Discount Substitution technique - Posted by John Behle
Posted by John Behle on November 07, 1998 at 10:27:40:
I arrange to purchase the property with a short term contingency clause in the offer. If the note seller were totally inflexible as to a discount or substitution of collateral, I could back out of the offer or re-negotiate.
Realities are that most note holders don’t want to take a substantial discount. That is why the substitution of collateral approach is always such a good backup. If they don’t want a discount, then the substitution of an existing note is a good possibility. As the article mentions, there needs to be plenty of enticement, like a trail of ten dollar bills to the Title Company.
So, let’s say Sam is the seller of the property and Nancy is the note holder (on the private loan “seller financing” on Sam’s property).
I approach Nancy for a discount and she either will not discount or is un-reasonable. That is the most likely scenario. Nancy probably provided seller financing and took a note specifically because she did not want cash or to discount the price of the property for a cash sale. She may view the 8% rate on her note as a good rate of return.
No problem. George is out there with a similar note for sale at a discount. I arrange to buy his note and use it as collateral for Nancy. She releases the property as collateral and secures this note purchased from George as collateral (Substitution of Collateral).
Why? Like I said, there needs to be motivation for Nancy. Maybe a higher rate, better collateral, nicer property, better terms, some cash, etc.
This type of transaction can work if you just have an option or right to buy George’s note, but it sure works better and easier (and is easier to explain) if you already own the note. This is one of the main reasons why I buy, finance and hold paper. “Flipping” notes is killing the “Golden Goose”.