying 16% interest for the next fifteen years, it may not be wise to restructure it, so you receive 35% yield for the next five years unless you have some place to put that extra money, such as another note.

If you are only going to put that money into a bank account at 4% interest, don't bother restructuring the note. Keep it for fifteen years at 16% interest. But, as a note investor you always want to increase your cash flow, so you can buy more notes.

First month: Early payoff

The first thing you should do when you buy a discounted note is to get the payor to pay it off immediately, usually by refinancing the property. You can do this by offering to pay the payor's points if he gets a new loan, or even to pay for the appraisal, or even pay for all closing costs, or even to give him cash, or even include a trip to Hawaii.

How can you afford this? Here's how: Let's say you bought a 10%, $40,000, 240-month note for a 16% yield--or $27,745 cash. How much would the note payor have to pay you if he paid off the note tomorrow? The answer is, obviously, $40,000.

So, clearly, you have $12,254 profit to play with. If you made that much in one day, your yield on that investment on my calculator, is “Error 5." That's my favorite yield!

Second month: Increase payments

If you do not feel that refinancing is a possibility for this payor, then the next month you can try to get them to increase their payments. You can show them that they can pay off their loan in a much shorter time by only increasing their payment by $25 per month.

For example, in the above note a $25 increase in payments will reduce the 240-month loan to only 200 months. A $50 increase will reduce the time to 174 months; and a $100 increase will reduce the time to 117 months. They will also save several thousand dollars in interest.

Third month: Increase note amount

If that doesn't work, the next month you could offer to loan them some money on a wrap around loan. For example, you could offer to loan them an extra $10,000 on top of the $40,000 but increase their interest rate from 10% to 12% on the entire note. Your effective yield is now almost 17% on the entire $50,000, and it's 19.32% on the extra $10,000.

Fourth month: Discount the note

If none of this works in future months you could offer to give the payor a 10% or 20% discount on the note if he would pay it off.

Fifth and sixth months: Principal reduction payments

Finally, by the fifth or sixth month you could tell the payor that you will discount the amount he owes on the note for every extra $100 he pays toward principal. He only needs to make extra payments when he has the money, and he can always go back to the old payment schedule.

Over $3,000 in profit from a simple letter

The point of all this is that you are missing a great opportunity if you are not constantly trying to get your payor to do something to increase your cash flow. Any time you can get more money from him, you are increasing your yield and the note's present value.

If you can get the payor to agree to a new contract with increased payments, you have increased the present value of the note and can now sell it for more money than you could have before the payor increased his payments.

For example, you could buy the above $40,000 note for $27,745 to give you a 16% yield. If you got the payor to increase his payments to $500 per month, he would pay off his note 107 months sooner. But you can now sell this note for the same 16% yield to another investor for $31,007. A profit of $3,262 for simply writing a letter to the payor.

A final caveat

Make sure you do not change the terms so substantially that you create a new note which now becomes a second note behind someone else's previous second note. Contact a title company when changing the terms of a note and trust deed, mortgage, or contract. They can assure you that your new note will maintain its priority.

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