Investing in Promissory Notes: How Private Lenders Can Help
Investing in Promissory Notes: How Private Lenders Can Help
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Bridge loans are usually associated with the acquisition of real estate, but hard money and private capital lenders will often underwrite loans that are secured by other assets, such as promissory notes or trust deeds. In our post-recession economy, banks often find it necessary to clear sub-performing or non-performing loans from their books. Savvy investors can pick up such notes at an incredible discount, but it can be difficult to obtain financing for their purchase if you don’t have the cash on-hand at the time. This is where private lenders can help by offering bridge loans to cover part of the purchase price of the note. However, before requesting a note-purchase bridge loan, there are two types of due diligence that you should conduct on any potential promissory note purchases: loan document due diligence and property value due diligence.
Loan Document Due Diligence
The number one thing to remember is that purchasing a distressed promissory note is not the same as purchasing the property outright. What you are paying for is the loan documents and debt apparatus. There are a few questions you should ask about the loan before deciding to purchase it:
- Are the terms of the note, or the note itself, negotiable? Make sure you know what defensive options are available to the borrower in the event of a default or foreclosure.
- What is the balance owed on the note? A note is difficult to enforce if there isn’t an accurate record of payment history, detailing the outstanding principal balance as well as accrued interest, late charges and any other amounts owing.
- Are the loan documents accurate and is the information complete? Even if you are purchasing the note from a reputable bank, it is still possible for the loan documents to contain errors. Review and verify that the loan documents match the loan commitment papers and any other correspondence, and that all necessary documents have been correctly signed off on by both the borrower and the original lender.
- Have the loan documents been amended in any way? Confirm whether the original lender has made any amendments, waivers, or other agreements with the borrower that would impact your ability to enforce the original loan documents.
Property Value Due Diligence
Once you have determined that the loan documents are in order, then it is necessary to conduct a careful assessment and valuation of the real estate and any other collateral securing the loan. The most important thing to keep in mind for this part of the process is not to accept anyone else’s assumptions at face value. Here are a few questions to ask about the loan collateral:
- Are there problems with the survey or title? You should closely examine the survey and title insurance policy and independently verify any assumptions made about the property, especially if you plan to put the property to a different use than the current borrower intends.
- What use is the property zoned for? Even if you plan to put the property to the same use as the current borrower, it is important to know about existing special use permits, nonconforming uses, and other land use regulations that could impact the value of the property (especially if there have been any changes in laws that could negatively impact the future of the property).
- Are there any outstanding leases? If the property has income-production potential, then your due diligence should also include a review of any lease documents to current tenants as well as rent rolls and other financial documents as this can greatly affect the current, and future, value of the property. If you plan to change the use of the property, you need to know if the current leases can be terminated.
It can take a bit of research to determine whether a promissory note is a promising investment, but once you do make that determination, it’s easy to get a bridge loan to help cover the purchase costs of that note if you work with hard money and private capital lenders.
If you have questions about Montegra’s note-purchase loan program, contact us at 303-377-4181.