Pre-Foreclosure Solutions

“Secrets To Foreclosure, Probate And The Flip &

Fixer upper Markets"

“How you can do it, common sense for the common man”

“Knowledge is POWER, POWER to the people!”

Real Options and Solutions Real Estate Investors

can use to Profit from the Foreclosure Market.

By Charles Galan
Introduction; Foreclosure is the most misunderstood real estate market in
our business. It is portrayed by the media and Internet "Gurus" as an easy
target of opportunity. Their programs are filled with promises for a fast buck
based on slick schemes for separating troubled owners from their property,
and their equity. Foreclosure is actually one of the most competitive markets
in real estate acquisition, and results in the greatest failure rate for the
inexperienced investor.

What the Guru's never tell you is that more than 90% of all properties in
default never reach the court house steps. These properties are either
refinanced or sold by conventional means, pre-foreclosure agreements, or
short sale acquisition methods. However, the beauty of the foreclosure
market is that it opens very profitable revenue streams even if the investor
never completes one purchase, and presents a "gold mine" of opportunity for
those who understand how this market really works.

You must first understand the property owner's state of mind. Many property
owners fall prey to the feeling of helplessness when faced with economic
stress, and simply give up and walk away forsaking their equity. Foreclosure
is generally the result of a complete emotional and financial collapse, and
the property is only one of many personal and financial concerns. Often the
value of the property is simply lost amidst the confused mind set of the
owner. Adding to the owner's confusion is the many offers they get from
lenders, real estate consultants and buyers when their property is reported in
default. Because of this you will find owners in default are generally very
resistant and almost impossible to contact. There are very few ways to
successfully approach defaulting owners during this emotionally charged
period when they are in fast retreat, and deep under cover. Therefore, you
will succeed only if you can open their door when no one else can.

The key to unlocking the door is empowerment. Not yours, but theirs.
Success in the foreclosure market is not found by "fooling" the homeowner,
or moving faster than the competition, but begins by establishing a
relationship based on trust. Properly understanding the homeowner's legal
and lender mandated workout options forms the foundation for all successful
foreclosure practitioners. The pros begin by learning these rules, and then
skillfully apply their knowledge as they establish the needed level of
property owner trust that separates them from the competition.

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"Workout Strategies For The Foreclosure Professional" is the foundation
for all successful foreclosure practitioners. This publication has been drafted
from the official guidelines established by the Federal National Mortgage
Association (FNMA), and is the basis for the loan mitigation policies of
virtually all home mortgage lenders throughout the United State and Canada.
Once available at considerable cost, this publication is no longer available to
the general public. These guidelines outline the rules for delinquency
resolution and foreclosure workout, and are essential to understanding how
the foreclosure market works, and your place as a foreclosure professional in
the process.

If you would like to be a highly successful participant in the foreclosure

markets begin by embracing this vital resource as the starting point for your
future success. Once you have acquired an understanding of these rules you
will be well on your way to becoming a solid professional, and a clear
standout among the competition.

However, this is only the starting point. You will then need to develop a plan
to effectively communicate with the property owner in a manner that clearly
establishes you as an ally rather than an adversary. If you will take the time
to learn the rules established by the Guide To Foreclosure, Probate & the
Wholesale Markets" your Mentor will create a high velocity business plan
using the special tools developed by Real Estate Investment Forum that
opens the door every time, and you will become the star of a market filled
with inept competition.

Preface The foreclosure market and the "flip" and "fixer" markets, which we
will henceforth refer to as the wholesale market, are highly integrated since
each can be separate, or the same. More to the point a foreclosure prospect
may also represent a fix and flip opportunity. While we will introduce them
separately, if you are planning to work in these markets it will be necessary
to think of them as interchangeable. Additionally, since you are making a
real estate investment you must extend the appropriate investment theory
and practice to the reality of foreclosure and wholesale markets with a
detailed look at the structure of a successful real estate investment and the
impact of clearly defined planning objectives that reach far beyond the
purchase decision leading you to a successful and profitable conclusion

Foreclosure & Probate What applies to foreclosure generally applies to

probate. Hopefully, the purists won't hold our feet to the fire. We are just

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trying to keep it simple. Both foreclosure and probate are governed by local
statute and a matter of public record. Probate occurs when the owner of real
property dies intestate, or fails to make trust provisions. While much is made
of probate as a target of opportunity for the investor seeking below market
opportunities most of the real sizzle has been removed by effective and
efficient use of estate preservation techniques such as the "Living Trust" to
shelter recipients from the kind of destructive taxation which results in the
liquidation of assets in probate to pay estate taxes. Additionally, court and
estate appointed trustees are formidable "gatekeepers" for the heirs making it
difficult to purchase probate property profitably. However, once you have
become familiar with foreclosure acquisition techniques you will find they
are interchangeable with probate requirements.

Public And Private The foreclosure market consists of the a public

(government) market made up primarily of the Department of Housing and
Urban Development (HUD) under which the Federal Housing
Administration (FHA) operates, and the Veterans Administration (VA)
which administers housing benefits for qualifying veterans. It also includes
the sale of real property by other government agencies such as the
Government Services Administration (GSA), and the Resolution Trust
Corporation (RTC) established in 1889 by the Federal Government to
dispose of property received from the failed chartered members of the
savings and loan associations. The private market consists of all other
properties. The foreclosure process is quite different for each of these
markets and offers quite different possibilities.

A property in default is not likely to go directly to foreclosure. Before that

occurs it is offered to the market and sold at market price thereby relieving
the owner of the debt. There is also a procedure known as "deed in lieu of
foreclosure" in which the property is voluntarily surrendered to the lien
holder. Many home owners select this option when they must relocate and
the property's debt exceeds the resale value. Owners of commercial property
opt for this solution when they can no longer support the property due to
insufficient income, or when overcome by management problems. These
properties are then added to the lender's REO inventory. The remainder of
the foreclosure market winds up on the court house steps. If after the many
hours of investigation, travel and inspection you wind up there too, you will
not be alone. For beside the secured and unsecured creditors will be all the
other foreclosure "trekies" that have been beating a wide path down the

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foreclosure trail. By the way, take cash, and plenty of it, because they do not
accept American Express.

Now, once your breathing and pulse rate have returned to normal, and
assuming you are prepared to accept these realities, you can now move
ahead with the focus and resolve required to be successful in the private
foreclosure market. And, trust us when we say that many have been very
successful in this market, and you can be too.

The Process Foreclosure in the private market is not an event, but a

process. It is a process that can work to the advantage of those seeking to
play the foreclosure market as well as those being foreclosed upon. While
the processes for public and private foreclosure share certain similarities the
difference occurs in the order and manner of the events. As with any process
it has a beginning (Pre Foreclosure), a middle (The Auction) and an end
(Sale, Or REO). Before the auction, at the auction and after the auction.
Each is a distinct phase of the process offering specific alternatives and
opportunities. The principle deference between public and private
foreclosure is in the rules of the auction and the absence of the REO. If you
are pursuing the foreclosure market you should explore each phase. As you
learn more about the foreclosure process you are likely to demonstrate a
preference for that part of the process which best suits your personality and
skill set.

The Purpose Foreclosure is an efficient process by which a lien holder of

real property may recover money owed by the property owner in the event
the owner defaults on a promise or pledge made for the beneficial interest of
a person, or entity, providing money, or services, on behalf of the owner of
the property. Two legal instruments are commonly used to create the debt
and recognize the obligation. The instrument used to establish an agreement
between the parties is commonly referred to as a note. The note defines the
working relationship between the owner of the property and the lien holder.
It provides for the amount of the loan, terms of repayment and procedures to
be instituted in the event of foreclosure. It is the agreement between the
parties. A second instrument is prepared and recorded in the county where
the property is located. This instrument provides the security for the loan and
constructive public notice as evidence of the debt. This security instrument
takes the form of a trust deed or a mortgage. The foreclosure procedure is
not only generically different for both, but the specific procedure and the
instrument used differ from state to state. Since it would be impractical to

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attempt a review of all the states procedures, it is important that you become
familiar with laws effecting foreclosure action in your state. The best way is
to obtain a copy the standard form mortgage or deed of trust, used in your
area which will include the statuary language for the foreclosure action.
These documents can be obtained from a local title or escrow company, and
their representatives are available to explain the foreclosure language in
detail. We also recommend that you invest whatever is required to have a
local attorney review the details and protocol for the foreclosure action in
your state.

The Procedure In many states mortgages are used as the recorded security
instrument for the debt while a deed of trust is used in others. In a few states
both the mortgage and deed of trust is used. When using a mortgage the
procedure begins following default when the lender files a local law suit
which initiates a judicial foreclosure. Upon judgment a sale is ordered.
Following the sale there may be a redemption period during which time the
borrower may recover the property by repaying the loan and related costs of
the foreclosure proceedings. This redemption period may be as short as 21
days and as long as one year. When a deed of trust is used as the recorded
security agreement there are a number of parties involved. The borrower
called the trustor, the lender referred to as the beneficiary and a third party
known as the trustee who records the deed of trust and acts on behalf of the
beneficiary. In the event of default the trustee records a notice of default
(NOD), and is empowered by the "power of sale clause" contained in the
deed trust to foreclose on behalf of the beneficiary without the need to file a
law suit. This is known as a non-judicial foreclosure since it is completed
without judicial intervention. The table below summarizes the procedure for
both the mortgage and deed of trust.

Filing For
Reinstatement The Sale Transfer
Foreclosure
Lender files From 21 days to Court Sheriff’s
Mortgage
lawsuit one year ordered sale deed
Beneficiary
Trust records Much shorter. Trustee
Trustee sale
Deed a notice of 90 to 180 days Deed
default

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Step #1 - Filing Foreclosure Where a mortgage is used the procedure
begins with judicial foreclosure and the filing of a lawsuit. In the event a
deed of trust has been used foreclosure begins when the notice of default
(NOD) is filed. The deed of trust is very efficient since it contains a "power
of sale" clause which the beneficiary may use to replace the need for judicial
intervention. This remedy relieves the borrower of any further financial
obligation, or recourse, resulting from a deficiency balance. The lender
may seek recourse, however, by obtaining a deficiency judgment using
judicial foreclosure.

Step #2 - The Reinstatement Period Twenty one days to twelve months

depending on the security instrument and the jurisdiction. It is during this
time that the borrower is given the opportunity to bring the note current and
cure all performance defects. If this is done the loan is reinstated.

Step #3 - The Foreclosure Sale If the borrower fails to reinstate the loan
the foreclosure sale takes place pursuant to the requirements of the state and
subject to the right of redemption. The borrower can still retain the property
up to the sale, however, by retiring the loan.

Step #4 - Sold, Or REO If the property is not sold based on the foreclosing
lender's opening bid which includes the loan balance and related costs, then
the property is deeded to the lender by the Trustee and becomes part of the
lender's real property inventory, or REO.

This table shows the approximate time between filing the foreclosure action
and the foreclosure sale in the individual states and territories.

STATE MONTHS STATE MONTHS

ALABAMA 3 MONTANA 6

ALASKA 4 NEBRASKA 4

ARKANSAS 3 NEVADA 4

ARIZONA 3 NEW HAMPSHIRE 3

CALIFORNIA 4 NEW JERSEY 10

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COLORADO 5 NEW MEXICO 5

CONNECTICUT 6 NEW YORK 10

DELAWARE 7 NEW JERSEY 10

DISTRICT OF
4 NORTH DAKOTA 4
COLUMBIA

FLORIDA 7 OHIO 8

GEORGIA 3 OKLAHOMA 7

GUAM 11 OREGON 5

HAWAII 7 PENNSYLVANIA 9

IDAHO 9 PUERTO RICO 12

ILLINOIS 10 RHODE ISLAND 3

SOUTH
INDIANA 9 6
CAROLINA

IOWA 7 SOUTH DAKOTA 4

KANSAS 4 TENNESSEE 3

KENTUCKY 7 TEXAS 2

LOUISIANA 6 UTAH 5

MAINE 10 VERMONT 10

MARYLAND 5 VIRGINIA 4

MASSACHUSETTS 5 VIRGIN ISLANDS 10

MICHIGAN 3 WASHINGTON 5

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MINNESOTA 4 WEST VIRGINIA 4

MISSISSIPPI 4 WISCONSIN 10

MISSOURI 3 WYOMING 3

Rule #1 "Avoid the auction whenever possible." The most successful

practitioners in the foreclosure market are skilled problem solvers that assist
the property owner in obtaining relief from a difficult financial and
emotional situation before the property goes to auction, while purchasing the
property at a price that insures a profitable outcome. This requires specific
solicitation and negotiation skills that take time to perfect. If the property
sells at auction the process and the outcome will be dictated by the system
and offers little or no advantage even if you are the only bidder.

Rule #2 "Purchase from the lender if you can". If Rule #1 fails and you
can't purchase the property at auction on your terms prepare for the
opportunity to purchase from the lender (REO) if it is not purchased at bid.
There are a number of circumstances under which this can be done and each
will be covered under Buying from the lender.

Rule #3 If Rule #1 has failed, and before you get to Rule #2, you may have
to invoke Rule #3. "When buying at auction plan your work and work your
plan". Since the foreclosure process often involves a great deal of
uncertainty it requires that you begin with the assumption that the property
will go to auction. Preparing for the auction, therefore, becomes the first
order of business. Your preparation is also essential to the Preforeclosure
and REO phase.

PreForeclosure

When most people hear the words foreclosure investing, they immediately
think of an auction sale on the steps of the courthouse. Yes, it is true that
investors can buy properties at bargain prices at foreclosure auctions. But
c'mon, that is super risky!

In addition to needing a considerable amount of cash, you must also be very

skilled at searching title for any and all liens and encumbrances that may be
recorded against the property. Many of these liens might not be wiped out by

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the foreclosure action, which means you could be bidding on debt that
exceeds the quick-sale value of the property and not even know it! I sure
don't have the stomach for that game. Buying homes at the foreclosure
auction can be a dangerous and costly game. But hold on, us little guys can
still make the big score if we know .... "The Foolproof Secret!" The truly
amazing opportunity is in pre-foreclosure prospecting!

Pay attention now, because this is almost too good to be true! In most states,
the foreclosure process must start with a published notice, sometimes called
the "notice of default". This is the official and legal notice to the
homeowner that he is in default on some aspect of the mortgage or trust deed
contract and the mortgage holder intends to take action against him. 99% of
the time it means the homeowner has missed at least two loan payments.
Wow, and double WOW!

Did you catch that? In a publication of general circulation, there will

appear a list of those facing foreclosure (notice of default) and the listing
will contain the name and address of the person in default. It is as if
somebody is waving a flag in your face signaling that "Here is where you
find super bargain properties". Look how easy ...

You locate where these foreclosure notices are published or filed. (I'll show
you how.) This will give you a daily list of distressed homeowners. Then
you use my exclusive system for persuading these homeowners to listen to
your offer of help. Yes, you can help them with this plan! Stay with me and
you'll get to the fun part.

"Everybody Wins" Deals!"

The accepted philosophy in dealing with distressed homeowners is to strive

for a deal that will benefit both of us. Yes, I am trying to make a profit and I
make no secret of that, but I refuse to fleece the owner in the process.

You must understand that the distressed homeowner is about to have a

foreclosure on his credit record for the next ten years or so. This will make
any credit he is able to get in the future very expensive. He's broke, has
rotten credit and his nerves are shot. Let's not kick him when he's down.

You come galloping onto the scene with an honest desire to try and

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minimize his financial pain. You will be armed with many clever ways to
offer help. (You will quickly learn these.) You probably can't save him
completely, but you might be able to help him save-face and even make it
possible for him to leave the property voluntarily with some cash in his
pocket.

Getting Started It is particularly important when working in the

foreclosure market that you approach the proposed purchase with a
completely unbiased assessment of the true market potential of the property
you are considering. The process of locating and identifying the value of a
property, therefore, becomes the first order of business. We will look first at
the various sources for obtaining property information.

Legal Notice Lenders are required to publish foreclosure action in a local

newspaper. This is the fastest way to locate a qualifying property and begin
a game plan. The notice will include the name of the lender, the person(s) or
entity against whom the action is taken, the location, date of the auction and
any other information required by local jurisdiction. These notices appear in
most every newspaper each day and present immediate opportunities to
venture into the foreclosure market.

Check the Legal Notice section of your newspaper. Locate a foreclosure

near your home and preview the property. This is your first visit to an
actionable property so start developing a precision approach to property
inspection. Take pictures of the site and the surrounding area. If you do not
have a digital camera, now would be a good time buy one. These cameras
are relatively inexpensive and essential to creating the computer file you will
be using later. This is not the time to speak with the occupant, or become
intimately involved with the physical aspects of the property. Obtain as
much information about the area as you can assume you have no previous
familiarity. Contact the local police department. Ask about complaints and
service calls dispatched to the area. Make an assessment of local retail
activity. Find a local real estate agent that will provide you with a market
valuation of the property and rental information. Most agents will be eager
to work with you in anticipation of building a business relationship. Reward
your agents work with your loyalty. If you are not willing to accept those
relationships don’t ask for the service. Then begin to evaluate your interest
in this property based solely on location considerations.

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Foreclosure Consultants Look for the opportunity to create relationships
with local foreclosure consultants These consultants includes centers of
influence such as attorneys, accountants, real estate professionals and
foreclosure specialists that provide a variety of services intended for the
benefit of the property owner from conducting workshops to packaging
expensive workout solutions. Many of their clients will continue on to
foreclosure. A well developed relationship may provide an inside track
during the Preforeclosure process.

Bankruptcy & Probate Probate and bankruptcy sales are a potential source
for below market transactions since they sometimes occur outside the
conventional marketing mainstream. A probate sale is used to settle estate
matters. Bankruptcy can precipitate into foreclosure, and it is often used as a
means of obtaining additional time by delaying a foreclosure action.

Foreclosure Lists In the past you located foreclosure lists from whatever
source was available. Local newspapers, referrals from a title company or
real estate attorney and others active in the foreclosure industry. But today
the .com has become an important resource. After all, that's how you found
this site. So, search the web first. At any time you are likely to find several
sites that offer a foreclosure list for your area. However, these lists are often
out of date before you receive them due to the labor intensive maintenance
requirements as well as the short life expectancy of their usefulness. Before
purchasing any list, be sure to sample the content first. Ask the publisher for
the most recent list compiled for your geographical area of interest.
Remember, one list has no recurring value so the publisher should be happy
to provide you with a list for validation. Particularly if it is good list offering
auction, lender and contact information at competitive prices. However,
before investing in expensive lists learn something about the process in your
area first.

A quality foreclosure list will be very expensive. Before considering this

purchase go to the local court house and determine how foreclosure,
bankruptcy and probate information is reported. Constructive notice of the
procedure will be in the form of a recorded lawsuit if a mortgage is used, or
the filing of a notice of default (NOD) for a deed of trust. Review the NOD's
and the bankruptcy and probate filings. Start in the recorders office and work
your way through the building until you are satisfied that you know how and
when timely information is available. The court house clerks are an excellent

12
source of information for locating list providers and other foreclosure
practitioners since they are frequent visitors to the court house offices.

Overview This section provides the process of going from Preforeclosure to

REO. While you may enter the process at any time each of these steps, and
accompanying check lists, provide the foundation for making an accurate
and well informed purchase decision.

Market Analysis If you have diligently worked through the recommended

field exercises you are now comfortable with the court house bureaucracy,
and you have found a real estate agent and at least one property of interest
based on location. Ask your real estate agent to obtain a Market Analysis for
a property you have selected. If you haven't located a property use your
home, or the home of a friend. The Market Analysis is a standard marketing
tool used by real estate agents in every community and made available
without charge to realtors by local title and escrow companies. These
reports contain important information about the property and include vesting
confirmation, liens of record and a plot map showing the physical features of
the site. Your agent will complete the Analysis by including the most recent
sales data for comparable properties in the neighborhood.

Physical Inspection Establishing value will be determined by your intent

for the property's use. If your intent is to occupy the property your purchase
considerations will be quite different than if you plan to invest with tenant
occupancy. However, no matter what your intent the first priority is to
complete a physical inspection of the property site. This is also the time to
take a personal inventory of your particular home improvement skills. Since
foreclosure implies the possibility of distress it is important to evaluate the
extent to which you are capable and willing to participate in the repair and
improvement requirements of the property. Your ability, and the extent to
which you can participate in the needed work, will often determine the
profitability if you are purchasing for investment. The following check list
provides for both inspection comments and estimated cost of repair. They
may not include all the inspection items for the property you are inspecting.
So, be sure to carefully annotate these forms as required.

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 COST OF
EXTERIOR
REPAIR
ROOF /TYPE $
SIDING $
PAINT $
GUTTERS & DOWN SPOUTS $
WINDOWS $
FENCING $
PATIO/WALKS/DRIVE $
LANDSCAPING $
OTHER $
OTHER $
OTHER $
COST OF
LIVING AREAS
REPAIR
WALLS & PAINT $
WINDOWS/COVERING $
FLOOR COVERING $
DOORS & TRIM $
ELECTRICAL $
OTHER $
OTHER $
OTHER $
KITCHEN COST OF
REPAIR
WALLS & PAINT $
WINDOWS/COVERING $
FLOOR COVERING $
DOORS & TRIM $
ELECTRICAL $
APPLIANCES $

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CABINETS $
COUNTER TOP $
SINKS/FIXTURES $
OTHER $
OTHER $
OTHER $
COST OF
BATHS
REPAIR
WALLS & PAINT $
WINDOWS/COVERING $
FLOOR COVERING $
DOORS & TRIM $
ELECTRICAL $
CABINET $
COUNTER TOP $
SINKS/FIXTURES $
TUB/SHOWER ENCLOSURE $
OTHER $
OTHER $
OTHER $
COST OF
SERVICES
REPAIR
ELECTRICAL $
HEATING/TYPE/BTU $
AIR CONDITIONING/LOAD $
PLUMBING $
POOL/SPA $
INCOMPLETE OR UNINSTALLED PROPERTY SERVICES $
OTHER $
OTHER $

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Conduct a physical inspection of your home if you have not selected a
foreclosure . Be sure to separate yourself from your understandable bias,
being as critical as you would be if it were a property under consideration.
Enlist the help of others to insure the inspection is complete.

Contracting For Repairs Some properties will require certain repairs and
replacement reaching beyond the capability of the most resourceful investor.
The following table is intended to assist you in identifying skilled and
responsible craftsman with a track record of quality work and timely
completion. Not all contractors, craftsmen and handymen will necessarily
have to meet the requirements of this check list. But it is advisable to keep
each of these things in mind as you interview prospects. If your skills
inventory and experience is limited it is particularly important that you
regard this as a learning process intended to make you an efficient manager
of contractor services.

Obtain at least 3 bids for each job and contract only by referral. You can
obtain referrals from material suppliers, contractors that you use and your
real estate agent. This is also a good time to begin compiling a vendor list of
preferred service and material providers such as painters, landscaping
maintenance and cleaning services that you will be working with in the
future.

Never give the lowest bid to the bidding contractor. Instead, offer that bid to
the contractor you consider to be the best. The bid, if it is reasonable, is
likely to be accepted by the contractor of your choice. If not, the preferred
contractor may renegotiate the original bid in order to obtain the business at
an intermediate price acceptable to you. Always attempt to get the best price
from the best contractor.

FINANCIAL RESPONSIBILITY: The basic method for establishing

financial responsibility is a credit report with bank references. This is
particularly important if you are considering the services of a small
independent contractor. If you purchasing for investment you will also need
to contract for credit reporting services in order to properly evaluate the
credit worthiness of prospective tenants.
LICENSED: Warning: A license neither offers nor provides consumer
protection. Not all contractors are licensed. In fact, some of the best
handymen and craftsmen are not. However, if there is an insurance and/or

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bonding requirement the contractor will probably require a license in your
state.
INSURED/BONDED: Verify that the contractor can post a completion
bond and provide the necessary liability and property damage insurance for
all employees, subcontractors and materialmen while working on your
property.
RESUME: Obtain client references and visit property sites where the
contractor has completed work.
THE CONTRACT: Most contracting services should employee some kind
of written contract. It may be as simple as a short handwritten agreement, or
a complex legal document that even a Philadelphia attorney would not
understand. You should also consider developing your own for those
situations where none exists.
MECHANIC LIENS: It is extremely important that you understand what a
mechanic's lien is, its purpose and how it benefits all parties. This statutory
lien recorded by contractors and materialmen providing labor or material for
the purpose of effecting repairs or improvements to real property is
recognized by statute to protect these contractors since they are providing
services that maintain or improve the value of property, and therefore
deserving of priority recognition if they are not paid as agreed by the
property owner. These laws vary in each state and are usually created when
the contractor records the contract and begins upon commencement of work
. These laws protect subcontractors as well. Therefore, if the contractor
intends to subcontract any part of the work to be performed your contract
must insure, and protect, payments to be made to all others in order to avoid
lien disputes with subcontractors. Be sure you understand the law in your
state, and the means by which a mechanics lien is removed.

Income Proforma Factors With the exception of a single family home the
present and future value of an income producing property has little to do
with the conventional notion of appreciation. If it is your intent to seek
foreclosure opportunities in the multi-family or commercial markets you
should understand certain investment fundamentals. The Income & Expense
Summary and Decision Model used here are reproduced directly from our
"Real Estate Investment Guide And Field Reference Manual". These
spreadsheet illustrations represent a 28 unit apartment building. While your
opportunities in the foreclosure market will most likely involve considerably
smaller buildings the wholesale market will offer a broad range of apartment

17
and commercial opportunities. The Income & Expense Summary and
Decision Model can be easily constructed to any scale, and by understanding
the more complex business decisions relating to a larger property you will be
in a much better position to make a more informed decision on smaller
properties.

"Income properties are bought and sold based on the strength and
durability of the current and future value of the "Net Operating
Income". The Net Operating Income, or NOI, is the Gross Scheduled
Income (GSI) after all operating expenses including vacancy and bad debt.
Write this down. Read it every day. This is the linchpin in the real estate
investment pendulum. Your grip on the driver. If you ever lose sight of this
most critical fundamental it is essential that you step back, regrip and re-
establish your target line with this concept, once again, firmly in mind.

"A Property Management Primer" The Income & Expense Summary is

the focal point for the analysis, valuation and selection process. Review this
illustration and the construction in detail. The field explanations provide a
solid foundation in the fundamentals of property management. Construct
your own for properties you are considering. Then compare your Summary
with the statement offered by the broker, or owner. Is the GSI actual income,
or is it based on market income, commonly referred to as effective rents. Pay
particular attention to the representation of vacancy and maintenance
expenses. Compute the GRM of the offering price based on your Summary.
Does your computed value compare favorably with the recent sale of
comparable properties in the same market. Keep in mind that comparable
means a similarity in condition, location and square footage of the rental
units.

Locate a competent broker with experience in the field of investment real

estate. Ask that he, or she, review your data along with the contents of this
presentation and validate your observations. Your broker may disagree with
some of the theory expressed here. Perhaps strongly. If so, it probably means
they are knowledgeable, and a valuable resource worthy of your trust.

A Decision Model The Income & Expense Summary provides the means of
evaluating the data associated with the property's day-to-day performance.
This data having been prepared and validated by the investor can then be
inserted into a decision model for the purpose of creating a defined future
expectation. The model can take any form necessary with respect to the

18
investor's particular objective. Decision models can be created for such
things as tax shelter analysis, evaluating competing investments, buy vs.
lease, sale leaseback and real estate exchange planning to mention just a
few. Most investors, however, are primarily interested in the future income
stream and potential growth of their initial investment.

The Cash Flow And Capital Gain Projection is an analytical tool created
for this purpose. It is very important to become familiar with this illustration
since the analysis further refines the data fields of the Income & Expense
Summary, and all the analysis that follows builds carefully on the principles
contained in this model. Use the data form your Income & Expense
Summary to construct a decision model for the property. Build your own
spreadsheet. You may have to brush up on some of the math required.
Experiment with different kinds of data fields and their location . You will
find this a particularly useful exercise for the development of more complex
investment models later. When you are finished evaluate the outcome. Is it
more, or less, than your expectations for this property. If it is less
experiment with changes to price, down payment, expenses and financing
parameters. Observe how changes in the data fields affect the Cash Flow
And Capital Gain Projection. When you reach an outcome consistent with
your expectations determine if you can realistically effect the needed
changes in the data. If your requirements have certain tax implications it
would be advisable to have your accountant assist in the construction of you
model..

These illustrations provide the simple basics for validating real estate
investment decisions. Many important questions often go unanswered in the
quest to enter an investment environment that continues to produce
extraordinary wealth, and the process has become considerably more
complicated. Structuring the transaction, establishing value and removing
the confusion about the best available financing now requires expert
professional guidance to stay ahead of the competition. Even the most
inexperienced real estate investor often finds this to be a daunting task, but
an extraordinary opportunity is ahead for those willing to learn how the
larger game is played. We believe that for those of you seeking to create a
large estate in real property the "Real Estate Investment Guide And Field
Reference Manual " will be the catalyst for your success. This presentation
will provide the foundation necessary to select the property that meets your
purchase and management objective. Beginning with the fundamentals it

19
moves ahead into advanced purchase, exchange and refinance modeling
essential for long term success.

As a real estate investor you will need more than just property knowledge
and management skill to be successful. You will need an inventory of
contracts and forms, and you will need to be adept in their use.
Unfortunately many people in this industry view the paperwork as a
necessary evil. So much "psychobabble" to satisfy the suits sitting in the
state capitol, or as a means of protection from the attorneys’ downtown with
their hands poised on the meter. Much of this attitude has been precipitated
by laws throughout the country deemed to be particularly pro tenant. While
this is probably true, even in your area, it has come about primarily as the
result landlord abuse. And like any suppressed minority tenants formed
unions and associations to protect their rights. But remember, the same law
that protects the tenant also provides the property owner with strict and
predictable management guidelines. And, if you choose to view your legally
mandated requirements as the first step towards positive tenant relations you
will find, believe it or not, that it will add real value to your property.

Purchase Offer Strategy You have found a property you would like to buy.
You have worked out an Income & Expense Summary, constructed a
Decision Model and you are ready to prepare the Contract. If you are
purchasing a property with long term investment implications then it is very
important that you understand the principles of "Refinance and Exchange
Theory & Practice" and the construction of the "Property Presentation,
Refinance and Exchange Models" contained in the Real Estate Investment
Guide And Field Reference Manual .

During the many years of our experience one observation remains

consistent. Prospective Buyers and Sellers often alienate the offering and
acceptance process in an attempt to maintain an edge. Control the high
ground. The Offer, instead should be thought of as the beginning of a
relationship not unlike the first date, or a job interview. This is not the time
to become defensive, Nor, for that matter, is there ever a time to be
overcome by self doubt and insecurity. Instead, this is the perfect time to
humanize the process and the principals. This could, in fact, be one of the
most important business relationships you will ever create. The Seller may
have a large portfolio of properties that he might be willing to share with
you in the future. He, or she, may be needed to provide transition assistance

20
after the close of escrow. The brokers offer valuable marketing services,
investment insight and control virtually all the property information in the
investment market. These are not people with whom you want an adversarial
relationship. Instead, seek to create an environment based on courtesy, trust
and mutual respect.

Contingencies Contingencies control the pace and outcome of the

transaction. Contingencies have little relevance to Preforeclosure and
Auction strategy, but are critical to the REO and Wholesale market. The
typical purchase offer will could include a broad range of contingencies.
Generally, however they refer to three primary considerations. Financing,
inspections and close of escrow.

Financing Most of the preparation for the removal of this contingency

can be done prior to the offer. It is important that as the buyer you determine
the primary sources of apartment and commercial financing. There will not
be that many competitive sources located in any geographical area. While
there may be a large number of mortgage brokers specializing in commercial
financing you will soon discover that each is corresponding with the same
core group of lenders. The only difference among the brokers will be there
fee and experience. Each lender will have an array schedule of financing
programs with varying terms. Each will have certain underwriting practices.
And each will be more, or less, competitive at any particular point in time
depending upon budget, commitment and reserve requirements. It is
important that you contact these lenders while in the process of developing
the Income & Expense Summary and Decision Model. They can complete
much of the work associated with qualifying you and the property during
this process. Then, when preparing the Purchase Offer any prequalification
can be included so that the time required to remove this contingency can be
shortened. This will add exceptional credibility to the offer both from the
standpoint of the Seller and the Lender. It will also provide a distinct
advantage should there be competing offers that are not as well prepared.
This will be your first opportunity to establish respect for your knowledge
and preparation in the minds of all the principals.

Inspections Needed or required inspections are too numerous to mention.

The usual inspection contingencies are contained in the sample Offer. Others
arise from local practice and law. It is particularly important that all
inspections requiring a vendor's service be ordered immediately after
acceptance, or upon recognition of the need. Unfortunately vendors have a

21
reputation for being slow, and notoriously unresponsive and independent
when busy. Inspection reports may also need to be supplemented either by
the reporting vendor, or with a second party vendor. Be absolutely sure that
your Purchase Offer provides for the time required to complete any
supplementary or added contingencies based on the requirement to obtain
additional reports. Continue to build your vendor list for property
management. Start with the property owner's list. These vendors are already
familiar with the property's unique requirements. A dependable vendor that
provides quality work and competitive pricing is hard to find and often
difficult to maintain. Start your list early and maintain it carefully.

Close Of Escrow (COE) You may not get to the close of escrow if you fail
to comply with the contingency requirements of the Purchase Offer. Each
Offer will specify the manner by which the contingency related provisions
will be removed and acknowledged. Be sure that you understand the
methods agreed upon. Many a Seller has pulled the rug from under an
unsuspecting Buyer in favor of a better backup offer for failing to remove a
contingency in the time required, or in the manner agreed upon. Many
Purchase Offers provide for either active or passive removal of
contingencies. We recommend the active option. This helps to insure that
you remain focused on the details, thereby keeping the rubber on the road. In
accordance with the Purchase Offer the close of escrow occurs not later than
a specified date, or on a date pursuant to a specified event. Good strategy
dictates that you attempt to create the COE as a contingency as well.
Contingent upon the removal of all other contingencies made a part of the
Offer. It is sometimes difficult to get agreement on this provision. Generally,
however the escrow is extended automatically if there remain unsatisfied
conditions and both parties are in compliance. If you are in an exchange
your facilitator will provide closing instruction that will protect you in the
event your exchange property is closing later than expected. Finally be
certain that your broker, or a third party, is granted the authority to extend
the close of escrow in the event you are unavailable on the date agreed upon.

The Lease Agreement The tenant lease is a contract in which the property
owner actually conveys, or transfers, certain property rights to the tenant in
the form of a leasehold. This is a particularly sensitive document due to the
nature of the landlord/tenant relationship referred to earlier, and should
always be constructed based on current local law. A generic form should
never be used. As a property owner it is imperative that you be thoroughly
familiar with the landlord/tenant laws in your state. These laws are generally

22
found in the Civil and Business and Professions codes, and may be easily
located on your state's web site. We strongly recommend that all forms and
contracts related to tenant management be obtained from your local board of
realtors. Most Realtor Associations provide the property management forms
that have been written and approved by the Associations attorney's for
compliance with current law. Use them.

Lease Strategy The lease is not only an important legal document it forms
the basis of your future relationship with the tenant. Other than the initial
interview and the date of installation, the lease forms the most lasting
impression of your management style and commitment. Consider the
following supplements to your lease.

• If your state prohibits a late fee, provide an incentive for early

payment and establish a date. Provide the tenant with addressed and
stamped envelopes.
• Require that routine communication be by FAX or E-mail. Provide an
emergency phone number assigned to a pager, or cell phone. Never
give the tenant your home phone, or address. Provide a list of
emergency vendors for times that you are away. Or, arrange for
reciprocal property management with a neighboring property owner.
• Schedule periodic safety inspections. This serves more than one
purpose. It enables you to identify unreported maintenance problems
before they become serious, and to discover lifestyle issues that may
create a property hazard or pose risk to other tenants.
• Provide a clearly stated policy converting payment options to cash,
money order or certified check in the event of chronic late payment or
a written notice to pay. Never customize a payment plan to suit the
tenant, or as a solution for the tenant's cash flow problems.
• State a committed policy for an unlawful detainer action.(eviction)
Once initiated it will not be terminated. Better to be wrong than
uncertain. Once the tenant has been lost to eviction it rarely pays to
chase the debt.

Getting The Good Tenant

Property Preparation

23
 • Resist the temptation to minimize vacancy by showing the property
before it has been vacated, or properly prepared. Never show a
property before it is ready for occupancy.
• Prep each unit as though it is for sale.
• Your preparation effort will live and die with the condition of window
and floor covering.
• Paint all units the same color.
• If your property is energy efficient use it as a selling point.

Marketing

• Comprehensive newspaper ads create the largest pool of prospective

tenants and reduces the time required to introduce the property.
• Do not make appointments to show property. Schedule a day and time
the property will be available for preview and include this information
in the ad.
• Do not promote questionable features and benefits. Avoid puff and
your honesty will be rewarded in the savings of time and appropriate
applicants.

Tenant Application

The Tenant Application can take any form. The basic rule is getting as much
information as you can. Construct your own and revise as you gain
experience. The important elements include Personal information, former
residence, employment (current and previous), banking and automobile
information. Never approve an application without a credit check,
employment verification and a reference from a previous landlord. You
cannot discriminate based on race, or national origin. You can discriminate
based on financial considerations relating to your opinion of the applicant's
ability to pay the rent, or in preference to another applicant. Be very, very
careful if there are no other applicants at the time of a denial, and use a form
letter approved by your attorney. Most states will allow a non-refundable
application fee. It's your call. We suggest you retain the fee with application
to the first months rent if approved. Then, when the tenant is approved, and
the lease is signed, get all the money the law will allow.

Recommended Forms These forms are offered as illustrations only. If you

choose to use any of them be sure they are in compliance with your laws.

• Statement Of Condition

24
 (MOVE IN / MOVE OUT) STATEMENT OF CONDITION

Address
Unit/Apartment#

Occupant(s)
Date

When completing this form, check the Premises carefully, and be specific in
all items noted. Use additional paper, if necessary.

SMOKE DETECTOR(S) has (have) been tested on MOVE-IN, and found to

be operative, except: ( ) INITIAL

LIVING ROOM AND DINING ROOM ITEMS: doors, locks, carpeting,

floors, baseboards, walls, ceiling, electrical fixtures, electrical switches and
outlets, windows coverings, windows, screens, and other it

MOVE-IN CONDITION (DATE)

MOVE-OUT CONDITION (DATE)

KITCHEN ITEMS: floors, baseboards, walls, ceiling, electrical fixtures,

electrical switches and outlets, cook top oven, hood and fan, refrigerator,
plumbing fixtures, sink, disposal, cabinets, counters, window coverings,
windows, screens, and other items:

MOVE-IN CONDITION (DATE)

25
MOVE-OUT CONDITION (DATE)

Received (Date) Occupant's Initials ( )(

) Page of Pages

NO REPRESENTATION IS MADE AS TO THE LEGAL VALIDITY OR

ADEQUACY OF ANY PROVISION IN ANY SPECIFIC
TRANSACTION. A REAL ESTATE BROKER IS THE PERSON
QUALIFIED TO ADVISE ON REAL ESTATE TRANSACTIONS. IF
YOU DESIRE LEGAL OR TAX ADVICE, CONSULT AN
APPROPRIATE PROFESSIONAL.

Page (2)

Address
Unit /Apartment#

BEDROOM ITEMS: doors, lock, carpeting, floors, baseboards, walls,

ceiling, electrical fixtures, electrical switches and outlets, window coverings,
windows, screens, closet, closet doors and tracks, and other items:

BEDROOM 1

MOVE-IN CONDITION (DATE)

MOVE-OUT CONDITION (DATE)

BEDROOM 2

26
MOVE-IN CONDITION (DATE)

MOVE-OUT CONDITION (DATE)

BEDROOM 3

MOVE-IN CONDITION (DATE)

MOVE-OUT CONDITION (DATE)

OTHER ITEMS/AREAS: (if applicable) Entry door and window locks,

heating and air conditioning, equipment, patio or balcony, yard areas,
fencing, garage or carport, and

MOVE-IN CONDITION (DATE)

MOVE-OUT CONDITION (DATE)

27
Received (Date) Occupant's Initials ( )(
) Page of Pages

NO REPRESENTATION IS MADE AS TO THE LEGAL VALIDITY OR

ADEQUACY OF ANY PROVISION IN ANY SPECIFIC
TRANSACTION. A REAL ESTATE BROKER IS THE PERSON
QUALIFIED TO ADVISE ON REAL ESTATE TRANSACTIONS. IF
YOU DESIRE LEGAL OR TAX ADVICE, CONSULT AN
APPROPRIATE PROFESSIONAL.

Page (3)

Address
Unit/Apartment#

BATHROOM ITEMS: doors, locks, carpeting or flooring, baseboards,

walls, ceiling, electrical fixtures, electrical switches and outlets, window
coverings, windows, screens, tub or shower, shower door or curtain, toilet,
sink, medicine cabinet, counter, towel racks, fan, and other items:

BATHROOM 1

MOVE-IN CONDITION (DATE)

MOVE-OUT CONDITION (DATE)

BATHROOM 2

MOVE-IN CONDITION (DATE)

28
MOVE-OUT CONDITION (DATE)

MOVE-IN:

The Move-In Inspection of the Premises was performed on (date)

Receipt of a copy of the Statement of Condition is acknowledged by:

Occupant (s)
Date

Landlord /Agent
Date

MOVE-OUT

The Move-Out Inspection of the Premises was performed on (date)

Receipt of a copy of the Statement of Condition is acknowledged by:

Occupant (s)
Date

Landlord /Agent
Date

Received (Date) Occupant's Initials ( )(

) Page of Pages

NO REPRESENTATION IS MADE AS TO THE LEGAL VALIDITY OR

ADEQUACY OF ANY PROVISION IN ANY SPECIFIC
TRANSACTION. A REAL ESTATE BROKER IS THE PERSON
QUALIFIED TO ADVISE ON REAL ESTATE TRANSACTIONS. IF
YOU DESIRE LEGAL OR TAX ADVICE, CONSULT AN
APPROPRIATE PROFESSIONAL.

• Notice To Pay Or Quit

29
| Contents |

NOTICE TO PAY RENT OR QUIT

To:

and all subtenants and any other occupants in possession of the premises
located at (street address)

(unit/apartment#)

City State zip

code ("Premises").

WITHIN THREE DAYS from service of this Notice you are required to
either (i) pay rent for the Premises in the following amount, which is past
due, or (ii) vacate the Premises and surrender possession.

Past Due Rent: $ for the period

to

And:

Total Due: $

If you do not pay the past due amount or give up possession, a legal action
will be filed seeking not only damages and possession, but also a statutory
damage penalty for an additional $ Landlord declares a forfeiture
of the lease if past due rent is not paid and you continue to occupy the
Premises. As required by law, you are hereby notified that a negative credit
report reflecting on your credit record may be submitted to a credit reporting
agency if you fail to pay your rent.

Landlord (Owner or Agent)

Date

30
NO REPRESENTATION IS MADE AS TO THE LEGAL VALIDITY OR
ADEQUACY OF ANY PROVISION IN ANY SPECIFIC
TRANSACTION. A REAL ESTATE BROKER IS THE PERSON
QUALIFIED TO ADVISE ON REAL ESTATE TRANSACTIONS. IF
YOU DESIRE LEGAL OR TAX ADVICE, CONSULT AN
APPROPRIATE PROFESSIONAL.

Notice Of Termination

| Contents |

THIRTY-DAY NOTICE OF TERMINATION OFTENANCY

To:

and all subtenants and any other occupant in possession of the premises
located at (street address)

(unit/apartment #)

(City) (state) (zip

code) ("Premises").

Your tenancy, if any, in the Premises is terminated thirty days from service
of this Notice, or on (whichever is later).

If you fail to give up possession by that date, a legal action will be filed
seeking possession and damages which could result in a judgment being
awarded against you.

Landlord (Owner or Agent)

Date

(Keep a copy for your records.)

NO REPRESENTATION IS MADE AS TO THE LEGAL VALIDITY OR

ADEQUACY OF ANY PROVISION IN ANY SPECIFIC
TRANSACTION. A REAL ESTATE BROKER IS THE PERSON
QUALIFIED TO ADVISE ON REAL ESTATE TRANSACTIONS. IFYOU

31
 DESIRE LEGAL OR TAX ADVICE, CONSULT AN APPROPRIATE
PROFESSIONAL.

Before we discuss foreclosure strategy this is a good opportunity to

understand something about the loan process and how a mortgage comes
into existence. For the borrower it probably seems very straight forward. Go
to the bank, complete the application, endure the qualifying and
underwriting procedure, close the loan and move in. For the lender,
however, the process is far more compelling.

Banks and savings & loan associations make real estate loans from money
on deposit. The high cost of property in many developing areas of the
country creates a demand for real estate loans which exceeds deposits, and
the money loaned needs to be replaced in order to maintain the required
reserves and operating capital. Most mortgage money is made available by
large institutional investors outside California and include large banks,
pension funds, mortgage REIT's and publicly traded investment pools such
Fannie Mae, Ginnie Mae and Fredie Mac. These investors demand a
guaranteed yield and timely placement of their investment. The guarantee is
provided in the form of a "commitment" by participating banks and S & L's,
also known as correspondents. Each commitment promises the delivery of a
package of loans in a specific amount and having a defined average yield
and maturity. In exchange for the commitment the correspondent will
recover the money loaned and profit from fees and other costs charged to the
borrower. Each loan in the package must be underwritten in accordance
with strict guidelines and delivered by a specific date. Failure to deliver the
commitment, or late delivery, results in severe financial penalties along with
the risk of being removed as an approved correspondent. The lender often
acts as the loan servicing agent by receiving the payment from the borrower
and transmitting the proceeds to the investor, or beneficiary. The lender also
creates a separate corporation to act as the trustee for the beneficiary if the
security instrument is a trust deed. You will recall that in the event of default
by the borrower the trustee forecloses on behalf of the beneficiary
and, depending on the contract, the lender could wind up with both the loan
and property if there is no sale at auction. It is precisely for this reason you
will usually find the lender eager to provide information regarding the
property and the procedures for foreclosure.

Before we discuss foreclosure strategy this is a good opportunity to

understand something about the loan process and how a mortgage comes

32
into existence. For the borrower it probably seems very straight forward. Go
to the bank, complete the application, endure the qualifying and
underwriting procedure, close the loan and move in. For the lender,
however, the process is far more compelling.

Banks and savings & loan associations make real estate loans from money
on deposit. The high cost of property in many developing areas of the
country creates a demand for real estate loans which exceeds deposits, and
the money loaned needs to be replaced in order to maintain the required
reserves and operating capital. Most mortgage money is made available by
large institutional investors outside California and include large banks,
pension funds, mortgage REIT's and publicly traded investment pools such
Fannie Mae, Ginnie Mae and Fredie Mac. These investors demand a
guaranteed yield and timely placement of their investment. The guarantee is
provided in the form of a "commitment" by participating banks and S & L's,
also known as correspondents. Each commitment promises the delivery of a
package of loans in a specific amount and having a defined average yield
and maturity. In exchange for the commitment the correspondent will
recover the money loaned and profit from fees and other costs charged to the
borrower. Each loan in the package must be underwritten in accordance
with strict guidelines and delivered by a specific date. Failure to deliver the
commitment, or late delivery, results in severe financial penalties along with
the risk of being removed as an approved correspondent. The lender often
acts as the loan servicing agent by receiving the payment from the borrower
and transmitting the proceeds to the investor, or beneficiary. The lender also
creates a separate corporation to act as the trustee for the beneficiary if the
security instrument is a trust deed. You will recall that in the event of default
by the borrower the trustee forecloses on behalf of the beneficiary
and, depending on the contract, the lender could wind up with both the loan
and property if there is no sale at auction. It is precisely for this reason you
will usually find the lender eager to provide information regarding the
property and the procedures for foreclosure.

THE THREE PART PROCESS All the work, preparation and planning
that you have done up to now has been intended to prepare you for entrance
into the foreclosure market. No matter where you begin the process it is
essential that you provide a profit margin for success and that it include
consideration for unexpected costs. Remember that unless there is a
negotiated settlement for deferred maintenance and repairs the property is
purchased "as is".

33
Preforeclosure Many property owners fall prey to the feeling of
helplessness when faced with economic stress and simply give up and walk
away forsake their equity. This is particularly true of government financed
properties. You might ask why they don’t just sell. Foreclosure is generally
the result of a complete financial collapse and the property is only one of
many personal and financial concerns. Often the value of the property is
simply lost amidst the confused mind set of the owner. Adding to the
owner's confusion is the many offers they get from lenders, consultants and
buyers when their property is reported in default. Because of this you will
find owners in default generally resistant to contact. Therefore, it most likely
that you will succeed as a bargain hunter in the Preforeclosure market based
on your patients and intuitive skills when communicating with owners in
financial distress.

There are many ways to creatively approach defaulting owners during the
reinstatement period. Your efforts will be extraordinarily empowered,
however, if your strategy is to offer assistance and guidance rather than
employing any approach that may appear to be adversarial or predatory.
Many very successful buyers begin by offering financial assistance by
supplying proceeds secured by a mortgage or trust deed that reinstates the
loan providing temporary financial relief for the owner. Investment in a note
is not the strategy here but many specialize in this form of financial return
very profitably. It is also another way of acquiring the property if the owner
should default again since as a mortgage holder the investor will have a
preferred, and secured, position at auction. This is a particularly attractive
strategy since more than 80% of all loans in default are reinstated, usually
with a financing solution.

The reverse of this process is to purchase with an owner carry. This works
when the buyer agrees to reinstate all conditions in default and gives the
owner a mortgage, or deed of trust to secure their equity. This can be an
especially attractive solution for the owner since it solves the problem and
creates an added income stream at the same time. The buyer may either take
the existing loan(s) subject to the existing terms, or create new financing.
While there are still a few conventional loans that may be taken "subject to"
the existing terms and conditions, they are very, very, rare. Actually, they
are very, very, very, rare. Many conventional loans can be "assumed" (Note
that we say assumed and not taken) subject to the existing terms, but the
buyer must qualify pursuant to the lenders rules and pay an assumption fee.
Some real estate investment gurus promote the notion that loans taken will

34
often be ignored if detected by the lender. While this is sometimes true any
assumption technique which ignores the lenders assumption requirements,
including those which we will recommend, risks immediate acceleration of
the loan balance. Private financing can provide an an exceptional
foreclosure solution and the Aggressive Strategies section includes a broad
range of special techniques for implementing an owner financed purchase.

Getting Your Message To The Owner When contacting the owner be

careful not to intrude into their personal space. Calling or appearing at the
property without an invitation is not the best way to build the personal trust
that will have to develop. These methods of contact should be deferred to a
time when you have more experience, or as a means of obtaining a very
quick settlement if that is your objective. Keep in mind that your goal is to
be placed ahead of all the others attempting to get the attention of the owner.
The most efficient and reliable means of communicating your intent to the
owner, whether a foreclosure or the wholesale prospect covered later, is by
use of a post card. Unlike solicitation letters which are rarely opened, a post
card is always read, and much more time and cost efficient to deliver. It is
the "perfect" tool. Consider the following message.

Dear Property Owner:

I buy and finance houses. If you would like to sell or refinance your house
quickly without paying a sales commission, or high loan fees, please contact
me. I can also recommend ways in which you may enjoy added income from
a sale.

Your Name
Your Phone Number

This message is short and to the point. It offers the property owner options
for immediate relief without embarrassment, or humiliation. Unless you
want to completely destroy your credibility with the owner do not make any
reference to default or foreclosure which would reveal the owner's situation
to the outside world and uninformed family members. This card is for the
sole purpose of getting an invitation to the property. When contacted by the
owner do absolutely nothing more than establish a meeting time. Never
discuss price, terms or the value of the property. Never! The easiest way to
avoid this discussion is by explaining that you "cannot confirm your interest,
or offer any honest opinion without first completing a preview of the

35
property". And, guess what? That is absolutely true. If the owner will not
give you an appointment without some confirmation of price thank him for
the reply and propose the possibility of follow-up in the future. By supplying
purchase information you are providing the owner with the means to
compete with other offers and to exclude you. Do not get caught in this
inescapable trap.

"A Short Course In Sales"

This is a particularly difficult and confusing time for the owner. Although
your letter does not disclose that you are aware of the situation, your
knowledge will be a foregone conclusion. Your ability to get an appointment
with the owner will be based on the time tested principle of successful sales.
Trust. First, the owner must trust you. The owner is ashamed, humiliated
and consumed by fear. He will agree to meet with you only if he believes
that his vulnerability is safe in your hands. Be prepared for the property
owner's response. Have a plan intended to reinforce your credibility as a
legitimate buyer, and that it sincerely communicates you desire to provide
the needed assistance.

Second, the owner must trust the recommendation or solution you offer. Do
not approach the owner with any preconceived notions. Listen, don't talk,
Allow him to disclose his intent to you. If that disclosure is not immediately
forthcoming ask questions intended to find the real need, or intent. Let your
questions evolve from the general to the specific. Do you remember your
conversation the last time you saw your doctor about some ailment.

"How are you?"

"Fine Doc."
"So, what can I do for you today."
"I've been experiencing some pain."
"Where is the pain located?"
"Well, it's on my side."
"Left, or right?"
"On the right side."
"Is it t here?"
"No. A little further down. About here."
"Right here?
"Yes."
"Does it hurt now?" Pressing easily.

36
"No." .
"Now?", Pressing harder
"Some."
Pressing much harder, "How about no?."
"Oh!, That really hurts"

Moving efficiently from the general to the specific your doctor quickly
located the precise location and relative intensity of the pain. A few more
questions probably produced a diagnosis and a recommended course of
therapy, or medication. A skilled negotiator asks questions intended to
locate the need, or source of pain, and listens for the answers. Then follows
with a plan that leads the other side to the desired conclusion based on a
solution that provides a trustworthy remedy.

The third principle of successful sales is trust in your ability to provide the
solution quickly and painlessly. Your doctor had already earned that trust
over time. But the owner will have to feel good about the decision they
make, and trust your commitment to perform. As you gain experience
during the Preforeclosure period you will learn how to lead the owner down
a comfortable and respectable path to an agreement while establishing the
needed trust along the way. Consider some of these ideas when working
with the owner towards affecting the solution.

• Pay the moving costs.

• Pay all, or a portion, of the rental deposits for relocation.
• Offer a lease back.
• Consider a lease with an option to purchase. Be sure the law in your
state does not consider this to be a loan rather than a sale.
• Reinstate the delinquent loans secured by a mortgage, or deed of trust.
• Purchase subject to reinstating the delinquent loans and all other
conditions in default, with the owner's equity secured by a mortgage,
or deed of trust.
• Form a partnership with the owner and complete a workout solution
directly with Fannie Mae if the FNMA is the beneficiary.

Getting From Value To Equity Once the owner has agreed to negotiate a
sale be sure your ducks are lined up for a fast close. By now you have
completed the property inspection and have established a value for the
equity using the EQUITY WORKSHEET below. The equity is the Market

37
Value minus Mortgages minus Mortgages minus Taxes minus Costs of
Foreclosure minus Repairs And Deferred Maintenance minus Your
Profit (20%-30% of market value) = Negotiable Equity. Negotiate the
equity purchase, not the value of the house. Time is of the essence. As
quickly as you can, arrange for a close in accordance with the financing and
the method of taking title customary in your area. The following EQUITY
WORKSHEET is prepared for both Preforeclosure or Auction.

EQUITY WORKSHEET
MARKET VALUE $100,000
MORTGAGES $(25,000)
TAXES $( 2,500)
COSTS OF FORECLOSURE $( 1,000)
REPAIRS/DEFERRED MAINTENANCE $(15,000)
20% Profit $(20,000)
OTHER $
OWNER'S EQUITY $ 36,500

There are three ways you can take title once the owner has agreed to a
settlement. The fastest way is to accept a Quit Claim Deed in exchange for
the agreed upon equity payment. You may also give the owner a note for
the equity or complete a conventional purchase with new financing Do not
complete any closing without executing a purchase offer, and always use the
services of a title or escrow company.

Since about 20% of all properties in default are sold at auction, or during the
reinstatement period the foreclosure property buyer with the best strategy for
communicating with the owner will find the profits to be rewarding.

The Auction Funny things happen on the way to the court house.
Foreclosure not always involves default on the loan of the foreclosing
lender. Secured loans are prioritized based on the date of recording. The
senior loan has the earliest date of recording, and junior liens line up based
on the earliest recorded dates thereafter. Where there is more than one loan
on a property it is possible that while only one is in default both lenders are
foreclosing. Most security instruments used today provide for immediate

38
foreclosure if a superior lien is reported in default, or if a Notice of Default
(NOD) is filed by any secured lender. Junior lien holders almost always
request notification from superior lien holders if the loan(s) are in default.
Even though the junior lien is current any default on a superior lien triggers
foreclosure pursuant to the terms of the mortgage, or deed of trust. When
one lien holder files for foreclosure all lien holders will generally file in
order to protect their position in the event of an auction. This particularly
true if the senior loan is foreclosing since, in most jurisdictions, a senior loan
can ignore a junior lien. Therefore, when a senior loan forecloses junior liens
foreclose in order to protect their position. An exception would exist if a
junior lien holder concludes that the market value of the property exceeds
the value of all superior liens.

It is very important to know which liens are foreclosing because if you are
the successful bidder it will determine the amount of financing you will
require. Often the senior lien holders will file for foreclosure, but yield to
the junior lien holder as a means of curing the default. When the property is
sold at auction subject to senior liens the successful bidder is responsible for
the condition of those liens and most jurisdictions allow the senior liens to
be assumed by the bidder even though the loans would not ordinarily be
assumable in the course of a conventional sales transaction provided they are
reinstated to a current condition. When preparing the BID/AUCTION
WORKSHEET make sure you know which liens(s) are foreclosing and
what your financial responsibilities will be should you become the
successful bidder.

NOTE: In most jurisdictions, and pursuant to the "right of redemption", the

successful bid accepts all secured and unsecured liens filed prior to the lien
foreclosed upon, and is relieved of all liens filed after subject to the 120 day
redemption period for Federal tax liens.

Auction Check List While you are inspecting properties you are interested
in you will need to confer with the people and agencies providing essential
information pertinent to the Auction. This table guides you through an
important fact gathering process. While auction protocol and closing
procedure is likely to be very inflexible, each of these considerations is
negotiable with the REO.

THE CONTRACT Be certain to remain focused on the profit objective.

TITLE Compare the title report provided by the referee, or attorney with

39
the one you have obtained for irregularities. Be sure you are not bidding on
a partial title.
RESPONSIBILITIES PRIOR TO CLOSE Who is responsible for the
condition and safety of the property between auction and close. Occupants
pose extended risk for the buyer, and may require added cost for eviction.
POSSESSION Who is responsible for the owner, or tenants in possession..
Be prepared to begin an immediate unlawful detainer action. Determine if
you can take possession of the property during the contract subject to
redemption. Be sure you understand the redemption statute in your state.
PROPERTY CONDITION: With rare exception the property is taken "as
is" at foreclosure.
LIENS AND JUDGMENTS If you are the successful bidder on a junior
lien you will be responsible for all secured liens that are superior. Determine
how unsecured liens are to be discharged, and be aware the federal tax liens
have a 120 redemption. If you want to take possession of the property
pursuant to a federal lien it will be necessary to negotiate a settlement unless
you want to risk government possession. If this occurs you will not lose your
deposits, but you will lose any money spent for repairs or to remove an
occupant.
PERMITS Contact the building department to insure the property is
compliance with certificate of occupancy (CO), or rental permit
requirements.
INSPECT AVAILABLE FILES Inspect the files pursuant to the
foreclosure action that are maintained by the designated government offices
and other authorities.
TITLE EXPERTS If your time is limited title experts, paralegals and
attorneys can be employed to do most of these tasks. Office clerks can
provide contact information.

Attend an auction. The principle purpose is to understand the auction

protocol, but complete as much of the total check list process as you can.
The better your preparation for the auction the more enhanced your total
understanding will be. If the property is sold speak to the buyer and attempt
to determine their intent. If they plan to resell the property follow the
progress of the resale to see how close it compares with your estimates. If
you are purchasing to occupy this is an opportunity to obtain a bargain.
Many buyers are eager to "flip" the property for a quick profit and may
agree to a sale on the court house steps. This is your opportunity to watch

40
the progress of foreclosure from filing the law suit, or Notice of Default
(NOD), to the final sale. Do not be in a hurry to start building your real
estate fortune. If you are not comfortable after the first time, repeat the
process until you are.

The REO This is the bargain hunter's dream. The defaulting borrower has
lost the property to the foreclosing lender and the emotion is gone. The
property is now in the lenders inventory (REO). Foreclosure, however, is not
the only way property ends up in the lender's back room. Often the property
is surrendered by the owner when offering a "deed in lieu" of foreclosure.
When a lender accepts a deed in lieu of foreclosure the property is relieved
of any additional liabilities arising from the mortgage obligation. The
important thing to understand now is that money lenders are in the business
of making loans. They make their money based on the spread between their
cost of money and the loan rate. Real estate owned (the REO) represents lost
opportunity since their investment is usually tied up in non productive
assets. Occasionally the bank takes an income producing property into
inventory, however this is rare. And, even when the property is producing
income the lender is rarely prepared with the appropriate resources to
manage the income profitably. With rare exception the lender is very eager
to convert the property to cash, and often at a loss.

Locating the REO This is a very simply task if you are looking to invest in
a house or an apartment building. The vast majority of residential loans are
made by members of savings and loan associations. Unlike commercial
banks which exist primarily for business purposes, savings and loan
associations have been formed exclusively for the purpose of providing low
cost residential financing. In most communities there are only a few S&L's
that make most of the residential loans. Ask your real estate agent who the
primary lenders are and contact their property departments for availability.
Another way to locate properties is to conduct an ownership search for the
banks and S&L's in your community, or the market you are interested in.
When the institution is shown as the owner the property is likely to be an
REO. If you are looking for office, industrial and retail properties contact
your local commercial banks.

Talking Smart To The Banker The longer a property remains in the

lender's inventory the more likely the property value established by the REO
department will be influenced by the lender's accounting practice. The
largest accounting liability is likely to occur at the time of receipt, and the

41
begin to diminish thereafter. The best time to approach the lender's
representative is when the property represents the greatest cost. Immediately.
An opportunity to remove an accounting liability without the requirement to
pay a sales commission, and at the same time remove the on going risk
associated with unlawful detainer (removing the tenants, or defaulting
property owner), repairs, deferred maintenance, vandalism and code
violations usually looks the most attractive to a lender in the beginning. So,
make you move while the property managers still feel the pain. An offer
directed to the bank president with a deposit check will usually get
immediate attention. Your offer may be in the form of a letter of
introduction and a simple property presentation attachment which includes a
picture and a general description of the property and the local market .

Date

The Lender
Street Address
City,State,Zip

Dear President:

I would like to submit a purchase offer for the property located at

Purchase Price:
Down Payment :
Financing Terms:

Closing Date:

Sincerely,

Attachment:

42
Be prepared for what happens next. If you do get a reply, follow up. This
applies to any communication that you initiate with parties to the foreclosure
at any point in the process. If the lender rejects your offer in writing, find out
why. If the lender is interested in your offer the reply is more likely to be in
the form of a counter offer using the lender's legally approved contract. If
you completed the Auction check list then you will have already seen the
contract and you will be better prepared to respond.

The REO Contract Check List When replying to the lender's contract
everything is negotiable. The table below is intended to help you organize
your reply to the lender's contract offer.

PRICE: When negotiating with the lender be sure to remain focused on the
net equity.
FINANCING: Attempt to make your offer conditional upon REO
financing. The REO lender has added incentive to provide preferred terms.
Be sure to review "Institutional Financing Techniques" in the Aggressive
Strategies Section.
CLOSING DATE: Insure the closing date allows enough time to explore
all financing options, or the completion of partnership formation.
PROPERTY CONDITION: Seek cash credits for repairs and deferred
maintenance. The cash will provide added reserves and will allow you to
contract for the needed work for less than the credits.
TENANTS IN POSSESSION: Insure the property is vacated at close of
escrow.
LIENS AND JUDGMENTS: Insure the property is free of secured and
unsecured liens at close of escrow.
CERTIFICATE OF OCCUPANCY: Insure the property is compliance
with certificate of occupancy (CO), or rental permit requirements.
TITLE, ESCROW AND CLOSING COSTS: Payment for these services
are often based on local custom and practice. But each is negotiable.

Contact your local lenders and locate their foreclosure departments or their
asset recovery division. Determine how they make REO information
available, and seek as much information about their disposal process as you
can. Be sure to ask for a list of the current inventory and request placement
on their mailing list if they maintain one. Occasionally lenders are reluctant
to cooperate with the general consumer, preferring instead to work through a

43
network of preferred brokers. Identify these brokers and contact them. Ask
your real estate agent to run an ownership search for local lenders.

THE GOVERNMENT MARKET

Leverage Properties purchased out of the government market are

particularly attractive since they can be purchased with considerably less
money. While the values tend to hug market levels the leverage and
government financed terms provide good value for investors, and excellent
home purchase opportunities for families.

THE GOVERNMENT MARKET

Leverage Properties purchased out of the government market are

particularly attractive since they can be purchased with considerably less
money. While the values tend to hug market levels the leverage and
government financed terms provide good value for investors, and excellent
home purchase opportunities for families.

VA and FHA Properties financed under the auspices of the Federal

Housing Administration (FHA), and the Veterans Administration (VA)
make up most of the government foreclosure market. These properties do
not go through the conventional foreclosure process discussed within the
context of the Private Markets. Instead, the properties are repossessed based
on the default guidelines and operating practices of the individual agencies
of the federal government.

With the exception of the disposal authority (FHA) and certain aspects
related to buyer qualification the sale process is the same. Private property
management companies are used by the FHA to facilitate the auction and
disposition. The VA manages the process directly from regional offices. The
properties are offered from regularly occurring lists and sold pursuant to
sealed bid. The current list of properties are available without charge from
the local offices of the Veterans Administration which also acts as the
disposal agent, and by the local or regional property manager acting as the
disposal agent for FHA offerings, and may be downloaded from the local
web sites. All bids must be presented through designated brokers pursuant
to the qualifying requirement.

Government Services Administration (GSA) Government sales occur

when the United states government offers property to the public for the

44
purpose of raising revenue or liquidating disposable real estate. Information
about these properties may be obtained by writing for the "U.S. Real
Property Sales List". The address is:

Properties
E. Consumer Information Center
Pueblo, CO 81009

Visit the local VA and FHA (disposal agent) web sites. Review the sites
contents for buyer qualification requirements, the current property list and
the procedure for presenting bids. Arrange to contact an authorized broker
for a property tour and to review the property listings and bidding process in
detail.

THE WHOLESALE MARKETS

It was noted at the beginning that the markets consisting of "fixers", "flips"
(wholesale) and foreclosure were integrated because they could be both
different and the same. We should note, however, that while all foreclosures
have the potential of a wholesale property, not all wholesale properties begin
as a foreclosure. The wholesale market will be defined here as a "fixer", or
"flip" purchased below market value of comparable properties that may, or
may not, be free of repair or deferred maintenance requirements. The
“fixer" is a property bought with the intent of removing repair and deferred
maintenance and then sold at market for the value of comparable properties.
The "flip" is a property bought for immediate resale usually below
market, and often with the intent of never taking title. It is a bargain that you
are passing on to other bargain hunters just like yourself. You are brokering
the property for a quick profit usually in the range of 4%-8% above your
contract price. The check lists used for foreclosure are applicable, all or in
part, to the wholesale market.

The "fixer", or rehab, is a very profitable strategy made possible by the

simple fact that retail (market) buyers will not compete with the wholesale
buyer because they are not willing to accept the time and work necessary to
restore the "fixer" to market condition. The key to success in this market is
assembling a dependable project team of tradesmen, designers and real
estate agents. Be particularly sure that the tradesmen will be available to
perform the needed work in a timely manner. Lost time can result in added

45
carrying costs if you intend to sell, or lost income if you intend to hold for
investment.

"Fixer" strategy has the potential for a high powered income stream that can
be created with an efficiently planned part time effort. As with any "fixer"
the more skill you can bring to the project the more profitable it will be. But,
in the end, your profit will be directly related to your ability to skillfully
manage the contractors you bring to the job, and your understanding of
market value. The rehab business, however, is not a fast track to riches
unless you plan to exchange or refinance the profits for investment. If this is
your intent you should use the "Real Estate Investment Guide And Field
Reference Manual" for planning your strategy. The Manual offers an
outstanding pyramid model for investing in single family houses.

Locating The "Fixer" This may very well be the easiest part of the process.
It is made particularly easy by the high visibility of the property. "Fixers"
are an exceptional target of opportunity since the general condition of the
property implies a lack of interest, or the inability of the owner to provide
for the property's needs. There is generally some level of discontent located
within the property, or associated with the owner. Death, divorce, illness,
loss of income, loss of a job or an unmanageable tenant are likely to
manifest in the appearance of the property. If "fixers" could speak they
would be saying, "Something is wrong here, can you fix it?". If your answer
is yes, then a new door to your financial future has opened.

Locating The "Fixer" This may very well be the easiest part of the process.
It is made particularly easy by the high visibility of the property. "Fixers"
are an exceptional target of opportunity since the general condition of the
property implies a lack of interest, or the inability of the owner to provide
for the property's needs. There is generally some level of discontent located
within the property, or associated with the owner. Death, divorce, illness,
loss of income, loss of a job or an unmanageable tenant are likely to
manifest in the appearance of the property. If "fixers" could speak they
would be saying, "Something is wrong here, can you fix it?". If your answer
is yes, then a new door to your financial future has opened.

Six Critical Resources In addition to foreclosure there are six basic

resources, or opportunities, for identifying a "fixer". The greater your
resourcefulness for using each the more successful you will be.

46
 The Real Estate Agent The real estate agents in your community are the
best source for property information. The local MLS (multiple listing
service) data base is the most comprehensive resource for property
information of any kind, and is the "fixer's" best friend. Work closely with
the real estate agents in your area and develop a close business relationship
with them.

Distressed Or Poorly Maintained Property Drive your market routinely

watching for any property that appears to be in distress. Don't think that
simply because you have done it once that you can ignore the area in the
future. Each time you drive a market you will see an opportunity that you
did not see, or overlooked before.

Absentee Owners An absentee owner is an excellent rehab prospect since

virtually all tenant occupied properties require significant rehab and repair
when sold. Maintain a data base of absentee owners using a simple mail
merge word processing program. Mail to your data base at least twice three
times a year.

For Sale By Owner (FSBO) These property owners resist paying real
estate commissions based on some kind of misguided principal and,
therefore, tend to be poorly informed about market value. These properties
tend to be the more poorly maintained as well. Watch for them.

Referrals Talk about your business. Ask your friends and acquaintances
to let you know about properties that you may be interested in. Offer a
referral fee.

Advertise The newspaper is not likely to be a cost effective source of

advertising. But you may want to run some trial ads to determine the value
of this medium in your area. The best way to use advertising is to find
locations for the permanent placement of your message. Signs along the
highway placed on private land are very effective. A simple sign including a
phone number might read, "I Buy Houses - Fast Close" Place a magnetic
sign with the same message on your car. Use business cards left in approved
locations, and any other form of permanent placement you can locate.

Contacting The Owner You are reminded that when the owner contacts you
it is a selling signal. Be certain to remain focused on the objective. The post
card is for the sole purpose of owner response followed by an appointment.

47
Under no circumstances is this the time to discuss any negotiating point. If
you break the rules you will almost certainly lose.

Money Making Improvements When making repairs, removing deferred

maintenance and considering improvements you will be faced with certain
repair, or replace, issues. Be cautious about creative options such as room
additions or any other physical improvement. Be absolutely certain these
added features fit the property type and are consistent with the general
lifestyle represented by the surrounding area. Do not be afraid to tear out old
or misplaced improvements such as a pool, or a garage conversion. Tear out
is cheap, removes physical clutter and often resolves resale problems. The
table below provides guidelines for repair and improvements that provide
the greatest return for the dollar invested.

CLEAN-UP Buyer interest begins at the curb. If you don't make the sale
at the outside you will never get the buyer inside. Don't start implementing
your rehab plans until you have completed the basic clean-up.
EXTERIOR It has often been said that each dollar invested in paint is
worth ten dollars at close. New roofing material will give the property a
"like new" look.
LANDSCAPE, FENCING, DRIVE & WALKS A poor landscape plan,
deteriorated fencing, cracked concrete and crumbling asphalt destroy the
exterior appearance. Include a landscape contractor as a part of your rehab
team. Repairing and replacing these components to provide esthetic balance
is the first step towards adding value greater than the cost to perform the
work.
INTERIOR PAIN, FLOOR & WINDOW COVERING: Locate a good
interior designer. The cost of their advise is minimal. These specialists are
compensated primarily by vendors of the interior design products they sell.
Each of these items can add extraordinary appeal by balancing color with
simplicity at very little cost. Expensive materials are not necessary to
achieve this effect. A good designer will give you a big bang for your buck.
REMODELING Physical improvements need to be highly discretionary.
One such improvement with the potential of adding real value is skylights.
A skylight provides natural light, illuminates an otherwise dark area and
adds a custom design feature for relatively little money. Creative lighting in
kitchens, baths and family areas offer an esthetic benefit and adds real value
at very little cost. Kitchen and bath remodel should be considered only as a

48
last resort. Consider the added value of certain components first. Start with
flooring and work up. Add new counter tops, sink and fixtures, major
appliances and modular cabinets in that order. Stop at the point of
diminishing return.
SWEAT EQUITY As much of the needed work that you can do, or learn to
do, will add handsomely to your profit. You may be surprised at how much
of this work you are already capable of. Make a commitment to improve
your personal skill set with each project. Take your experience from the
contractors you employ, and build an efficient team that will be dedicated to
saving time and money.

The "flip" is as complicated as the "fixer" is simple. "Flip" opportunities

come primarily from your search for foreclosures and "fixers", and you will
have to apply the same detailed preparation in order to make a safe and
profitable decision. The difference, however, is that the resale market for
"fixers" and foreclosure is active and dynamic, the "flip" market is not. You
will be required to create your own market consisting of prospects with
which you have developed business relationships, and whose needs you
clearly understand. This is process that develops over time,

Your Market Your market will evolve naturally from your involvement
with foreclosure and wholesale properties. The buyers, sellers, your
contractors, real estate agents and other specialists that you have worked
with are all potential bargain hunters. In fact, you should be eager to act as
the buyer of a property "flipped" to you if the potential profit is consistent
with your objectives. You might also experiment with an advertising plan,
and do not forget the possibility of short term lease/option strategies.

Setting The Stage The stage is set with two words added to the buyer line
of your purchase contract. When establishing your identity as the buyer
simply add the words "or assigns" For example: John Doe, or Assigns
PURCHASER/BUYER: . With the sellers acknowledgement on the
purchase offer you now have a reservation which allows you to transfer all
rights under the contract to a third party pursuant to their acceptance of
terms and conditions of the agreement. The assignment provision should not
be used arbitrarily. Capricious use, or intent, neither serves the validity of
the agreement, or the intent of the parties. This provision should probably be
restricted to your ability to clearly identify an assignment to at least one
properly qualified assignee with the financial capability to perform in your

49
place. As the assignor you should also be aware of your ethical and financial
responsibility to the seller in the event the assignee fails to perform as
agreed. The laws in your jurisdiction may find you responsible in the event
of assignee default, so you need to be prepared for this possibility.

The Contract Become familiar with contract formats structured for

investment. Frequently the purchase offer is assigned by simple notification
to the seller by means of an amendment to the contract substituting the
assignee for the assignor (purchaser). A preferred method is to identify all
the parties by using separate contracts.

The Assignment of Contract is an example of the form you might use.

Sample forms for the purchase and management of tenant occupied
properties can be found at the Contracts & Forms link in the Contents
window.

Novice Advise As a beginner you should not put a "flip" under contract
unless you are certain you can close either with a confirmed assignee, or on
your own. Never contract for a property merely because it is dripping with
profit potential. Greed has trapped more than one investor in the swamp of
litigation that's filled with alligators and sharks. Do not be afraid to pass on a
good deal due to the absence of current options. These opportunities are like
trolley cars. There is another one coming down the track every five minutes.

Understanding the foreclosure and wholesale markets and the forces that
move them is not enough to be successful in this very dynamic environment.
It is important that you take specific action to empower an ongoing effort to
acquire the necessary skills and experience that will allow you to recognize
the right opportunities.

If there is one secrets to successful real estate investment strategy it is

finding the property that fits a clearly defined strategy. If you do not have
one, do not start. Whether it is foreclosure, fixer, flip or hold for investment-
- the objective is profit. Keep your eye on the goal.

BONUS INFO 2

INVESTMENT STRATEGIES USING THE TAX CODE

Preface Buyers, owners and sellers of income producing properties and

investment real estate need to understand and apply tax rules to their real

50
estate transactions to maximize the financial rewards. This condensed Guide
is not intended to be complete treatment of the complex nature of real estate
taxation but, instead, a guide to the tax considerations which normally arise
in the course of an investment decision, and to advance the readers
awareness of the tax rules that apply to the transaction under consideration.
Always seek the guidance of a tax professional for the purpose of
determining the proper application of the rules to your particular situation.

Purchase & Improvement Loans Two types of interest deductions exist on

loans secured by the principal residence and vacation home :

• interest on purchase or improvement loan to $1,000,000; and

• interest on all other loans to $100,000.

The rule applies to that portion of the loan that does not exceed the fair
market value of the property. The second home may be any residence
selected by the owner, including mobile homes, recreational vehicles and
even boats

Interest on money loans and carryback credit sales, originated to purchase or

substantially improve the owner's first or second home, is fully deductible on
combined loan balances up to $1,000,000, and limited to $500,00 for
married persons filing separately. This division of entitlement remains for
most interest deduction rules.

An improvement (repairs do not qualify) is substantial if it increases the

owner's basis in the residence by:

• adding to the market value

• extending the useful life; or
• functional change to residential use

Home Equity Loans Interest on a loan secured by the first or second which
does not qualify for the purchase and improvement loan deduction would be
loan obtained for any other purpose, commonly referred to as a home equity
loan, d is limited to $100,000 . This deduction is further reduced by the
amount by which a purchase and improvement loan exceed the $1,000,000
cap.

51
Taking The Deductions Interest deductions on home loans are only
allowed on interest which has accrued and been paid, referred to a qualified
interest.

Interest on loans related to real estate owned and used in the course of trade,
or business is given the most favorable tax treatment. Confer with your tax
professional for details.

Interest Interest on a loan made to purchase investment property is

deducted from the net operating income. Interest paid to acquire, or
improve, a residence is deducted from the owner's adjusted gross income
(AGI)

Points Points paid on the origination of a loan are prepaid interest and
generally written over the life of the loan. An exception is made for points
paid on a purchase or improvement loan on the owner's principal residence,
and may be deducted in the year of the loan provided:

• the loan is not made for a second residence, or vacation home.

• the loan is secured by the principal residence
• the points are called "points", "loan origination fees", "loan discount",
or "discount points" and are computed as a percentage of the loan
amount.
• the payment of points is an established business practice

This exception does not apply to a second residence, or vacation home.

Qualifying point may be paid by the buyer, or seller, but not the lender.

Refinance Points paid to refinance a purchase loan are not deductible. An

exception is made for temporary purchase financing such as a short-term
balloon note evidenced as all, or part, of the purchase financing.

Profit taken by an individual on the sale of a principal residence is eligible

for the $250,000 profit reporting exclusion if the individual owned and
occupied the residence for a least two to the five years preceding the sale.

Married Exclusion Profit taken by a married couple on the sale of a

principal residence is eligible for the $500,000 profit reporting exclusion if
the couple files jointly and owned and occupied the residence for a least two
to the five years preceding the sale. Each may also take the $250,000

52
exclusion on properties owned separately subject to the ownership and
occupancy requirements.

Additional Exceptions The exclusion may also be taken when:

• there is a change in place of employment;

• a change in health
• unforeseen circumstances defined in regulation [IRC 121(c)(2)(A)]
• the payment of points is an established business practice

The exclusion may not be taken on a sale reported within two years of the
taxpayer's use of the exclusion.

When estimating the annual income tax liability, total income and the profits
and losses from all sources are first classified as belonging to one of these
categories:

• professional or owner-operated business opportunities, called trade or

business income
• rental and non-owner operated business opportunities called passive
income
• investment, or portfolio income

These categories are mutually exclusive and observe different accounting

rules

Trade, Or Business Income

• earnings from the owners occupation of real estate[IRC 469(c)(6)(A)]

• income and losses from the owner's trade or business opportunity and
the real estate owned and used in the trade of business if the owner is
a material participant in management [IRC 469(c)(1)]
• income and losses from owner-operated hotel, motel or inn operations
with an average occupancy of 30 days , or less, and the owner is a
material participant in the management of the business operations.

Rental Income

• rents, expenses, interest and depreciation form annual operations, and

profit and losses from sales, of residential and nonresidential rental
real estate which have an average occupancy of more than 30 days

53
 • income or losses from business opportunities not managed by the
property owner

Investment, or Portfolio Income

• interest earned on savings accounts and secured or unsecured notes

• annuities, dividends and royalties from personal property
investments(bonds and securities)
• income, profits and losses from ownership of ground leases, and triple
net leases of real estate held for income [IRC 469(f)(1)(A)] it is
important that you determine the proper tax category before building
your business plan and investment strategy.

Only accrued mortgage interest may be deducted, or expenses. The only

exception is points paid on purchase and improvement loans secured by a
personal residence.

What Are Points? Points are prepaid interest paid to the lender at the time
of loan origination evidenced by payment, or a discounted loan amount for
the purpose of enhancing the lender's yield, or return on investment. These
added fees collected by the lender at the time or origination must be
amortized over the life of the loan except for owner occupied purchase and
home improvement.

Investment Deduction Categories All properties are classified into three

categories. Each property is a type which requires all of the property's
income, profits or losses to be reported in one of three ways:

• trade or business income from real estate held, or used, in the

taxpayer's business
• rental income received from owner operated passive activities
• portfolio income received from property held for profit

Rental Property Deductions Interest paid on loans for the purpose of

purchase, improvement or to carry the cost of rental property, to the
exclusion of business property, and to refinance balances is deductible from
the property's income.

Operating losses:

54
 • may qualify to reduce the property owner's adjusted gross income
(AGI)
• may qualify to be deducted from AGI under the $25,000 rental
operating loss deduction, reducing both standard and minimum
taxable income [IRC 1.163-8T(a)(4)]

Unused deductions, or suspended losses, may be carried forward as an

offset to future rental income from that property or the profit of any other
property at the time of sale.

Investment Property (Portfolio) Deductions Interest paid on loans to

purchase, improve or to carry the cost of portfolio properties is deductible
against income or profits from all sources within the category. Portfolio
income includes earnings from savings, notes, bonds, securities and carry
back notes. Unused losses may be carried forward to future years.

Trade & Business Deductions Interest paid on loans to purchase, improve

or to carry the cost of the properties owner's trade or business is an expense
against the NOI

Depreciation is defined as a loss of property value caused by wear or

obsolescence. Since the IRS allows real property, which is generally
considered to be an appreciating asset, to be depreciated [IRC 167(a)] , the
depreciation schedule becomes a valuable business planning tool.

Basis The basis in real property is the cost of acquisition, or the purchase
price. The basis of the property must be known before any allowance for
depreciation can be taken.

A property basis includes:

• All loan proceeds, new and assumed, used for the purchase or
improvement of the property
• cash added
• the value of any property added, or traded, toward the purchase or
improvement

Land vs. Improvement Since the IRS does not recognize land as a
depreciable asset, the depreciable portion is limited to the physical
improvements which may be depreciated based on the IRS schedule for the
applicable property which is currently:

55
 • 27.5 years (40 AMT - check with your tax professional) for residential
property
• 39 years (40 AMT) for nonresidential property

Basis is established at the time the property is placed in service, usually at

the close of escrow or transfer of a leasehold.

Operating losses are generally allocated for tax purposes as:

• an adjustment to the AGI without limitation

• a deduction up to $25,000 pursuant to the passive loss rule

The adjustment, or deduction, depends on the nature of the owners business,

material participation in the management of the property and actual time
spent. These rules are a bit complicated, therefore it is very important that
you confer with your tax professional to determine the manner in which your
operating losses, if any, should be reported.

Reportable losses from the operation of each rental property are applied first
to other rental property , and then as a deduction, or adjustment, to the AGI.
subject to qualification.

The $25,000 Loss Deduction Qualifying owners may take a deduction of

up to $25,000 against the AGI.

To qualify:

• be an active owner-operator participant with at not less than 10%

ownership interest.
• have an AGI of less than $150,000 [IRC 469(i)]
• the loss must occur in the rental real estate category

Active Participation The investor must be an owner-operator exercising an

active participation in the management of the property. The owner-operator
may delegate duties and responsibilities to third parties such as property
managers and leasing agents, but must remain as the final arbiter of the
management function.

To qualify:

56
 • be an active owner-operator participant with at not less than 10%
ownership interest.
• have an AGI of less than $150,000 [IRC 469(i)]
• the loss must occur in the rental real estate category

AGI Limitations The AGI deduction is reduced by 50% for each dollar
over $100,000 of AGI. Unused losses may qualify to be carried forward, or
suspended in accordance with the rules.

Depreciation is defined as a loss of property value caused by wear or

obsolescence. Since the IRS allows real property, which is generally
considered to be an appreciating asset, to be depreciated [IRC 167(a)] , the
depreciation schedule becomes a valuable business planning tool since the
depreciation allowance is, in fact, a non cash expense that reduces the net
operating income of the property, or the AGI which in either case reduces
the overall tax liability.

Basis The basis in real property is the cost of acquisition, or the purchase
price. The basis of the property must be known before any allowance for
depreciation can be taken.

A property basis includes:

• All loan proceeds, new and assumed, used for the purchase or
improvement of the property
• cash added
• the value of any property added, or traded, toward the purchase or
improvement

Land vs. Improvement Since the IRS does not recognize land as a
depreciable asset, the depreciable portion is limited to the physical
improvements which may be depreciated based on the IRS schedule for the
applicable property which is currently:

• 27.5 years (40 AMT - check with your tax professional) for residential
property
• 39 years (40 AMT) for nonresidential property

Basis is established at the time the property is placed in service, usually at

the close of escrow or transfer of a leasehold.

57
Depreciation, however, is not a free lunch. All depreciation, straight line
and accelerated, is recovered at the time of sale. For each year of ownership
in which the owner takes a depreciation allowance it is also applied to the
cost of the property , or recaptured, as a reduction in basis thereby increasing
the profit at the time of sale. Any profit recognized is then taxed at the
current capital gain rate.

The important element to understand about the recapture of depreciation is

that excess depreciation taken in excess of the straight-line schedule, is
treated separately in the year of sale, and is not subject to the capital gain
limitation.

Since tax surprises can occur as the result of depreciation recapture at the
time of sale it is imperative the investor plans the use of depreciation
schedules in order to maximize the desired tax benefit, both during the
holding period and when the property is sold, or exchanged.

Low income earners may take a qualified five year gain as of January 1,
2001 and high income earners beginning 2006. These rules are somewhat
complicated, but very meaningful for the investor engaging in a purchase
and sale strategy to be conducted within a known time frame. Sine income
determines the tax rate please confer with your tax professional to determine
how you qualify

High Income Profit taken on the sale of properties acquired after the year
January 1, 2001, and held for more than five years are eligible for the
qualified five-year gain treatment of 18%.

Low Income Property held for five years and sold on, or after, January 1,
2001, is eligible for an 8% and 18% tax rate depending on the amount of
qualifying income.

The differences are:

• high-income wage earners become eligible for the qualified five-year

gain after January 1, 2006
• low-income wage earners become eligible for the qualified five-year
gain after January 1, 2001

58
Tax Avoidance Profits from real property are reported in the year of the
sale unless:

• excluded in accordance with Internal Revenue Code 121

• exempt pursuant to an exchange of the proceeds in accordance with
Internal Revenue Code 1031
• deferred, such as a note carried back to secure proceeds pursuant to an
installment sale in accordance with Internal Revenue Code 453

Electing Out A Seller who elects out of an Installment Sale by reporting all
the profit in the year of the sale may use the gain to:

• offset a trade or business loss

• offset a rental operating income from a rental property
• offset AGI
• offset capital losses of rental or passive business investment
• offset capital losses in the investment property category

Installment Sale Reporting The profit reported and taxed in the year of sale
and contract payments, or any preemptive payments including
hypothecation, in future years is based on the contract ratio expressed as the
net profit over the net equity where:

• net profit is the contract balance after down payment and closing
costs
• net equity is the contract price less costs minus the basis

The balance of the cash received in the first year, and all future payments is
deemed to be a return of capital.

The interest income portion included in each payment to a carryback

mortgage is reported as investment/portfolio category income. Unless the
interest income is offset by operating or sales losses, the earning will be
taxed up to the maximum rates for ordinary income.

A common carryback strategy by is to lower the note rate and increase the
principal balance in order to capture increased profit which is taxed at a

59
lower rate, thereby reducing the overall tax liability. This is often suitable
for the Buyer of the property since the mortgage is often structured in a way
to reduce the monthly mortgage obligation even though the purchase price is
may be higher. The Internal Revenue Service regulates this practice by
imputed interest reporting rules.

The AFR Imputed interest reporting requires an Applicable Federal Rate

(AFR) of interest be set for every debt (extension of credit) carried bask by a
seller. Any carryback note which states an interest rate lower than the AFR
triggers the reporting of a portion of the note's principal balance as interest.
This reallocation of principal to interest is called imputing [IRC 1274(b)].

Applicable AFR AFR's are set monthly by the IRS, based on the rates of
return paid on Treasury bills and other federal notes and control the
minimum reportable carryback rate in accordance with:

• the date of the purchase agreement

• the due date
• the payment schedule

The application of AFR's are complicated and require careful tax planning if
the Seller intends to construct tax favorable treatment through the receipt of
principal and/or interest payments. Be sure to confer with your tax
professional before engaging in any form of Seller carryback financing.

Perception Tax and price consideration often motivate Sellers to use lease-
options to generate a sale. The advantages often thought to be associated
with lease-option transactions are:

• a higher price
• option money, tax-deferred profit or income
• an interest free transaction
• rental income
• tax benefits from depreciation coupled with operating losses

Conversion To A Sales Contract Failure to document a lease-option

properly may, in fact, be determined to be a sales contract and the Seller will
find that the option will be recalculated as an installment sale by the IRS
resulting in:

• rental income recomputed as interest at the applicable federal rate

60
 • a reduction of the sale price
• option proceeds converted to interest income, or
• as payments applied to the purchase price distributed in accordance
with the contract ratio
• adjustment to operating losses and depreciation allowance

The IRS will audit a number of factors when determining whether a lease
=option is really a sale, such as:

• has the buyer established in the property

• risk allocation
• payment of property taxes
• the relationship of rent to market value
• the relationship of the price paid to the market value at the time of
exercise

Remember: If the lease-option agreement appears in any way as though the

Seller and Lessee have created a purchase agreement, it is probably a sale.

Perception Tax and price consideration often motivate Sellers to use lease-
options to generate a sale. The advantages often thought to be associated
with lease-option transactions are:

• a higher price
• option money, tax-deferred profit or income
• an interest free transaction
• rental income
• tax benefits from depreciation coupled with operating losses

Conversion To A Sales Contract Failure to document a lease-option

properly may, in fact, be determined to be a sales contract and the Seller will
find that the option will be recalculated as an installment sale by the IRS
resulting in:

• rental income recomputed as interest at the applicable federal rate

• a reduction of the sale price
• option proceeds converted to interest income, or
• as payments applied to the purchase price distributed in accordance
with the contract ratio
• adjustment to operating losses and depreciation allowance

61
The IRS will audit a number of factors when determining whether a lease
=option is really a sale, such as:

• has the buyer established in the property

• risk allocation
• payment of property taxes
• the relationship of rent to market value
• the relationship of the price paid to the market value at the time of
exercise

Remember: If the lease-option agreement appears in any way as though the

Seller and Lessee have created a purchase agreement, it is probably a sale.

"Paper Profit & The Discounted Mortgage"

Preface Is there an investment that yields a return of up to 50% each year in

which your principal is secured, management free and that can be created
with very little money? Yes there is, but you will not find it in the usual
places.

Exceptional investment opportunities arise form exceptional economic

conditions. When Albert Einstein was asked if the Theory of Relativity was
his most important discovery he thoughtfully replied, "No, compounded
interest.". Ever since man began trading in the "coin of the realm" the power
of compounded interest has been the driving force of all financial institutions
and those behind them. Your bank lends money to make money, and you
should too.

This publication is all about creating and purchasing mortgage notes secured
by real property for profit and income. It is not about buying notes taken in
exchange for retail services. It is not about buying notes taken in exchange
for rental income. It is not about buying notes secured by small business
assets, or anything else. And, it is not about spending years developing the
knowledge, experience and networking data base required to be a successful
note broker.

There are any number of programs available on the internet, and elsewhere,
promising success in the "note brokerage" business. There are 132 reasons
why you may wish to avoid this endeavor. Reason number 1: The successful

62
note broker, particularly in the beginning, spends 95% of a business day
engaged in an exhausting search for note sellers and buyers, then the
remaining 5% packaging, promoting, selling or otherwise attempting to
make a profitable purchase and sale. Reason number two: Reason number 1
multiplied by 131. So, do the math before you set out to become a note
broker.

However, As an investor in discounted mortgages you can enjoy the

profitable upside without the backbreaking downside. Consider the
possibilities:

• You structure the note to meet your yield expectations.

• You make all the profit rather than a commission, or percentage,
sandwiched between seller and buyer.
• You never have to look for buyers for your notes because as an owner
they will come to you.
• You make more money on fewer transactions with less time.
• You may buy, sell and trade your notes profitably using the same
methods that apply to real property without the same ownership and
management risk.

The opportunity to make money in discounted mortgages is boundless, and

creative note solutions lead to returns that simply cannot be captured in any
other reasonable investment other than real property. We will focus on the
simple basics here in order to establish a safe and easily understood starting
point for the inexperienced. Your particular requirements and continuing
interest will dictate the extent to which you become involved in the more
aggressive purchase solutions requiring more skillful application of basic
financing principles. You will learn everything you need to know at the
appropriate time and place.

Almost all mortgages that are sold, or assigned, are junior liens. A junior
lien is any mortgage recorded after the first. These mortgages represent
secondary financing and are commonly referred to as seconds, thirds and so
on ordered by the earliest date each was recorded. While most secondary
financing is provided by institutional organizations there remains a
significant amount of private financing which is the object of the discounted
mortgage market. These loans are made by the owner of the property in
order to facilitate the sale, or enhance return on investment usually for a
term of three to ten years. If the holder, or beneficiary, of a private note

63
wants money before the maturity date of the note it may be sold , all, or in
part, to an investor specializing in the acquisition of mortgages at a
discounted rate. The discount required by the investor can range from as
little as 10% to more than 50% depending on risk and the yield expectations.
Although privately financed mortgages represent a very small part of the
total financing market, private financing is active in every community every
day.

"Mortgage" is a generic term referring to a real estate financing obligation.

In many states the mortgage obligation is represented by a note which is
evidence of the obligation and a trust deed which is the security instrument
for the note. However, in some states the term mortgage assumes a more
defined meaning. In these states the "mortgage" is both the evidence and
security instrument for the indebtedness.

Some states use both the mortgage and deed of trust as the security
instrument. Visit your local county recorders office. Find out how real
estate obligations are recorded and secured. The recording clerk will assist
you in understanding these documents, and will answer you questions.

Purchase strategy is really a matter of style and expectation. If you are

satisfied with a better than market annual rate of return of 10 to 15 percent
you will not find negotiations difficult since the professional investor is
generally seeking a minimum YIELD of 20%. However, swimming in
deeper water requires a life line. This means you will need to prepare more
than one offer for the seller's consideration. Two is good, three is better and
four is best.

While the purchase of a note can be as creative as the human mind is

complex, there are four basic offers that you will consider in the beginning.
You may offer to purchase the entire note, or a partial note. The partial
offer may be for all, or a portion of a fully amortized payment schedule. Or,
if the note is interest only with a balloon payment you can purchase the
interest only payments, part of the interest only income stream and part of
the balloon payment, or just the final balloon payment upon maturity. Each
offer provides the seller with a different option, thereby enhancing your
opportunity to a create purchase with an investment yield acceptable to you.
Sounds like a calculation nightmare? Perhaps for the money changers of
ancient Rome, but it is quite simple for you..

64
The payment schedule is nothing more than the agreed upon rate, or speed,
at which the interest is paid and the principal is returned to the lender. There
are many ways in which interest and the return of principal can be
scheduled, but most are some variation on four basic methods.

• Amortized A computer generated schedule that provides for the

payment of principal and interest over the term of the loan in equal
monthly installments.
• Simple Interest This schedule provides that interest and principle
will be in the form of one payment at the end of the loan period, or
upon the maturity date.
• Interest Only The interest only schedule provides for periodic
interest payments, most often monthly, with the principle due at the
end of the loan period, or upon maturity. The principle payment is
referred to as a "balloon".
• Partial Amortization A schedule frequently used for commercial
loans in which the loan amount is amortized for a longer period than
the term. A schedule that calls for the loan to be amortized for 30
years with the balance due in 10 years schedules the loan as though it
is amortized for 30 years, but the final payment will be the remaining
balance in the form of a "balloon" at the end of 10 years.

Every serious mortgage investor is armed at all times with a financial

calculator. It is a constant companion, and as much a part of the investor's
day-to-day needs as car keys and credit cards. It is the final arbiter of
financial decisions. Consider the mortgage investor who, when asked by his
wife during a particularly stressful period in their marriage how he would
calculate their chances for success, pulled out his calculator and replied by
asking, "Would you like that for 5 years, or 10"

The table below displays the calculator keys on the hewlett packard financial
calculator. These keys, and the related functions, can be used almost
exclusively to make most any mortgage purchase or sale decision. The
calculator will compute for the unknown value when all other values are
known. When using other financial calculators the key pad display may
appear different, but the process will be just as easy. Note from the table
how the total principal and interest changes with the schedule even though
the loan amount and interest rate are the same. It is very important to
recognize from the beginning that the value of a mortgage is not determined
by the amount of money received during the holding period. Nor, is it

65
particularly determined by the loan amount, interest rate or the term of the
loan. As you will find out very soon the value is determined entirely by the
cost of the income stream, and the value measurement is referred to as the
yield.

YIELD is the numerical measurement of the speed

at which principal and interest is returned to the investor.

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
AMORTIZED
12 .67 1000 87.00 0 1044.00
SIMPLE INTEREST
1 8 1000 0 1000 1080.00
INTEREST ONLY
12 .67 1000 6.67 1000 1080.00
PARTIAL AMORTIZATION - 1 YEAR DUE IN 6 MONTHS
5 AMORTIZED PAYMENTS OF $87.00 AND 1 FINAL
PAYMENT (FV)
OF $87.00 +THE REMAINING PRINCIPAL BALANCE OF
$509.00
12 .67 1000 87.00 596 1031.00

Before reading another word purchase a standard financial calculator. It can

be a Hewlett Packard, Texas Instrument, Sharp or any other suitable for
business applications. Become familiar with the basic amortization and the
mortgage applications. You will find the calculator easy to use and
understand. While we will not employ the use of sign convention in our
examples, be sure you recognize the sign [+][-] protocol required for your

66
model when making an entry. Soon you will be comfortable with the
common and frequently used mortgage calculations.

Now that you are familiar with your financial calculator and the more
common mortgage features we can look at the most basic of dismounted
mortgage calculations. Consider a $15,000 second mortgage purchased at a
15, 20 and 25 percent discount, and where the first payment has not yet been
made. The PV values represent the investors purchase, and since the loan is
fully amortized the RATE [i]and the TERM [n] are shown as monthly
calculations. We created this table by first amortizing the mortgage then
[RCL] [PV] entering the discounted value (BOLD) and recomputing the
RATE [i]. Work through each of these calculations until you are comfortable
with the computer's key stroke protocol. Remember: You can compute the
unknown, or desired value, by simply entering the known values, the solving
for the new value.
TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
$15,000 SECOND AMORTIZED FOR 5 YEARS
60 1.0 15000 334 0
DISCOUNTED @ 15%
60 1.62 12750 334 0
DISCOUNTED @ 20%
60 1.86 12000 334 0
DISCOUNTED @ 25%
60 2.13 11250 334 0

As you can see a discount of as little as 15% converts the income from a
12% yield to 19.5%, or an increase of 62%. Since most private mortgage

67
investors are seeking a minimum of 20% you are likely to find this
purchase easy to complete

As we begin to demonstrate the kinds of situations and considerations you

will be offered we will be making reference to due diligence. Due diligence
is the process of confirming all the details in order to confirm that the terms
of the note are accurate, and that the transaction is within the bounds of risk
you are willing to accept.

• The Good A good note is very easy to recognize. If it is made on

good property, with good equity, good borrower and the note has
good seasoning. Anytime you see a lot of goods in the description it is
probably a good note. If it walks like a duck and quacks like a duck,
then it is probably a duck. We all know that. A good property as
most know is any property that enjoys a desirable location in the
community without regard to size, or condition. Good equity means
that all loans on the property have a combined loan amount (LTV) no
greater than 80% of the current market value of the property. A well
seasoned note is one with all scheduled payments current, each having
been made on, or by, the due date required by the terms of the note
and is at least six months, but preferably one year old. Assuming the
$15,000 mortgage illustrated in the table above meets the requirement
of a good note, we can examine some possibilities beginning the
second year. The Yield [i] is annualized.

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
$15,000 SECOND AMORTIZED FOR 5 YEARS
60 12.00 15000 334 0
DISCOUNTED @ 15% BEGINNING THE SECOND YEAR
FOR THE REMAINING TERM OF 4 YEARS

68
 48 11.67 12750 334 0
DISCOUNTED @ 20%
48 14.95 12000 334 0
DISCOUNTED @ 25%
48 18.54 11250 334 0

What if the seller of the note just needs some cash and does to want to lose
the benefits of a good note over time. Consider buying the income stream
for some period of time with increasing YIELD over time. TERM [n] and
YIELD [i] are annualized . This is referred to as a Partial.

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
$15,000 SECOND AMORTIZED FOR 5 YEARS
5 12.00 15000 334 0
PURCHASING THE 1ST YEAR INCOME STREAM @ A 15%
YIELD
1 15.00 3700 334 0 4008.00
PURCHASING THE 2ND & 3RD YEAR INCOME STREAM @
A 15% YIELD
2 17.00 6755 334 0 8256.00
PURCHASING THE 2ND, 3RD & 4TH YEAR INCOME
STREAM @ A 15% YIELD
3 19.00 9111 334 0 12384.00

69
You receive your rights to a note under the terms of an Assignment. At the
end of the Assignment period the remainder of the note reverts to the seller.
Are you wondering yet what happens to your yield in the event of an early
pay-off. Or, more particularly, if the note is paid off while you are a co-
beneficiary under the terms of a PARTIAL. The news is good. But we will
get to that later.

• The Bad If a good note has a LTV no greater than 80% of the
current market value of the property, what about the note secured by a
property with 100% LTV. Joe came to us with a $50,000 note on a
property he had sold 24 months earlier. Joe agreed to sell the property
to Dick and Arlene for $250,000 subject to a $200,000 first. The bank
surely believed that Dick and Arlene were adding $50,000 in cash to
complete the transaction. However, after the close of escrow Joe
quietly recorded a note for the balance which called for 12% interest
only payments of $500.00 per month and a 3 year balloon. It looked
like this:

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
12% INTEREST ONLY WITH A 3 YEAR BALLOON
3 12.00 50000 500 50000 $68000.00

Our appraisal of the property indicated a market value of $260,000. After

the cost of sale this property had no equity. Joe had shopped this note
around the local investor community without receiving one offer. On the
surface this is a very bad note, but after turning over some rocks we found
opportunity. Dick and Arlene both had very good jobs, good credit and had
never been late on a payment to Joe The property was located in a good
area of town and the house was in very good condition resulting from
improvements made by Dick and Arlene. This note started out looking like

70
Daffy Duck, but was now looking more Donald Duck. However, we were
not ready to show Joe the money quite yet. This loan was negotiated on a
short term and the big balloon was due in less than year. We also needed to
understand Joe's motivation for money. Was it personal, or were Dick and
Arlene showing signs of going bad. Keep the arithmetic simple. If you do
not have a lot more goods than bad you better look for another investment.
But, so far, we liked the math.

It did not take long to discover Joe's motivation was very good. His
daughter was engaged to be married and he needed $10,000 to send her off.
A small price to pay for a daughter's love and devotion. Joe gave us
permission to speak with Dick and Arlene. There concern was the same as
ours. The balloooooon. All the goods were in the right place except equity.
We were not going to invest in this note without security. Without equity
there is no security. Without security you have a very, very bad loan. We
found out, however, that Dick and Arlene owned a very nice (another word
for good) lake side lot given to them by Dick's family, and which they were
willing to offer as security if we could do something about the balloooooon.
We now had a very good note. Still risky, but good.

We made the following offer to Dick and Arlene: We lowered the interest
rate to 10% and removed the balloooooon by amortizing the loan for 7 years
adding 6 years to the pay-off. They could easily afford the higher monthly
payments and were very grateful for the solution.

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
CURRENT NOTE
1 12.00 50000 500 50000

71
 7 10.00 50000 830 0

When Dick and Arlene accepted the new terms we made the following
offers to Joe:

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
NOTE REPLACEMENT
7 10.00 50000 830 0
OFFER #1
2 25.00 10000 830 0
OFFER #2
3 30.00 19500 830 0 8256.00
OFFER #3
4 40.00 21300 830 0 12384.00

Offer # 1 gave Joe what he needed. For $10,000 we would receive the first
25 payments. Offers #2 and #3 proposed to purchase the first 36, or 48
payments at higher YIELDS. Our reasoning: The longer we accept
assignment of the note, the greater our YIELD expectation.

• The Beautiful If you manage to capture a 50% YIELD when

purchasing all, or a portion, of a note you have broken the bank. We
believe any note purchased with a YIELD greater than 50% most
likely exceeds any acceptable boundary for risk. So how do we
increase YIELD without breaking our rules. We Sell It.

Joe accepted Offer #1. This was re-cast into a very good note which

72
 we thought was marketable to a passive investor that buys notes
through a broker, or intermediary. It was also made particularly
attractive for a passive investor due to the relatively short term. This
is how we elevated our YIELD. TERM [n] is shown in months.
RATE/YIELD [i] is shown as the monthly rate.

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
NOTE REPLACEMENT
84 .83 50000 830 0
OFFER #1
24 2.08 10000 830 0
INVESTOR PURCHASE
24 1.67 16850 830 0
OUR YIELD
1 68.5 10000 0 16850 6850.00

That's right!!. The monthly YIELD 68.5 x 12 , or 822% annualized. We

converted a $10,000 investment into $6,850 in less than 30 days. Is this a
common occurrence. Just every day. There is a hitch. To sell notes you
must develop a passive investor network which takes time. And, there is one
other important consideration. In many, if not all, states, you are limited as
to the number of notes you purchase and sell in any one calendar year
without being a licensed real estate broker. Some state also require that note
brokers have a special endorsement. So, know the law in your state.

You now have enough information needed to evaluate the quality and
structure of either a Full, or Partial note purchase. This is a good time to
look at a note. There is no shortage of note brokers in your community

73
willing to sell you a note from their inventory. They are easy to find. They
advertise in the newspaper, phone book and on the Web. Contact a broker,
or seller and have them submit investments for your consideration. Look
only at notes secured by property near your home. Drive by the property
and review the information provided by the seller. The investment package
should contain a current estimate of property value, payment history, not to
be confused with the payment schedule, and a note purchase contract which
sets forth the terms of sale. If there is more information, that's fine. We will
explain how to complete your due diligence in a later section.

Now that you have looked at some notes for sale you are probably eager to
make your own deal. Negotiating in any business is largely a function of
time and experience. There is no substitute for you, or anyone else. There
are three very important factors, however, that you can manage directly in
the course of negotiating the purchase of a note. The seller's motivation, the
borrower's performance and the seller's performance.

When purchasing Joe's note it was important for us to determine his

motivation in order to set the minimum amount required to purchase all, or a
portion, of the note. The seller's motivation always leads to a minimum
dollar requirement. You must find out what it is. Never make an offer
without knowing why the seller needs money, and how much. If you
determine the seller is just shopping the note break off discussion. You are
wasting time. If you are satisfied with the seller's stated motivation then
be sure the note is current and that the motivation is not being supplied by
the potential for default. There are several way you can do this. You can
request the payment record used for tax purposes, a copy of the IRS tax form
used to report the payment information or you can request an estoppel letter.
An estoppel letter is a written acknowledgement by the borrower that all
payments are current and in compliance with the terms of the note. And,
finally, any accepted offer you make should be secured by a refundable
acceptance fee paid into the purchase escrow by the seller. Then, upon
purchase, or mutual cancellation, the acceptance fee can be returned to the
Seller. This will serve to discourage the seller from abandoning your
agreement for a better offer.

Let's look at some of the creative ways that a $25,000 note @ 10% interest
for 5 years can be made, or purchased. Calculate the discount rate.
TERM RATE/YIELD PRESENT PAYMENT FUTURE TOTAL
TERM IN EXPRESSED VALUE MONTHLY VALUE PRINCIPAL

74
 MONTHS AS AN THE PAYMENT FINAL &
OR ANNUAL OR LOAN VALUE INTEREST
YEARS MONTHLY AMOUNT OR TOTAL
RATE OR PAYMENT PRINCIPAL
AMOUNT &
PAID INTEREST
PAID
n i PV PMT FV
FULLY AMORTIZED
60 .83 25000 531 0
30% DISCOUNT
60 2.22 25000 531 0
NEGATIVE AMORTIZATION ON REDUCED PAYMENT OF
$400. FV REGISTER COMPUTES THE BALANCE OWING AT
THE END OF THE TERM
FOR A 40% YIELD
60 2.92 13100 400 -10200
PARTIAL W/SPLIT PAYMENT SCHEDULE- HALF THE
PAYMENT OF $265 FOR 30 MONTHS. THEN ALL THE
PAYMENT FOR THE REMAINING TERM
60 2.5 16000 398 0
5 YEAR INTEREST ONLY W/ALL PAYMENTS DEFERRED
@40% YIELD
60 3.33 5300 0 37900
5 YEAR INTEREST ONLY
5 1.79 16250 208 25000
GETTING ALL THE MONEY All of our previous examples assumed the
loan was paid as agreed for the full term. So, does your YIELD change with
an early pay-off. Look at what could happen if you purchase a new 5 year
note at a 30% discount.

TABLE A

TERM RATE/YIELD PRESENT PAYMENT FUTURE TOTAL

75
 TERM IN EXPRESSED VALUE MONTHLY VALUE PRINCIPAL
MONTHS AS AN THE PAYMENT FINAL &
OR ANNUAL OR LOAN VALUE INTEREST
YEARS MONTHLY AMOUNT OR TOTAL
RATE OR PAYMENT PRINCIPAL
AMOUNT &
PAID INTEREST
PAID
n i PV PMT FV
FULLY AMORTIZED
60 .83 25000 531 0
PAYOFF AFTER 12 MONTHS
12 .83 25000 531 20950 27322.00
PAYOFF AFTER 12 MONTHS W/30% DISCOUNT
12 4.32 17500 531 20950 27322.00
PAYOFF AFTER 24 MONTHS W/30% DISCOUNT
24 2.87 17500 531 16500
PAYOFF AFTER 36 MONTHS W/30% DISCOUNT
36 2.43 17500 0 11500

Is your heart racing? If this doesn't get you excited your doing business on
another planet. Notice the YIELD on a fully amortized note for full value
does not change with the pay-off. In reality there is a fractional increase, but
insignificant. Compare the TOTAL PRINCIPAL & INTEREST with the
PRESENT VALUE for the full value and discounted note and you can
immediately see why there is such an extraordinary difference in YIELD
with an early pay-off. What is the strategy if you find yourself holding this
note? Don't just sit there, get the borrower to refinance the first, and your
second, in the form of one note as soon as possible.

In the previous example you owned the note. What if, however, you
purchased a PARTIAL for the first 36 months with a nice 20% YIELD, and
the note is paid off after 12 months. Easy enough, you say. The owner
sends you a check for $12,750 the remaining 24 payments of $531 and
everything is cool. But. let's see if that is what really happens. Your
transaction began like this:

76
 TABLE #1

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
20% YIELD
12 1.67 14300 531 0

When the pay-off occurs after 12 months you are expecting a check for
$12,750 and the final computation for the transaction should look like this:

TABLE #2

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
i PV PMT FV
EARLY PAY-OFF = 35.5% YIELD
12 2.96 14300 531 12750

But when the check arrives it's for $10,500 and the final computation looks
like this:

TABLE #3

TERM RATE/YIELD PRESENT PAYMENT FUTURE TOTAL

77
 TERM IN EXPRESSED VALUE MONTHLY VALUE PRINCIPAL
MONTHS AS AN THE PAYMENT FINAL &
OR ANNUAL OR LOAN VALUE INTEREST
YEARS MONTHLY AMOUNT OR TOTAL
RATE OR PAYMENT PRINCIPAL
AMOUNT &
PAID INTEREST
PAID
n i PV PMT FV
EARLY PAY-OFF = 24.00 % YIELD
12 1.67 14300 531 10500

"What !!?", you say. "I wasn't bending over." In order to understand the
difference between Table #2 and Table #3 and the manner in which a Partial
Purchase-Early Payoff is settled we need to explain the purpose of the
amortization schedule.

THE AMORTIZATION SCHEDULE Whenever a loan is made both

borrower and beneficiary are provided with a complete amortization
schedule which tabulates each component of the payment. The first and last
scheduled payments on the amortization schedule for the fully amortized
loan in TABLE A would look like this:

SCHEDULE A

REMAINING
PAYMENT DUE PAID TO PAID TO
AMOUNT PRINCIPAL
NUMBER DATE INTEREST PRINCIPAL
BALANCE
1 00/01 531 208 333 24677
60 00/05 531 44 487 0

Typically, Schedule A is used to tabulate the amortized scheduled for the

borrower to the note. Schedule C is the commonly used schedule for Partial
Purchase pay-off. The difference between each is that Schedule A is a fully
amortized schedule with no other purpose than to tabulate the principal
required [FV] pursuant to any payment date on the schedule. Schedule C,
while appearing the same, calculates the [FV] in order to maintain the

78
investor's YIELD for any payment date on the schedule. Therefore TABLE
#3 shows the correct [FV] cash settlement required to maintain the investor's
YIELD TABLE #1. If you want the big pay-off benefit shown in TABLE
A you must be the owner of the entire note. So, is this the best you can
expect when receiving an early pay-off from a Partial Purchase. Yes, unless
you use Schedule B.

SCHEDULE B Schedule B is a more equitable and profitable settlement

schedule, and is used by the sophisticated note buyers and institutional
investors. Schedule B is actually a combination of Schedules A and C, and
is a way of distributing the benefits of early pay-off between the Partial
Purchase investor and the Seller of the note. The theory is simple. The
settlement is based on the present value [PV] of the Partial Purchase rather
than the YIELD. The [PV] is calculated by using the payment and note
rate shown on Schedules A, and the term of the Partial Purchase shown on
Schedule C.

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
PRESENT VALUE OF THE FULLY AMORTIZED NOTE IN
TABLE A PURCHASED WITH A 20% YIELD
36 .83 16450 531

This calculation simply shows the loan value for the given RATE [i],
TERM [n] and PAYMENT [PMT]. As you can see, the present value of
the Partial Purchase, $16,450, is greater than the cost of $14,300 and
accurately represents that portion of the $25,000 loan purchased by the
investor. Key these entries into your calculator. These calculations are not
intuitive, so be patient. It will come to you with practice and experience.

79
The table below tabulates the value of the Partial Purchase given an early
pay-off after 12 months. Without clearing your calculator from the previous
computation replace the TERM [N] with 12 and solve for the FUTURE
VALUE [FV].

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
PRESENT VALUE OF THE FULLY AMORTIZED NOTE IN
TABLE A PURCHASED WITH A 20% YIELD
12 .83 16450 531 11,500

The total pay-off on the fully amortized note after 12 months is $20,950. Do
the calculation. The $11,500 shown in the [FV] register is the amount owed
to the Partial Purchase. With this information we can now calculate the final
YIELD for this Partial Purchase. Without clearing your calculator replace
PRESENT VALUE [PV] and solve for the
RATE/YIELD [i]

TOTAL
PRESENT
PRINCIPAL
RATE/YIELD VALUE FUTURE
TERM &
EXPRESSED THE VALUE
TERM IN PAYMENT INTEREST
AS AN LOAN FINAL
MONTHS MONTHLY TOTAL
ANNUAL OR AMOUNT VALUE
OR PAYMENT PRINCIPAL
MONTHLY OR OR
YEARS &
RATE AMOUNT PAYMENT
INTEREST
PAID
PAID
n i PV PMT FV
PRESENT VALUE OF THE FULLY AMORTIZED NOTE IN
TABLE A PURCHASED WITH A 20% YIELD
12 2.28 14300 531 11,500

80
You have just completed the Schedule B calculation resulting in a final
YIELD to the Partial Purchase investor of 2.28 x 12 = 27.3%. The early
pay-off produced a 37% increase in the investors’ return. The message, here,
for any investor in notes should be very clear . Seek out notes having the
potential for an early pay-off. Or, where possible, attempt to encourage an
early pay by the borrower.

It's time to get serious if you intend to invest in notes. From the previous
Field Exercise take a closer look at notes offered for your consideration Try
to identify those having the potential for early pay-off. Go back to your
sources for more offerings and begin, now, to develop even more sources for
discounted mortgagees.

Now that you know how the professionals buy a note let's look at how they
make a note. You know from your experience that when making a loan there
are costs attached to acceptance of your application. In addition to the
various administrative fees such as escrow, document preparation, recording,
notary etc. you are required to pay a loan fee, or points. Each point, or
fraction thereof, represents 1% of the loan amount and is either paid in
advance of funding, or added to the loan amount. The loan fee is added to
enhance the YIELD to the investor. Consider a note in the amount of
$10,000 @ 12% fully amortized for 3 years, and the loan fee is 5 points =
$500.

The table below tabulates the YIELD enhancement depending on whether

the fee is paid in advance, or added to the loan amount. If the fee is paid in
advance the loan proceeds are reduced by the amount of the fee, but the
payment and pay-off is calculated on the full amount. If the fee is added to
the loan it becomes part of the beginning balance and amortized for the
period of the loan. The TERM [N] and RATE/YIELD [I] are annualized.

PRESENT
LOAN
RATE/YIELD VALUE FUTURE
FACE TERM
EXPRESSED THE VALUE
VALUE, OF TERM IN PAYMENT
AS AN LOAN FINAL
THE NOTE - MONTHS MONTHLY
ANNUAL OR AMOUNT VALUE
THE OR PAYMENT
MONTHLY OR OR
BEGINNING YEARS
RATE AMOUNT PAYMENT
BALANCE
PAID
n i PV PMT FV

81
 LOAN FEE PAID IN ADVANCE - BORROWER RECEIVES
THE FACE VALUE OF THE NOTE LESS THE FEE
10000 36 15.6 9500 333 0
LOAN FEE ADDED TO THE LOAN AMOUNT - REMEMBER
THE PAYMENT IS COMPUTED ON THE FACE VALUE OF
THE NOTE
10500 36 15.4 10000 349 0
It is important to acknowledge that when a purchase money note is sold by
the original holder, or beneficiary, it represents lost equity that is secured
by the mortgage. The following tables serve to demonstrate the importance
of mortgage enhancement. It matters little which side you are on. Mortgage
enhancement is the process of increasing the YIELD and minimizing the
discount, thereby offering a more profitable solution no matter where your
position is in the property, or the note transaction. Mortgage enhancement
skills is a indispensable tool in the real estate investment industry. You
ability to manage this tool will greatly improve your chances for success.

Consider the rather common owner financed transaction in which the owner
accepts a $10,000 payment on a $100,000 property and accepts the buyer's
note for the remaining balance of $90,000 @ 10% interest only for 5 years.
The note is soon after sold for a 30% YIELD.

PRESENT
RATE/YIELD VALUE FUTURE
TERM
EXPRESSED THE VALUE
TERM IN PAYMENT
PURCHASE AS AN LOAN FINAL
MONTHS MONTHLY
PRICE ANNUAL OR AMOUNT VALUE
OR PAYMENT
MONTHLY OR OR
YEARS
RATE AMOUNT PAYMENT
PAID
n i PV PMT FV
100000 5 10.00 90000 750 90000
SOLD FOR A 30% YIELD
100000 5 30 43650 750 90000

82
Let's try to build some mortgage enhancement for added equity and YIELD
preservation the event this note is sold. Let's add 10 points, $9,000 in loan
fee, to the note payable on maturity. All other terms remain the same.

PRESENT
RATE/YIELD VALUE FUTURE
TERM
EXPRESSED THE VALUE
TERM IN PAYMENT
PURCHASE AS AN LOAN FINAL
MONTHS MONTHLY
PRICE ANNUAL OR AMOUNT VALUE
OR PAYMENT
MONTHLY OR OR
YEARS
RATE AMOUNT PAYMENT
PAID
n i PV PMT FV
100000 5 12.75 90000 750 99000
SOLD FOR A 30% YIELD
100000 5 2.5 45700 750 99000

Some help, but not much even after increasing the principal balance 10% at
the back end of the loan. This is a good time to return to our definition of
YIELD. Do you remember what it is?

The value of a mortgage is not determined by the amount of money

received during the holding period. Nor, is it particularly determined by
the loan amount, interest rate or the term of the loan. As you will find
out very soon the value is determined entirely by the cost of the income
stream, and the value measurement is referred to as the yield.

YIELD is the numerical measurement of the speed

at which the principal and interest is returned to the investor.

Let' speed things up and see what happens to our Yield.

PRESENT
RATE/YIELD VALUE FUTURE
TERM
EXPRESSED THE VALUE
TERM IN PAYMENT
PURCHASE AS AN LOAN FINAL
MONTHS MONTHLY
PRICE ANNUAL OR AMOUNT VALUE
OR PAYMENT
MONTHLY OR OR
YEARS
RATE AMOUNT PAYMENT
PAID

83
 n i PV PMT FV
100000 3 13.3 90000 1000 90000
SOLD FOR A 30% YIELD
100000 3 30 60500 1000 90000
100000 2 30 67600 1000 90000
100000 1 30 77200 1000 90000

All we have done is increase the PAYMENT and decrease the TERM
which serves to rapidly accelerate the speed at which the principal and
interest is delivered to the investor. The PRESENT VALUE of the income
stream at a 30% YIELD is increased from $43,650 to as much as $77,200, or
77%. If you need to sell this loan you have set up the potential for a high
YIELD low discount note.

You are probably wondering if this loan can realistically be written for term
as short as one year. This depends entirely on the motivation and financial
strength of the Buyer. The basic rule: The weaker the Buyer, the shorter
the term. This is an aggressive loan, therefore you cannot be fearful, and you
must be prepared for the possibility for default.

If you cannot negotiate a shorter term, work on the payment. Institutional

investors have long known that borrowers are much more sensitive to the
TERM if they can afford, or budget the PAYMENT. The lesson here is
when accepting, or making, a loan, always think enhancement.

This guide contains more than 80 "no down" and "low down" institutional
and private financing techniques for the purchase and sale of real property.
Each of these techniques requires the creation of a mortgage. If you are
going to work in this aggressive environment it is important that you learn
how to construct marketable paper. Whether you are taking or making the
note, always assume the mortgage will be sold. This will result in a much
higher YIELD for you as the note holder, and if you can add value as the
maker you may be providing the needed profit incentive for the property
owner to accept an offer using a note. Review these techniques. Practice
using the techniques you feel comfortable with by building a mortgage into
the purchase strategy. If possible, use properties that you can find in your
local market.

84
Due diligence requirements vary by state. Even though a note is personal
property treat it as though you are purchasing real property, and observe the
following rules:

• Use an escrow company experienced in the sale and assignment

procedures for a note.
• Identify an attorney skilled in foreclosure procedures. Do not wait
until you need one. And, do not attempt to undertake foreclosure
proceedings on your on. This action is very tricky in most states,
tends to favor the property owner and can result in long delays.
• Obtain a copy of the recorded mortgage documents.
• Many states provide the borrower with the right of redemption in the
event of default. Be sure you understand the law.
• Obtain a current income & expense statement if the loan is secured by
income property. Be absolutely certain the net operating income
(NOI) will support all loans on the property. If you do not understand
how to read it find someone who does, or go to the Real Estate
Investment Forum @ www.highnoi.com.
• Never purchase without interviewing the borrower.
• Obtain a copy of the borrower's credit report. If possible, get a current
copy. This requires the borrower's authorization. Tip: If the seller of
the note obtained the original report the borrower's authorization may
still be current
• Ask for an audited payment record.
• If an audited payment record is not available ask for a copy of the
Seller's tax record for the previous year, and obtain an estoppel letter
from the borrower.
• Get an appraisal for the fair market value of the property. This can be
obtained from any source you believe to be reliable.

Locate an escrow company. Discuss your plans with an escrow agent and
obtain a check list of the items needed by escrow to effect proper assignment
of the note in your state. The escrow company should also be able to
provide you with a copy of the standard form mortgage and assignment
documents for your file.

Hypothecation is the process of offering something as security without

losing possession, or surrendering title. A mortgage, or trust deed, is the best
example of hypothecation. The property is offered, or pledged, as the

85
security for the loan, however the owner can continue to use the property
and remains in title.

The income stream from a mortgage may be pledged, or hypothecated, for

the purpose of securing a loan. The mortgage, or trust deed, is the security,
however the borrower continues too receive the income stream from the note
and enjoy all the benefits of ownership.

As we know the loan value of any property, personal or real, is based on the
strength of security the pledge offers. The better the security, the higher the
loan value (LTV) is likely to be. Many banks accept properly secured notes
as the pledge of security. The value established for the security is based on
the safe YIELD expectation of the institution which is often much less than
the private investor.

PRESENT
RATE/YIELD VALUE FUTURE
TERM
EXPRESSED AS THE LOAN PAYMENT VALUE
TERM IN
AN ANNUAL AMOUNT MONTHLY FINAL
MONTHS
OR MONTHLY OR PAYMENT VALUE OR
OR YEARS
RATE AMOUNT PAYMENT
PAID
n i PV PMT FV
5 10 25000 531
VALUE TO A PRIVATE INVESTOR WITH A 25%
YIELD
5 25 18100 531
VALUE TO A INSTITUTIONAL INVESTOR WITH A 13
% YIELD
5 13 23345 531

Institutional lenders loan on notes using much the same underwriting

procedure as for real property. The loan-to-value (LTV) generally will not
exceed 80%, and these notes usually must be fully amortized. Based on the
indicated value of $23,300 and LTV of 80%, a lender could approve up to
$18,650. Most lenders, however, will not lend more than the purchase price.
Given these loan terms the investor could conceivably borrow back the

86
amount paid at an institutional rate considerably less than the 25% YIELD,
keep the spread and reinvest the loan proceeds.

You will find many ideas for structuring a syndicated note purchase under
Purchase & Sale Strategies. Keep in mind that you can buy and sell notes
the same way you can buy and sell real property.

• The Real Estate Agent Begin to build you agent network. Real
estate agents continue to be the most intimate business connection
within the real estate community. Try to identify the most active and
creative agents and develop a personal relationship.
• The Real Estate Office The best way to meet agents quickly and
efficiently is during the office meeting. The meetings are usually
conducted each weekly. Office managers are always seeking a topic
of interest to be presented as a special feature of the meeting itinerary.
Contact the office manager with a presentation proposal which
includes a brief commentary on discounted note construction and that
features the service you can offer towards meeting the agent's needs
for private financing solutions.
• The Real Estate Board Most local publish a local newsletter for
their members. These publications generally accept ads for industry
related products and services. Many Boards also schedule meeting
rooms at the Board office for the presentation of promotional services.
If your state has a continuing education requirement consider
preparing a short course that offers credit. Offer the course at little, or
no cost. This may be an excellent opportunity to present your services
in the presence of a large audience.
• Advertising Since you have already replied to at least one
newspaper ad you are familiar with the procedure and relative
effectiveness. Experiment with different ads until you are receiving
the kind of call you want. Try road side signs and specialty
publications. And, if you live in, or near, an adult community promote
your business by mail or in the association magazine. Many of the
residents are holding notes as income producing assets.
• Mail List Develop an on-going marketing program that includes
routine mail. This is the most efficient means of connecting with your
market. Locate a title or escrow company that offers promotional
services for the real estate industry. Often these companies have
developed extraordinary printing and mailing services for their clients
at below market pricing. Construct a marketing piece in the form of a

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 post card and budget at least four mailings a year. Your mail list
should include agents, real estate companies, and centers of influence
such as attorneys, accounts and financial advisors.
• The Local Investment Club If you have a local real estate
investment club attend the meetings. Some of your most profitable
notes will be purchased through club members.

These purchase and sale strategies will add extraordinary fire power to your
business arsenal. Review these techniques routinely so that you are
comfortable with each, and to stimulate recall.

Your outside risk when buying discounted mortgages is that the borrower
won't make the payments and you may have to foreclose to protect your
investment. Risk management is preparation for the expected. Just like the
trapeze artists at the circus, put the safety net under your act for the
expected fall. Circus performers know they will fall, but live to fly another
day. So, this very important advise is given again.

Identify an attorney skilled in foreclosure procedures. Do not wait until

you need one. And, do not attempt to undertake foreclosure proceedings
on your on. This action is very tricky in most states, tends to favor the
property owner and can result in long delays.

However, be thoroughly familiar with the process, and be willing to start

proceedings at a defined point in time. In some states the foreclosure
process can take years. Do not risk a loss because you were not ready for the
expected. Be prepared, it's so simple.

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Glossary of Terms

ADJUSTABLE RATE MORTGAGE

A mortgage that has a rate change frequency determined by the prime
rate, treasury rate, or other money exchange rate during different term
intervals of the loan.
APPRAISAL
A report compiled by a certified appraiser that includes the probably
market value of your home, including similar sales of properties within
your community during the last 6-12 months.
ASSET SEARCH
A search requested by a lender through an investigative agency to
uncover any hidden assets of the borrower not previously revealed.
ASSUMPTION
A transaction involving a buyer and seller (borrower), whereby the buyer
purchases the property and assumes the payments of the borrower.
AUTOMATIC STAY
A legal term that prohibits any creditor from pursuing further debt
collection from the party in bankruptcy until further notice.
BANKRUPTCY
Insolvency. A proceeding in federal bankruptcy court allowing the
borrower to eliminate some or all of his/her debts in accordance with the
bankruptcy laws. In most cases, the debtor’s liabilities exceed his/her
assets.
BANKRUPTCY COURT
A court of law that hears consumer and corporate pleadings involving
cases where the borrowers are seeking relief and a “fresh start” from
excessive debts.
CAPITALIZE
To incorporate the existing delinquent payments, taxes, insurance costs,
etc. from the existing mortgage loan into a new loan with lower payments.
CHAPTER 7 BANKRUPTCY
A court petition that involves the total liquidation of the borrower’s
unsecured debts.
CHAPTER 11 BANKRUPTCY
Payment Plan – A court petition that allows the borrower to reorganize his
debts and pay his creditors a stipulated amount so that the business can
continue.

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CHAPTER 13 BANKRUPTCY
Payment Plan – A court petition that allows the borrower to enter into a
payment plan with the court, usually 3 to 5 years on the arrears of the
loan(s) as well as continue with all future payments due the lender.
CREDITOR
Any individual, partnership or corporation that has advanced money to a
borrower in return for payments over a certain period of time.
DEBTOR-IN-POSSESSION
Pertains to a Chapter 11 Bankruptcy filing where the borrower makes
direct payments to the creditors instead of a court appointed trustee.
DEED IN LIEU
A voluntary conveyance of the homeowner’s property over to the lender
to satisfy the delinquent debt and avoid foreclosure.
DEFICIENCY JUDGMENT
A legal means whereby a creditor pursues money damages through the
courts from a borrower who lost his or her property through a foreclosure
and did not satisfy the full obligation of the loan.
DEPRECIATION
A federal tax deduction taken by a consumer in conjunction with the life
span of a house, automobile, or business equipment.
DISCHARGED
An order entered by the Bankruptcy Court discharging an individual
debtor from claims and liabilities of creditors.
DISMISSED
A borrower’s bankruptcy petition is dismissed when the court declares it
null and void.
FHA MORTGAGE
A mortgage granted to a borrower that is insured through the Federal
Housing Administration.
FAIR MARKET VALUE
The value of a property as determined by a certified appraiser utilizing
comparable sales of similar properties within the last 6 months.
FIXED RATE MORTGAGE>
A mortgage document that states the rate will stay the same over the life
of the loan.

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FEDERAL FUNDS RATE
The interest rate charged to borrowing banks by the Federal Reserve
System.
FORBEARANCE AGREEMENT
An agreement between the borrower and the lender whereby the latter
party agrees to reduce or postpone payments in a hardship case.
FORECLOSURE
The legal right a mortgage lender or other third party lien-holder uses to
gain ownership of a property when the borrower defaults on their
payments.
JUDGMENT
A court approved order allowing a creditor to record a money claim
against the debtor’s property.
JUDGMENT HOLDER
With respect to a judgment, the part to whom money is owed to.
JUNIOR LIEN-HOLDER
A lien-holder who holds a mortgage recorded with the county clerk’s
office subsequent to the first mortgage.
LIEN-HOLDER
A creditor or other third party who holds a mortgage or judgment against
a borrower.
LIQUIDATE
The process by which an asset (car, home, boat, etc.) can be sold and
converted to cash to pay off a debt.
MODIFICATION
A form of refinancing a delinquent mortgage by changing one or more
terms of the mortgage to help the borrower and avoid a foreclosure.
MAXED OUT
Running up one’s credit cards to the maximum limit causing an
insolvency leading to a potential bankruptcy.
MORTGAGOR
A borrower (debtor) who pledges his property as collateral in return for a
loan.
MORTGAGEE
The creditor who holds the mortgage on the borrower’s property as
security for a mortgage loan.

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PAYMENT PLAN
A written and signed agreement between the creditor and the borrower,
whereby the creditor allows the borrower to spread his delinquent
mortgage payments over a period of time, usually 6 months or more.
PRE-PETITION PAYMENT
In a bankruptcy proceeding, payments which were in default prior to the
bankruptcy filing date. These payments are distributed over a period of
time (i.e., 48 months) in installments to the creditors.
POST-PETITION PAYMENT
All future payments which will be due to creditors after the filing of the
bankruptcy petition.
PRIME RATE
The rate charged by creditors to its best borrowers as advertised in the
Wall Street Journal.
PROMISSORY NOTE
A legal document containing the specifics of the money obligation, such
as amount advanced, interest rate and term signed by the borrowers and
promising payment to the creditor.
PRO-SE
A borrower (debtor) who voluntarily files his/her own bankruptcy petition
with the court without the service of an attorney.
QUITCLAIM DEED
A transfer of title to a property by the seller without any obligation or
warranty.
REFINANCE
A new mortgage loan on the existing property. The creditor draws up new
loan documents, lowers the monthly payments at a reduced interest rate,
and records a new mortgage with the county clerk’s office.
REPOSSESSION, SAME AS FORECLOSURE
SHORTFALL
SHORT PAYOFF
A remaining balance due a creditor after a third party sale is sufficient
enough to pay off the entire debt obligation.
SHORT SALE
A sale of property that results in a short payoff that is accepted by the
creditor without further obligation by the borrower.

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SOLVENCY
Having the necessary income and assets to cover monthly expenses. The
opposite of being overextended on debt obligations.
TEASER RATE
A low, short term rate offered by a creditor on loans and credit cards.
After the expiration date, the cost rises to the agreed upon rate by creditor
and borrower.
TRUSTEE
A court appointed officer empowered to manage and distribute the assets,
if any, of a debtor in a bankruptcy proceeding.
UNSECURED DEBT
A money obligation that is not secured by any form of collateral l.
VA MORTGAGE
A mortgage that is insured by the Veteran’s Administration. Should the
property be foreclosed, the VA will pay off the lender.
WAGE GARNISHMENT
A court order authorizing the creditor to seize a portion of the borrower’s
monthly income through his/her employer.

References:

The National Urban Alliance

Foreclosure Assistance In Association With The Federal Department of

Housing & Urban Development (HUD)

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