Jack Sternberg -- the man who brings us The Noteworthy Newsletter -- has been kind enough to rip back the veil shrouding the note business, helping Mogul readers get a full-on immersion into one of the hottest, least-known profit centers in real estate today.
Last time, Jack told us about how you can use notes to create tremendous value for yourself with “The Paper Wrapper”. If you missed it, you can read all about it here. (And if you wanna take an even longer trip in the ol’ time machine, click here to check-out Jack’s initial lesson about “The Paper Broker” as a creative dealmaking strategy.)
In today’s main event, we’re diving down deep into one of the easiest, most profitable ways to make money with notes. We’re calling this “Double Your Pleasure”…
JP Moses: OK, Jack, so what is exactly is Double Your Pleasure – and how can Mogul readers benefit from it?
Jack Sternberg: Double Your Pleasure is for when you sell a house on terms. Many real estate investors do this – and Mogul subscribers can, too. Instead of taking back a single note, Double Your Pleasure involves taking back two notes, to double your pleasure. I do this a lot… this is one of my favorite ways of selling a house.
JP: Let me clarify, Jack. With Double Your Pleasure, you take back two notes – from the same party? Do I understand this correctly?
Jack: That’s right, J.P. Here’s how it works: You sell one note for cash to recoup the money you used to buy the house, and you keep the second note for cash flow and multi payments. Let me explain why this is such a viable strategy for making money (and it’s better than taking back a single note).
If you sold a $100,000 loan for a note you took back in today’s market, you might get $60,000 for it. This is an example, but it isn’t far off the mark. So you're leaving $40,000 on the table.
Now, look what happens if you create two notes – a first and a second to come up with the same $100,000 total: If you create a $70,000 first mortgage and a $30,000 second mortgage, that $70,000 first mortgage is still worth $60,000 (if you sell it to an investor/institutional lender, with the required discount). So you'll basically take a $10,000 haircut.
JP: Is the discount based on a percentage of the note or a percentage of the loaned value?
Jack: It's both. Note buyers require a discount. I actually gave too big of a discount in this example, just to show you how it could work. Any institutional purchaser requires a discount because they don't buy notes at face value.
This $10,000 discount means the $70,000 note is worth $60,000, compared to taking back a single $100,000 note that would have to be discounted 40% for an institutional buyer – $40,000 (minimum).
By taking back two notes, you sell only the $70,000 for $60,000, plus you still have a $30,000 second mortgage. This keeps you from discounting too much.
JP: How do you structure repayment on the two notes? Do they have staggered repayment terms, or should they be the same length of time?
You have to stagger them. For instance, the first mortgage could be a 30 year, fixed rate, long-term loan for $70,000. The second, $30,000 mortgage might be a 30 year fixed rate – but you have to build in a two or three year balloon.
The reason I give a 30-year term is I want the payments really low for them, for the customer. In two years when they have their act together, they can refinance the whole thing and I get paid off. Does that make sense?
JP: If I understand what you’re saying here, Jack, You're not really going for the payments. You'll certainly enjoy the payments while you have them, but you're not trying to beef up the payment amounts. It sounds like this strategy is designed so you can extract as much cash out of that paper as possible. Do people go for the Double Your Pleasure strategy? Is it effective?
Jack: People prefer having a second mortgage at a lower interest rate that must be paid off in a shorter term. The shorter term is good for the investor, because it encourages the buyer to hurry up and get it paid off. For example, I just did one and the first mortgage was a 30-year, 80% mortgage. The second was at 2% interest with a two-year balloon. Your readers shouldn’t worry about the difference in payment – over two years, it’s lunch. In the deal I’m talking about here, the monthly payment on the second mortgage over a two-year period was $79 at 8% and $53 at 2%. That’s tiny.
JP: Jack, this flies in the face of the way a lot of investors work owner-financing. They basically jack up the interest rate and make the payments on the smaller note as high as possible. Are you saying this doesn’t make sense?
Jack: I just think it’s better business. You won’t make that much in interest on $30,000 over a two or three year term. And a buyer really likes getting what they think is a good deal on interest – even though the payoff is much, much shorter. Instead of stretching the payments out for 20 or 30 years – always a bad idea – or forcing them to refinance with high, unaffordable payments, give them a good interest rate discount in exchange for a shorter payoff.
I just recently did this again on a deal. I gave the lady the option of an 8% loan with a 10-year balloon or a 2% loan with a three-year balloon. She took the three-year balloon – just like most people. The motivation to refinance shouldn’t come from payment pressure, when a shorter balloon will do the same thing (and keep the borrower happier).
JP: What is required to be able to execute a Double Your Pleasure transaction like the one that you just described? Are there variations you could describe that would work for today’s Mogul readers?
Jack: You need a seller willing to sell and a piece of property that isn’t overleveraged. With the deal I'm referring to, I just paid cash outright for the property, and created two notes. It would be very easy to add a motivated seller to the mix – one who will give you terms. Then, everything else is the same.
Now It’s Your Turn!
Thanks to Jack Sternberg, it’s incredibly easy to see how profitable it can be to Double Your Pleasure. Don’t leave this important moneymaking strategy on the table – put it to work on your next deal.
To Double Your Pleasure, all you’ll need to do is:
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Pay Cash -- Pay cash for an undervalued property or get the owner to accept terms.
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Create Two Notes -- Create two notes for your buyer – a first mortgage for $70,000; a second for $30,000. (Don’t get tangled up in the numbers. Make the first mortgage 70% of the total financed; the second could be the remaining 30%.)
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Sell at a Discount -- Sell your first note for a discount, allowing you to cash out of that part of the deal.
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Ensure a Low Rate -- Make sure the second note is at a low interest rate (about 2%) with a two or three year payoff.
It’s just that simple! Double your fun today by putting the Double Your Pleasure strategy to work on your next deal. Do it to it!