Hypothecationis a fancy word for borrowing money against a promissory note. It is an area that savvy Colorado investors are using more and more today to raise money for purchasing bargain priced bank owned properties. This smart use of Colorado hard money is allowing a select group of investors to take advantage of this new opportunistic area of real estate finance.

Bank Foreclosure Properties

No one knows for sure how many bank owned properties are in default, but the number is very large.  Once a bank takes title to a defaulted property it is well known that they are likely to suffer a significant loss in selling it.  First, they have to go through the foreclosure process to get title.  Next, they have to deal with the eviction of the homeowner – a process that doesn’t earn the bank many friends.  Then, they turn the property over to their REO (real estate owned) division to clean it up, suggest re-sale value, and find a Realtor to sell it.  Buyers that bid on bank owned properties typically offer far less than fair market value.

In order to avoid all of the difficulties above, many banks are now willing to sell the Promissory Note and Deed of Trust on their defaulted loans to investors at a discount.  If the bank sells the Note, then the purchaser of the Note has to deal with completion of the foreclosure, eviction of the tenant, clean up, and resale of the property. This can be an attractive alternative to the bank management.

Colorado Hard Money

The investor however has one significant problem to resolve before making a bid to the bank to buy the Note.  Where are they going to get the money?  If the investor has 100% of the funds in their checking account – no problem. Otherwise, an investor may be well advised to talk with a Colorado hard money lender, like Montegra, to see if they can obtain a portion of the purchase price by “hypothecating” the Note they intend to buy from the bank.

How it Works

Here is how using hypothecation with bank foreclosures it works:  Investor “John Sharp” makes an agreement with “First Imaginary Bank” to buy their Promissory Note and Deed of Trust on a house now in foreclosure.  The bank’s original Note amount is $200,000 but they will sell this Note to John for $150,000 – all cash – if John can close quickly.  John believes the value of the house today is $225,000 so there is a substantial profit to be made but…John only has $90,000 in cash. John may turn to a Denver hard money lender like Montegra Capital to see if they will lend him the additional $60,000 cash he needs for the bank’s $150,000 sale price.

Montegra is open to discussing funding a loan to John where the bank transfers ownership of the Note to John (after receiving their $150,000 in cash). John in turn assigns the Note and Deed of Trust to Montegra as security for the loan – secured  not by the real property (yet), but by the actual Note and Deed of Trust.  Through a somewhat complex process Montegra allows John to complete the foreclosure and take actual title to the house.

Once title is transferred to John by the Public Trustee, then John will give Montegra an actual Deed of Trust on the property. John, having obtained a one year loan from Montegra, evicts the former owner, cleans up the property and does minor remodeling. Then John is able to list the property for sale and realize close to its fair market value of $225,000. With a purchase price for the property of $150,000, plus the added remodeling costs, and loan costs John Sharp still makes a good profit on his invested dollars.

Part Two of this Blog Series will discuss the possibility of Montegra helping John Sharp actually acquire a property by bidding against the lender and other bidders at a Public Trustee auction.

[google_authorship], because of his more than 40 years of experience in funding hard money loans, is considered an authority on hard money or bridge financing.  He frequently speaks at meetings and conferences and writes articles on these subjects.