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NPRO
H & P Capital Investments LLC
Issue 27
September 2007
No Equity? No Problem! Advanced Wrap Technique
by Tom Henderson
deal2

Those who do not live in Texas are fortunate to be able to use contracts for deed as wrap vehicles on homesteads without jumping through hoops. However, in Texas, contracts for deed can still be a valuable means of disposing of property where the buyer is not a homeowner, but an investor. At any rate, here is another number crunching exercise that shows the power of wraps, whether you are selling on a contract for deed or a note.

Say you purchased a house for $150K, with terms of 30 yrs @ 6%, with payments of $893.33 P+I. Ten minutes after you purchased the house, you decide you want to move. OUCH!!!

Why not immediately sell your property for $155K with $5k down using a wrap, except change the interest to 9% and the terms to 40 years. I know some of you are saying, "Huh!!!!"

Let's look at your underlying note:
N= 360
I= 6%
PMT= $899.33 P+I
PV= $150,000
FV= 0

Now let's look at the wrap note:
N= 480
I= 9%
PMT= $1,157.04 P+I
PV= $150,000
FV= 0

Not looking bad, is it? $1,157.04 - $899.33 equals $257.51 Positive Cash Flow.

What happens in an early pay off, pray tell.
Let's look. Assume the buyers pay off the loan in 2 years. Here are the pay off figures.

Wrap Note Balance: $149,160.93
Underlying Note: $146,202.23
Money To YOU $2,958.70 (TAX FREE)
+ Payments for 24 mo (24x257.51) + $6,180.24

This is a total of $9,138.94 in two years with a house with no equity.
Not bad, huh?

How can this be? It is just another wonder of using the time value of money to solve problems. Are you starting to understand why I like using notes as a tool to buy and sell real estate?

What is amazing, is the longer the pay off, the more of a spread in the note balances. According to my accountant, the difference in spread balances is tax free. (This means more money in your pocket.)

As usual, be sure to check with expert legal and tax advisors before using any owner finance technique.

If you have questions about notes, or know of someone who wants to sell a note remember me.

Copyright H&P Capital Investments LLC All rights reserved

To buy a note or sell a note, contact me at www.hpnotes.com
Note Professor Notebook
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If you have not attended a Note Professor "How To Get Rich with Notes" class, be sure and purchase the Note Professor Note Book manual to enhance your knowledge of creative real estate financing and note selling.

Owner Financing Education
Tom's Speaking Schedule
Apartment Buying Class-Oct 27&28
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Apartment Buying Made Simple
Two Day Event
Saturday, October 27, 2007 at 8:30 am
Sunday, October 28, 2007 at 1:00 pm
DALLAS, TX
Sign up here: seating limited to 20.

Tom will speaking on "How to Make Obscene Yields with Small Money" October the 4th through October 7th 2007. NoteWorthy Convention. Las Vegas, Nevada

Note Professor Notebook on sale at the NoteWorthy Bookstore.

Why Is There a Discount on MY Note?
by Tom Henderson
why a discount

One of the most frequently asked questions I receive from note holders is "Why is there a discount on my Note"? If you answered because of the time value of money, you are only partially correct. The time value of money does not explain the sudden change in note pricing for properties with low equity combined with a buyer's mediocre credit (below 650).

The correct answer to the above question is "the discount of a note is proportional to the RISK being taken by the purchaser of the note." The concept of the time value of money is only one risk to be considered. In this issue, I am going to concentrate on how the discount on your note has been affected by current events, specifically the subprime meltdown. The discount on notes has increased greatly on those notes that have payors with low equity in the property and mediocre credit (below 650).

There are several risks in investing, not only in notes and real estate, but in any investment. Let us examine 2risks that are affecting the price a note buyer can pay for a note in today's.

1. Collateral Devaluation and Deterioration Risk
With real estate prices declining in many areas around the country, there is the possibility that prices could decrease drastically in any neighborhood. Prudent note buyers have to take the climate of the overall real estate market into consideration when purchasing a note. For example, if a house with a $95,000 1st lien, is worth $100,000, and there is a 10% devaluation in real estate prices, the note buyer is now faced with the possibility of having a $95,000 note, with a house worth only $90,000. If foreclosure happens, the note buyer must account for the cost of foreclosure, any needed repairs, and any devaluation of the property. Therefore the note buyer is looking at a possible triple loss.
(This is becoming a reality for many banks). Note buyers are not going to make this same mistake and are now taking into account the risk that the collateral could decline in value.

2. Credit Risk of Payors
Contrary to what many believe, note buyers would rather have a root canal than to be forced to foreclose. For this reason, the amount of the discount on the note is now strongly influenced by the risk of having to foreclose. Credit scores are merely a way to measure this risk. Here are some statistics from Equifax that will put credit scores into perspective: for FICO scores of 500 to 549, there is a 70% probability that either a loan will go into default and bankruptcy filed, or a loan will fall at least 90 days past due within the next 2 years. Scores ranging from 550 to 599 have a 51% probability of the above scenario, while scores of 600 to 649 have a 31% probability of going bad. With scores of 650 to 699 the probability of default drops to 14%, and while scores of 700 to 749 statics show only 5% of debt will go bad. WIth scores of 750 to 799 the chances of a loan going bad decreases to only 2%.

Using only these two risk factors, are you beginning to see why note buyers are no longer paying 90+% for notes that have little equity, and have credit scores in the low 600s. Not only does the note buyer take on the risk of the price and value of the property going down, but this risk is magnified when statistics say 31% of the notes who have borrowers with credit scores below 650 are going to get into some sort of debt problem within two years.

Remember, note buyers do not have private mortgage insurance. If the note goes bad, the only "insurance" we have is the equity in the collateral of the note. Because of the declining real estate market, and increasing foreclosure rate, the mediocre credit scores, with only 5% down, are not looking as good as they did 2 years ago, when real estate prices were constantly increasing.

THE SOLUTION: If you are owner financing and must sell to someone with credit below the mid 600s, GET AS MUCH DOWN AS POSSIBLE (10% to 20%). Look over their credit application to see if they have other assets they can trade or convert to cash to use as a down payment.

With all this being said, QUALITY NOTES are still getting 90% of the face value of the note. I recently quoted a price of 94% of the unpaid balance on a note where the seller put down 20% and had a 680 credit score, with a year of seasoning and an 8% interest rate.

So if note broker/buyer tells you the reason for the discount is the time value of money, just take it in stride. You now know the real reasons for the discount, and that is what is important. The discount is proportional to the risk being taken.

If you have a note to sell, contact me.

Copyright H&P Capital Investments LLC All rights reserved

Buy or Sell Notes
Definition
Liquidity Risk

Possibility an investor will not be able to sell an investment quickly enough or in sufficient quantities because buyers are not available to assure a rapid conversion from an investment to cash. This concept also applies to collateral of a debt.


Tom Henderson
H&P Capital Investments LLC

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