Hypothecation: lender's security, compensating notes.(long) - Posted by Alex Gurevich, TX

Posted by John Behle on June 20, 1999 at 12:52:18:

If I am using the most preferable method and securing the “compensating note” by equity in another property, I will just create a trust deed and note. There is no tie or reference to the note I am buying. I could sell, trade or restructure the note I purchased the next day without affecting the compensating note.

The terms don’t have to mirror the “un-purchased” part of the note (tail) and in some cases definately shouldn’t. One example is if there were a 5 year balloon. If you were going to pass that balloon on to the note seller, your note should have some cushion. Your balloon might be 6-12 months later to give you time to collect or deal with any problems with the payment coming in to you.

The “loan” issue with partials is mostly with the contractual method that most of the industry uses. Some funding sources are so worried about the loan issue that they no longer do partials. If it is construed as a loan, then it can be dragged into a bankruptcy, considered usurious, or have tax consequences. There have even been a couple court precedents where the court has said a “contractual” partial is just a loan.

I doubt my method of doing partials would successfully be challenged that way, but it can’t hurt to be cautious and structure the note a little differently. As I mentioned, that may happen to build a cushion into the balloon, but it can also happen through spreading the loan over equities in a couple properties. It’s always nice to find the note seller’s needs and structure the note in a win/win way. You might start with discussion of a note that mirrors their own and then alter it as you find more about their needs. For example, with a balloon, they might not really want or need that. An increased payment in 5 years might suit them just fine or a series of “bubbles” instead of balloons.

Hypothecation: lender’s security, compensating notes.(long) - Posted by Alex Gurevich, TX

Posted by Alex Gurevich, TX on June 18, 1999 at 17:37:26:


Suppose I am buying a note and would like to borrow money for a purchase from a private lender, pledging a note as collateral. In case of a loan against the home I’d sign a deed of trust or a mortgage. In case of a loan against a note, what kind of security documents would I sign in favor of lender ? Do they need to be recorded? Do I phisically transfer a note to my lender ? Who holds what papers ?

I’m planning a conversation with a couple of hard money lenders I’ve been working with for a number of years. They’ve been financing homes for me. I would like to educate them on a subject of financing purchases of notes. I know their 1st concern would be how their interest is protected, which instruments, etc.

Could you please clarify what needs to happen for them to be secured properly. I’m sure their lawyers would have to OK that too.

Now what if we put another layer of complication on top of that. I was just offered a 120K note at 7.5% 30 yrs amort., 5 yrs balloon, 40%LTV. To yield even 17% it has be discounted to about 80K which did not excite seller too much.

The seller, however, was interested in discussing a sale of monthly payments, while he’d keep a balloon. John, you always said you didn’t like the contractual partials, but rather used a compensating note tecnique where you’d buy a full note but write a note “for the difference” to seller.

In this case does it mean, I’d buy the whole note for the cash price of just payments (whatever I can negotiate with seller) and also write a (compensating) straight note in favor of seller with no payments and balloon in 5 years to match the balloon on the original note ? Would the straight note I write to seller be secured by seller’s original note (assuming I could not provide other collateral) ?

And to further complicate things: If I were to borrow money from a private lender to pay cash for seller’s monthly payments, what security would I give to my lender, and would there be a conflict between my lender’s and seller’s security rights since I’d be using the same note to secure both ?

Last but not least. If there’s a default what are the rights of all parties in this transaction, including mine and what documents govern these rights ?

Well, you already know I’m really confused.
Thanks much for any clarifications.

Compensating note and partials - Posted by John Behle

Posted by John Behle on June 19, 1999 at 15:42:22:

Borrowing from an investor to do a partial is always tricky. It is one of the major reasons I like to give other collateral when I use the compensating note technique. The issues of early payoff, default, foreclosure, restruction, etc. are another reason for other collateral.

It can pay to JV with someone who has collateral (Collateral Rental) rather than get into the contractual intricacies involved in using the note as collateral for the seller and investor. You can do it, but one of the basic premises I operate from is that “a confused minde always says no”. I avoid complicated technical solutions when a simple one might do.

My approach would be to look for some other collateral, but I would do the contractual method if that was all that was available - then continue the search for some other collateral.

REPLY- Re: Hypothecation: lender’s security, compensating notes.(long) - Posted by Michael Morrongiello American Note

Posted by Michael Morrongiello American Note on June 18, 1999 at 18:13:12:

What is typically used in Pledging a note instrument (Asset) to obtain a loan is a “collateral Assignment” of the deed of trust / mortgage in favor of the lender along with an endorsement of the note instrument in favor of the lender. The collateral assignment can also contain the repayment terms that lender wants on the loan they are making you or they may also require you to execute a seperate prommissory note outlining those repayment terms.

In this way the lender now holds the note that was pleged and has also has the deed of trust which secures that note assigned to for Collateral Purposes Only.

With regards to your other question regarding buying just a PARTIAL interest in the note. There are many methods to do this. You can use a contractural agreement, you can also use the note you are buying as collateral, Your can give a note & lien back to the seller on another piece of collateral you owned, etc.
The space to respond to this question is limited here in this forum. Why not ask it as another posting and one can then respond to just that issue.

For more info on notes see our banner ad above or call American Note @ 800-659-2274

Michael Morrongiello
Operations Manager

Re: Compensating note and partials - Posted by Bud Branstetter

Posted by Bud Branstetter on June 19, 1999 at 21:12:16:

With your compensating note do you generally secure it as a deed of trust directly against real property or against another note and deed of trust? I had learned from Wes Curran that you do not want to make the terms the same or the IRS might interpret it as a sale.

Re: REPLY- Re: Hypothecation: lender’s security, compensating notes.(long) - Posted by Alex Gurevich, TX

Posted by Alex Gurevich, TX on June 22, 1999 at 10:31:31:

>>In this way the lender now holds the note that was pleged and has also has the deed of trust which
>secures that note assigned to for Collateral Purposes Only.


I am still confused. Are you referring here to the original deed of trust securing the original note being purchased by me. Or you say besides the collateral assignment agreement, also another deed of trust is signed by me and recorded to secure a loan to borrow funds for a note purchase.

I also assume once the lender’s loan is paid off the note I purchased will be endorsed back to me, correct ?

I guess I am still trying to understand how lender’s security is perfected at the courthouse.