The credit crunch and tough times in the mortgage market are creating new profit opportunities in a highly-specialized real estate investment niche: Buying seller "carryback" mortgage notes.
Carrybacks, also known as "seller takebacks," are essentially replacements for standard mortgage financing, and become popular whenever banks tighten down credit standards sharply.
For example, say you're selling a house that you own free and clear, or that has only a small amount of debt on it. Your buyers have downpayment money and solid incomes, but they can't quite qualify for a conventional loan.
What do you do? Instead of canceling the deal, you might "carry back" a first mortgage that you can then turn around and sell for cash to investors in the private note secondary marketplace. The mortgage documents and terms should be as close to standard as possible, and carry an interest rate that is affordable to your purchasers.
You can either hold onto that note as an investment for yourself, or offer it for sale to private investors, who will buy it at a discount below the full face amount.
Though there are dozens of private note brokers you can locate online, one popular site is NoteGiant.com, where hundreds of notes are posted for sale or auction bids.
John Collins, one of the owners of NoteGiant, says current market conditions are producing a bumper crop of private notes that can provide investors excellent returns -- provided they take sensible precautions. Many of NoteGiant's clients are small pension fund investors, Realtors, and even hedge funds.
In a discussion with RealtyTimes, Collins offered a few basic piece of advice:
Number one, if you are new to note buying, limit yourself to properties close to where you live or work. That way, you can check out the underlying real estate, and drive by to see what the collateral looks like.
Stick with first lien notes that have substantial equity cushions so you can't lose your shirt if you've got to pull the plug and go to foreclosure. Avoid second lien notes.
If you don't feel confident doing the necessary "due diligence" research to check out title, appraisal, credit scores and other note features, turn to pros who'll do it for you. NoteGiant staff can perform what they call "validation" underwriting for note investors for a $495 fee.
Finally, as you become more knowledgeable about note investing, consider moving up the risk-reward ladder to "nonperforming," delinquent mortgages. If you pick your deals well, even if you have to foreclose, the underlying property may be a good investment in its own right, with positive monthly rental cash flows.