How To Finance Paper

(by John D. Behle)

THERE ARE A variety of ways to finance paper, both short-term and long-term.

Short-Term Financing

When a good note is for sale, it will usually be gone in just a few days. In most areas, note buyers have cash and are ready to move. You will greatly improve your profits by being able to pay cash for notes with a 12 hour notice or less.

First, we'll look at some examples and then we will begin looking at ways to develop financing resources.

Example One

A short while ago a note seller called me about a note that they needed to sell quickly. The call came at about 8:00 on a Thursday night and the seller needed cash by 8:00 Monday morning.

The first thought that came to my mind was that 8:00 would be too early in the day to record any documents at the county recorders office. That meant that I would have to close on Friday. We negotiated the price over the phone and set an appointment for 8:30 the next morning (they mentioned an appointment with someone else at 9:00 - I wanted to be there first).

I left with a blank check in hand from an investor and did all I needed to close the note by about 3:00 that afternoon. By moving as quickly as I did, I bought a real good note at over a 24% yield before other note buyers had even returned the seller's call. You snooze, you lose....

Example Two

A seller called on Friday afternoon and needed a loan. We easily closed and gave him cash at the county recorders office on Monday. Since we had cash and could close quickly ourselves, we received a 21% yield and ten points.

Example Three

An agent called on 8:30 on a Monday morning about a property that was scheduled to go to sale at 10:00 for a foreclosure of the FHA first loan. By 10:00 we had bought the second of $7600 for $2000 and the third loan of $3000 for $400 and reinstated the first loan.

We had already pre-arranged with the tenant to buy the property. A couple days later, we closed on the sale of the property on a wrap around loan (contract) to the tenant. Nothing down and an instant cash flow for 30 years.

Example Four

Because we could close in one day, we were able to buy a nice first trust deed of $42,000 that had been seasoned for two and a half years for just $19,000.

The seller of the note was leaving town and sold for much less than two or three of our other competitors had offered, because we could close a few days sooner. It just took a few hours to close the note.

Ready Cash or Credit

Maybe this illustrates why you need to have either ready cash or ready credit to be able to buy notes with. Short-term financing or super-quick long-term financing is the key to tying up many good deals out in the marketplace.

Long-Term Financing (Institutions)

There are two general categories of long term financing. Let's look at institutional financing first.

The first place people go to try and finance notes is to their local bank. Institutions will finance paper, but the smaller institutions will be your best bet. Finance companies, credit unions and thrift and loans are usually much more flexible than large banks. In dealing with institutions, there are two very important factors that can help you.

First, a personal relationship and track record with your banker can make all the difference in whether you get a loan. Work hard to develop good relationships with the institutions that you deal with.

The second important factor is to have a good backup package containing all of the information an institution could ever want to know about your note.

This could include: appraisals, pictures, title reports, credit reports (yourself and the payor), copies of the note and trust deed, copies of loan documents on any other loans, information about any other loans, payment record, amortization schedules, any information you have about the payor of the note and any other information that is pertinent. Remember, with a bank, you are "Paid by the Pound."

What's Wrong with Financing with Financial Institutions?

It can be hard to find an institution that will finance you. They do not understand "paper" and the time value of money. If a banker has a financial calculator on his desk - it is a paper weight. You may have to train and educate the banker and then do it all over again as he is promoted or transferred.

Their policies can change at a moments notice and they can be very strict on their lending policies. They may not lend on the length of term that you need. They can be very slow and fickle.

Long-Term Financing (Private Investors)

I much prefer using private investors for my financing. Once they are familiar with paper, they can be easy to work with. I have the best success in cultivating investors from scratch.

I show them how their cash flow can be increased through investment in paper and techniques like "Equity arbitrage" and the "Discount Refinance." I teach my investors about paper, familiarize them with the forms I use and prepare them to move quickly. I make sure that their funds are readily accessible to them (cash or immediately accessible credit) and that they realize how important timing can be in buying notes. We look at sample notes of past transactions and discuss the steps in closing the note.

Many of these investors come from calls I receive because of my ad in the classifieds for buying paper. They read the ad and then call to ask if I also sell notes. Another way to find investors is to advertise to sell a particular note that you have. Anyone that is receiving less than a 12-18% rate of return is a good potential investor. I stress the safety of paper and the fact that it is backed up by real estate.

Once they see the cash flow, they start getting excited. I determine the rate to give them based on what we negotiate. I learned along time ago that in negotiations, "he who names a number first loses."

I try to determine early in the negotiations what the comfort zone of the investor is, because I have found that it can be devastating to offer them too high of a rate of return if they don't believe it is possible. Many investors will invest with you at 14% when 20% would scare them and make them feel it is risky - even though it is the same identical investment.

Risk Versus Rate of Return

Even though I would like to give them a high rate of return, some investors would feel there is risk. Somewhere along the line they bought the fallacy that a high rate of return means a high risk. Paper is a perfect violation of that rule of thumb. I secure the money borrowed from the investor by the note that is being purchased. I buy the note at yields of 14% and higher and borrow the money at from 10 to 14%. The terms are structured similar to the note that is purchased.

Sources of Short-Term Financing

Credit Cards. One of the best sources of short term financing is to use credit cards. It isn't too hard to build up credit card credit. The short-term financing that you need should be about 10 to 25 thousand dollars. There is nothing at all wrong about having credit cards or easily available credit. It can be one of the best assets that you can have.

The only problem comes when someone uses this credit improperly. Credit cards can be an expensive form of financing if used for a long term. If used for a short time period (less than 30 days), many cards do not charge any interest at all. If interest is charged, it amounts to very little when compared to the opportunity cost of missing out on a good note.

Refinance with lower interest long term financing as soon as possible.

Home Equity Line of Credit. You may find the best of both worlds to be the Home Equity Lines Of Credit that is secured by your home. The amounts available can be in the tens of thousands and the rates can be very reasonable. These lines of credit usually come with a checkbook giving you the ability to fund immediately.

A nice thing about using short-term financing is that you can purchase the note and then gather the information and documentation needed to put together a real nice financing package to obtain long-term financing.

Unsecured Credit Line. Another source of short term credit is to line up an unsecured line of credit with your banker that can be accessed easily and quickly. Investors and private money brokers can be cultivated to act quickly and loan money for interim financing between when you buy the note and refinance with a long term loan. They may want high rates, but it can be well worth it if it helps you get a good note. Avoid points if at all possible on any short-term financing.

There can also be a mixture of the two forms of financing in cases where an institution may loan against the note, but not all that you need to buy it. An example is an institution in our area that at one point had a policy of loaning only 75% of what they would buy the note for.

This may be all I need if I am getting a better yield than they are willing to pay. If getting the same yield, I can borrow the 75% from them and then worry about getting the extra 25% from somewhere else.

This should give you some ideas about financing notes. I have found it possible to finance every note that I buy at 100% or more of what I have needed to pay, and it can happen just as easily for you.

About the Author . . .