CONTENTS
 

INTRODUCTION............................................................ ...................................I

NO OTHER BOOK CONTAINS THIS INFORMATION.........................II

BETTER GET OUR HEADS OUT OF THE SAND, AND FAST!........III

WHY 97% OF US WIND UP BROKE AT RETIREMENT AGE..........IV

THE JAWS OF INFLATION AND RIPOFF...........................................V

HOW INFLATION WILL CONTINUE STEALING YOUR WEALTH
- OR - "THERE IS NO GOLD IN FORT KNOXX" (part 2)

LEARNING THE MIDAS TOUCH............................................................VI

THE PERFECT CRIME COMMITTED AGAINST US ALL.................IX

AVOID FRAUD, SCAMS, AND RIPOFFS.............................................X

MANY RETIRE RICHER, RETIRE SOONER, OR BOTH!....................XIII

PROVEN KNOWLEDGE IS YOUR STRONGEST DEFENSE...............XIV

THE 37 POINT SAFE TRUST DEED INVESTING CHECKLIST.....XIV

MINI CHECKLIST............................................................... .....................XV

IN CONCLUSION.............................................................. .....................XVIII

BIOGRAPHY..........Page1

EARN FIVE TIMES MORE RETIREMENT INCOME..........Page 3

THERE IS NO GOLD IN FORT KNOXX..........Page 5

TRUST DEED INVESTMENTS..........Page 7

TOOLS OF THE TRADE..........Page 14

WORRY..........Page16

TRUST DEEDS..........Page19

LOAN TO VALUE RATIO (LTV)..........Page 21

ESTABLISHING VALUE..........Page 23

THE 50-60 RULE..........Page 27

TITLE INSURANCE..........Page 30 .

CLTA vs ALTA TITLE COVERAGE..........Page 33

FIRE INSURANCE..........Page 36

LATE FEES..........Page 38

ACCELERATION..........Page 39

LOAN POINTS AND YIELDS..........Page 40

INCREASING YIELD..........Page 45

WHAT THE HECK IS SUBORDINATION?...........Page 51

"WELCOME TO MONEY MATTERS"..........Page 61

FORECLOSURE & BANKRUPTCY..........Page 72 .

STOCKS -vs- TRUST DEEDS..........Page 75

WHAT THE HECK IS "HARD MONEY"?...........Page 81

STORIES..........Page 82

37 TIPS TO SAFER TRUST DEED INVESTING..........Page 93

MINI CHECKLIST ..........Page 103

DEVELOPING A CLIENT BASE OF YOUR OWN..........Page 106

PRIVATE INVESTOR'S COMMENTS..........Page 109

Appendix A: GLOSSARY..........Page 114

Appendix B: PROTOCOL III..........Page 145
 
 
 

BIOGRAPHY

The youngest of four boys, Brad learned early what it was that he needed or wanted. He wanted off the bottom of the totem pole!

Brad lives in the gold country area of Northern California with Boots, his wife and business partner. Their home rests in a lazy valley where neighbors are not seen nor heard and where they operate a successful investment brokerage from a small computerized home office.

But Brad's dreams weren't realized overnight.

Born on November 14th, 1950 in Tacoma Park, Maryland. By the time Brad was 20, in 1970, he had his real estate license and was already working on his education in the high volume area of Concord, California.

"I got my education in this business in a very busy market" he remembers. "At the age of 22, I became for awhile Contra Costa County's youngest broker." Later he had his own Real Estate company in Benicia, California. Once I had 8 listings on the same street and I got tired of seeing my own signs!"

He soon began buying and selling property on his own, reading all of the "no money down" and other creative helpful real estate investment books he could get his hands on. Starting with nothing, starting from scratch with only ambition and high hopes.

"I had no money" he admits. "Every opportunity I had I developed myself. I bought twenty-two houses once, starting when I was twenty-four years old, with an average purchase price of around $60,000.00, and I did it with no money! That's where I gained some more of the basics of what would become some very valuable knowledge in the notes and deeds of trust investment field! This experience also provided much information about what deals investors should avoid."

"In three years I sold and refinanced every single house and every lender got every penny he had coming to him", says Brad. "It was definitely a hardship and I thought I had bitten off more than I could chew, but I swallowed the responsibility and Boots helped me every minute. I still sometimes wonder how we did it!" It took me so long to pay everyone off that the homes had appreciated enough thru inflation that suddenly for the first time in my life I had something to worry about! I remember thinking I don't have the energy to go thru that again so I'd better not lose it! I began collecting some of the very first trust deed Do's and Don'ts almost 20 years ago I guess."

He had without realizing it established himself with a few knowledgeable private lenders by accident or necessity and the next time he or a client saw a house that was a good deal and needed a little capital, a small loan secured by a deed of trust, he contacted those private lenders.

"I took the profit from the homes I'd sold and headed for the foothills to live happily ever after and strum my guitar.

Business followed Brad and he soon found himself busier than ever. "I moved away to semi retire, but something else happened. Through referral from other lenders I began getting more and more lenders asking me to invest their funds."
Today his company works with more than 115 private lenders regularly from a list that includes more than nine hundred, some of which are very famous people! He specializes in private construction financing exclusively now and will share that method of earning even higher returns safely in his next book.

Calling his own shots has allowed Brad to realize his musical dreams as well.

An accomplished musician, Brad has built a state-of-the-art recording studio in his home where, with Boots and a third member, he produces the sounds of his band, Motherlode, as well as business related audio and video sound tracks. "It has always been my dream to move to the foothills and play my guitar. "To have the freedom to be creative in whatever way I want" is how I expressed my goal at age 18. The information in this book has enabled me to achieve that. My real life has actually exceeded my dreams or goals."
 
 
 

EARN FIVE TIMES MORE RETIREMENT INCOME

If a tailor asked ten people to describe their favorite suit he'd get ten different responses. So, too, are the tastes of private investors varied. There isn't one single type of investment that's suitable for all. In this chapter you'll be the customer and as a tailor we'll design the investment that best fits you.

First of all let's determine what size trust deeds you should be looking for. I strongly recommend people take whatever the total trust deed investment portion of their nest egg is and divide by at least 5 or 10. Should you have, theoretically, $200,000.00 of your portfolio to allocate to trust deed investments, you should be in the market for trust deed investments somewhere in the neighborhood of $20,000.00 to $40,000.00 or less. I'm sure you are aware of the old saying, "Never put all your eggs in one basket". You will be receiving regular monthly payments of interest on each of your notes and you'll want to keep that income coming from several different places just in case one, or more, of them isn't as punctual as you might like them to be. If one of your borrowers makes his payments late or even defaults, at least that one will represent only a fraction of your monthly trust deed portfolio income. Chances are not all of your borrowers will be late at any one time.

Today, many brokers in and out of California won't broker loans with loan amounts of less than $30,000.00 for several governmental reasons. Occasionally we will do a $20,000.00 loan but only if it meets State and Federal lending laws and if the collateral is so attractive that we can't think of a reason not to. Our average loan remains at about $75,000.00 to $85,000.00 and currently we broker a lot of loans for the construction of single family dwellings (which is another book altogether).

Many ask "What if all you have is $10,000.00 to invest?". Well, it's true you have to start somewhere. Don't despair, there is a place for you in the trust deed investing business. There will be many factors to consider and they will be covered throughout this book.

You can reach retirement sooner earning high yields from trust deeds. Even the beginner just starting to build a retirement income for the future can put small, tax deductible amounts of money away monthly into a pension plan acceptable to the IRS and then begin lending small amounts of money in trust deeds, if he can find a recognized trustee to handle and service the retirement plan for him. I've set up a retirement plan account where I can do my own thing in trust deed investing with a money market checkbook monitored by a recognized trustee and my annual contributions are deductible and the interest is not taxable until I begin drawing it out to spend at retirement.

A one time $20,000.00 deposited in a bank at 7% simple interest compounded annually for 20 years will grow to over $77,000.00 and at 7% provide $5,400.00 per year, or $451.00 per month for life without touching the principal. The same $20,000.00 invested in trust deeds at 15% simple interest compounded annually for the same 20 year period will grow to more than $327,000.00 and generate, without touching the principal, more than $49,000.00 per year, or more than $4000.00, per month, and that's over 9 (nine) times more retirement income!
 

THERE IS NO GOLD IN FORT KNOXX

Read the fine print on the dollars in your wallet. Those dollars no longer read anything about being "redeemable in silver". You and I can't ride the bus to the mint and trade our dollars in for real silver anymore, they are only redeemable in "lawful money" or Federal Reserve dollars. Can't you just hear Andy Rooney of "60 Minutes...." "And what is lawful money anyway? Has anyone ever seen a lawful dollar or filled a tooth with lawful money?"

What does that mean? Are the words "lawful money" referring to those new fake pennies or maybe those sandwiched copper quarters which suddenly make me wonder if someday all money will be plastic? Or are we already at this point? Especially if you consider all the plastic money in your wallet or purse in the form of Visa or Mastercard.

If my money can't be backed by gold or silver, then maybe having it backed by a house isn't such a bad idea after all. It is my firm belief that the single family home is the very building block of our civilization and people will always need a roof over their head, a place to live regardless of economic, political or social climates.

One of our tips is never lend money to a corporation alone unless the corporation owners are also willing to sign on the note and trust deed as individuals as well. If corporations really are formed to shield the incorporated from liability or limit the liability for the corporation's members, then that makes me wonder if and how far FDIC would be willing to extend their liability past the assets of FDIC. (which has been described as less than one cent on each dollar insured).

The solutions I've read on the FDIC and FSLIC's problems have ranged widely from merging FSLIC and FDIC clear through to abolishing them. This sounds like they are not getting to the real problem.

From the newsletter, "Bottom Line:" vol 11, # 24, Dec 1990.
WHAT'S GOING ON? The Federal Deposit Insurance Corporation (FDIC), the agency that insures bank deposits, has just 60 cents in its reserve fund for every $100.00 of insured deposits, a ridiculously low figure - less than half of the $1.25 government recommendation. The failure of just one major bank could drain what's left of the rapidly declining reserve fund.

If you have money in a bank that fails, it's now possible that you may never see it again. (This 60 cents for every $100.00 is less than one cent on the dollar.)
 
 
 

ROLL THAT IRA INTO HIGHER YIELDING
TRUST DEED INVESTMENTS

"Why would people want to invest in trust deeds?"

First: All trust deed investors investing for their retirement agree that if their retirement plan dollars are stuck in a low yielding mutual fund, a bad stock that might be going down in value, or a savings account which is paying 2-3-4% when a trust deed can earn 10%, the trust deed can offer that investor as much as 5 times more retirement income. Secondly: All trust deed investors still planning for their future retirement (IRA, KEOGH, 401K, etc.) know that through the effects of annually compounding that 10% interest, safer trust deed investments can earn a retirement planner five times more retirement nest egg, or even slice years off the time necessary to reach ones current goal or target date for retirement.
 

"Show me the math. . ."

John puts $1,000 in his IRA at 2.5% compounded annually. At the end of 20 years that $1,000 becomes $1,638.61 and would pay apx $41.00 per year retirement income 2.5%. (using any calculator multiply 1.025 times $1,000 and punch the equals button 20 times to compound annually for 20 years. 1.025 represents "1", your initial $1,000 plus ".025", your 2.5% yield)

Fred on the other hand puts his $1,000 in one year safer trust deed investments paying 10% for the very same 20 years which would become $6,727.50 and would at 10% then pay $672.75 per year income for the same $1,000 invested. (using any calculator multiply 1.1 times $1,000 and punch the equals button 20 times to compound annually for 20 years. 1.1 represents "1" your initial $1,000 plus ".1", your 10% annual yield).
 
 
 
 

OVERVIEW

It doesn't take a rocket science to understand that people everywhere coast to coast need to live in houses. All houses in existence today had to have been financed (or are currently still being financed) by someone (or some entity like a bank or a savings and loan) because most people can't afford to pay cash up front on the barrel head for something as expensive as a home. For many years the document used to secure most house financing was something called a mortgage. A mortgage is nothing more than a great big IOU. Mortgages still exist in many states but over the years the document called the trust deed developed and is now more and more widely accepted in many states because of the more simple steps it requires (as compared to a mortgage) to foreclose if someone stops paying on their IOU mortgage. Although mortgages are still in use in some states today they have become less popular than trust deeds in that a mortgage holder/investor/lender will have to face something equivalent to a law suite in order to foreclose on a mortgage as mortgages don't contain a power of sale clause. Trust Deeds accomplish the same end as legal instrument used to secure debt against real estate but by a trust deed's unique ability to assign certain rights or powers on the lenders behalf to a neutral 3rd party trustee (normally your title company) the need for an attorney and any lengthy legal battle or process necessary in order to foreclose has been streamlined or eliminated. A trust deed in simple terms sets out that if after a loan against real property has been funded the borrower does not pay his payments on time as agreed, the lender won't need an act of god, a judge and jury and an attorney. The trustee (your title company) exercising your rights under the power of sale clause contained in all trust deeds allows you to offer the property for sale at a foreclosure sale in 90 days (plus apx. 20 days of publication from when payments stopped) instead of being tied up for years in court, at which time either someone shows up at that above described sale to cash you out or the property is automatically sold and title passes to the investor/lender. If one can learn, and remember to follow, a few simple rules (similar to the rules that we all must follow in order to stay alive on the highways each day) even if one trust deed does then go awry you'll find that for example in simple terms foreclosing on a $100K house and receiving full title to the house under the terms of your $50K first trust deed may not be the end of the world. Today about half of all debt secured against all real estate in these United States is through the use of a this trust deed document. Some of our 100 private investors think that trust deeds are easier to understand than for example learning to invest in the stock market. After all if trust deeds secured by houses are good enough for banks and savings and loans to invest in . . . they should be good enough for you and I, right?
 

"What if I only have $10K and not $50 to invest?"

Many of our 100 investors started out asking this very question and the answer is simple. If 5 people have the same problem wishing to fund a $50K loan but only have $10K each, no problem as we have developed a safe way to put those people together. At 20% ownership each in the $50K trust deed the problem is solved. This is called a fractionalization. Each fractionalized partner also receives a power of attorney which enables them individually to file a foreclosure if a partner is for example out of the country or unable to be reached on safari.
 

"How long will trust deeds continue to be a secure investment?"

In my opinion safer trust deed investments well secured by single family houses will continue to hold their value so long as people need to live in houses.
 

"How does a "safer trust deed" differ from any other trust deed?"

In the example above of the $100K house that had to take back when the borrower didn't make his payments as agreed on a $50K first, we had a "safer trust deed investment" because we made sure that we had $2 of the borrowers equity dollars as collateral for every $1 invested. Hence two to one collateral (also expressed as 50% loan to value ratio). Now you should already understand why one of safer trust deed investors 37 tips state simply . . . always require 2 to 1 collateral for each of your loan dollars on houses. There are a few more parts to that rule, such as if the home is to be owner occupied we will allow up to a 60% loan to value ratio but for example if the loan was on vacant land, you better keep the ratio to 3 or 4 of their equity dollars for each of yours (25 to 33% Loan to value ratio).
 

"Why would I need a broker if I learn all 37 safer trust deed investing tips myself?"
In California there are usury laws which regulate how much interest you can charge a borrower. In California, real estate brokers are exempt from that law, so I can actually charge a borrower a fee for my services and still net you a higher interest rate than you could legally charge yourself. What's more, because I charge the borrowers for the loan there is no need to charge investors anything for our service. I can't speak for you but I would never attempt to remove my own appendix especially if the hospital said there would be no charge for the service! Would you?
 

"Sounds too good to be true what is the down side?"

Every silver lining has it's cloud. No investment is without risk. However, I have been licensed for nearly 26 years now and I have not seen any investor of mine lose his investment on any of the approximately 1000 loans that I have brokered. Remember what I said earlier; After all, if loans on houses are good enough for banks and savings and loans to invest in nationally they should be good enough for you and I, right?

Safer trust deed investors know that borrowers sometimes don't pay as agreed. Although over the big picture this poses no serious threat, it can affect your income if you are trying to rely on the trust deed payments for you monthly income. Safer trust deed investors know all the rules though like the one on diversification. Don't put more that 10% of your entire trust deed portfolio into any one trust deed and if a delay arises on a note the other 90% of your income stream is uninterrupted. Don't fund a loan against a piece of real estate for an amount that exceeds what you would be willing to buy the property for today with cash for. Yes, I would be willing to pay $50K for a home that is really worth $100K because this does happen on occasion if a borrower doesn't pay and you are forced to foreclose to protect your investment.
 

"Why do you know so much about it?"

I started in the real estate business when I was 20 and sold real estate in the bay area. A month didn't go by that some deal would pop up that required the seller to carry a note when that seller needed cash. My broker had a few investors that would buy those notes. Later I began to buy real estate in the bay area and after I had accumulated 22 rentals I had a few of those private investors calling me now to buy or fund that excess needed now and then. I decided to sell those 22 alligator rental houses and when the smoke cleared there I was with now a hand full of notes myself. The next phase of my unplanned real estate career found me in the foothills (Grass Valley) building homes. The bank took so long and had so much red tape I felt like an American Gladiator simply obtaining construction financing and the nail pounding hadn't even started! The first time I used private money to build a house that retiree/investor said, "I have more funds available Brad find me some more construction loans." After building 20 houses myself I had a dozen retirees and retirement planners saying "find me another house to finance Brad". Each time I encountered a problem with a privately funded trust deed investment, no matter how small (whether I was the borrower or the lender) I came up with a solution that worked and wrote it down and 15 years, 1,000 loans brokered, 50 web pages, a lot of grey hairs and 37 safer trust deed investing rules later, I'm here wanting to share with you a recipe that has already proven itself on a thousand investments for a hundred investors for the better part of two decades.

The process grew the way it did, I guess, because somehow each investor had a brother or sister or friend that also said "find me a new house to finance for a higher yield Brad".
 

"Why would a borrower pay 10% interest when banks offer loans at a lesser rate?"

Many reasons of which I will touch on two. Probably the biggest reason is time. Most of our borrowers would like to build a home and be living in the new house in a few months instead of still finding themselves dealing with the aggravation, frustration, and verification a bank brandishes! A developer knows that time is money and a slightly higher costing private loan might not be such a bad deal after subtracting for the costs incurred for months spent waiting for bank financing.

Our analogy is that if you do have to foreclose nothing is more important than the collateral for your loan. You won't get the savings account, the spouse's income, or the sail boat. As a private investor you will learn to hang your hat on the equity in a transaction and pay a lot less attention to the irrelevant details that conventional lenders spend months scrutinizing. Verifying useless details of borrower's rags to riches to rags stories will not shield you, scrutinizing the collateral or equity for each safer trust deed investment will. Anyone with great credit can divorce, go broke, climb into a bottle, and so on. So while the bank is wasting time checking the borrower's savings account balance and spouse's income, we'll be instead looking at the only really relevant things concerning the actual collateral for our loan.

A flip side occurs once you adopt this philosophy. If a doctor with flawless credit wants a 70% LTV loan, it's not a safer trust deed investment and never will be one. If a divorcee who is changing jobs currently and has no spousal income, no sail boat, and no credit established but wants a 50% LTV loan offering us 10% and 2 dollars of equity for every loan dollar, you can see where this loan request has just passed 1 of the 37 rules and may result in a safer trust deed investment than the good doctor's loan, if it can meet the rest of the criteria.
 

"How can I invest in safer trust deed investments with my IRA?"

Ask your accountant and your pension plan administrator if you can invest in well secured trust deed investments with the particular plan you currently have. If they say yes, we'll add you to our data base, if they say no, write to us for a list of pension plan administrator that will. Always check with your CPA however because although our 100 investors do so with everything from their family trust to their IRA, I can't guarantee that the current pension plan that you are using can.

NOTE: The following list may not be up to date, and some of the following companies may or may not hold TD's, may not hold real properties and if foreclosure is necessary, some may force you to transfer assets to a custodian that will handle real property, so always be sure to check with your attorney and accountant before choosing your custodian.
 
 

PENSCO Pension Services

120 Montgomery Street
San Francisco, CA 94104
tele: 415-274-5600

TRANSCORP Pension Services

P.O. Box 31051

Laguna Hills, CA. 92653

tel: 1-800-821-6398

POLYCOMP

P.O. Box 31051

Laguna Hills, CA. 92653

tel: 1-800-821-6398

LINCOLN TRUST COMPANY

P.O. Box 5831

Denver, CO 80217

tel: 1-800-825-2501

FIRST TRUST CORPORATION

P.O. Box 173301

Denver, CO 80217-3301

tel: 1-800-525-2124

Finally, we have too much fun sharing this with nice folks to spend time with those that are impatient, demanding, rude or nasty. If you're like that, no need to contact us. If safer trust deed investing interests you and you're a nice person, contact us and give us a chance to answer all your questions or send you our video or other propaganda! Let me know how I can help you.
 

TOOLS OF THE TRADE

Whether you are an experienced trust deed investor operating completely on your own or a beginner working through a broker, there are tools of this trade.

First and foremost is the title company you choose who will act as your "Trustee". You will want to acquaint yourself with a local, professional title company. One that you know to have a good reputation. Don't be afraid to call around to real estate offices and ask them for referrals to the most popular title company in your area. Don't hesitate to visit title companies, introduce yourself and ask them to convince you to bring your business to them. Then remember, you're looking for good, accurate, professional work, not personality. Ask if they make property profiles, offer ALTA coverage to private lenders, have a courier, a fax machine and are computerized, etc.

You will also need a local fire insurance agent. Although fire insurance should always be handled in escrow (and prepaid by the borrower) at the time you make the note, occasionally a borrower will not make later payments on his policy or will let it lapse for some other reason in which case you will be notified and will have to quickly get a binder to protect your interest if the house burns. You'll want to make sure that under the terms of the deed of trust the borrower is required to keep an active fire policy on the property naming any lenders as loss payees on the policy. Since you are named on the policy as loss payee, you should have received a copy of the policy and should always be notified if the policy were about to expire for any reason. Of course, the borrower is responsible for this and if expiration occurs he (the borrower) is technically in default as adequate fire coverage is required by the terms of a standard deed of trust here in California. The first action for you to take as the lender suddenly in jeopardy without coverage would be to get a new binder yourself and bill the borrower. That is where a professional and cooperative local insurance agent who is as close as your phone comes in real handy.

In order to get the highest rate of return, you need to constantly stay in touch with your broker in your area and at the same time keep one finger on the pulse of the market. There are times when I am trying to fund a loan at the last minute for one reason or another and I see investors almost daily lose out on funding some really good deals simply because I am unable to reach them. I encourage my investors to have an answering machine hooked up in their homes. Remember, time is of the essence, you're product will be money, but money quickly.

A VCR in your home can also be helpful. Occasionally a broker will videotape a property and send you the tape for viewing to save time and travel on your part.

Call waiting can also be an invaluable telephone service, particularly to investors. It enables your broker to reach you even if the kids or grandkids have the telephone held hostage!

Another absolute must is a P.O. Box. You would never want to give out your residence address and chance being disturbed by unannounced borrower visits. On numerous occasions borrowers have become an extreme nuisance to lenders who disclosed their home phone numbers or street addresses. I strongly suggest you obtain a P.O.Box rather than using your street address to collect payments. (Also, never allow a borrower to make any payments by way of direct deposit to your bank account.) Borrowers will hound you relentlessly for extensions, additional advances, personal loans, etc. You will get less of this type hassle if a borrower has to write to you rather than phone or visit!

With the advent of the information highway, the internet, unless you want to be forgotten, one should have and e-mail address.

Lastly, a fax machine can be a very useful item, I couldn't do business without one.

It would be very difficult to build a house without a hammer and saw or other basic tools. As a matter of fact, it's difficult to operate any craft, service or trade without having the basic, proper tools of the trade.
 

WORRY

Notes and deeds of trust are not for everyone. Even though they can be safe, high yielding and fun if done properly, they're just simply not for everyone because they do require some management. And let's face it, it is also a fact that a lot of our so called "B" borrowers have less than flawless credit and don't have a million in the bank. If they did, why would they be willing to pay as much as 14.5% interest on borrower money? It can be a problem if you are depending solely on every penny of the monthly payments for your living expenses. I would suggest keeping a 6 to 12 month reserve buffer fund if this is your situation.

Trust deed interest payments commonly come late. Some people worry if a single payment comes late, even with a six to ten percent late charge bonus. Some people can't sleep nights if a loan is paid back thirty days late even though it was with interest, and even though a higher return was yielded. One lady took her money out of her low interest checking account and bought some notes yielding 15%. When a few payments came late, and even though her money was secured by 2 to 1 collateral and she got her late charges, she said, "This is too worrisome for me." When the loan paid off, she put the money back into her low interest checking account to stay. I guarantee you that inflation will eat up her nest egg. Do you remember when people actually retired with a nest egg of $30K? The longer you are retired, the worse the effects of inflation are on you.

Another perfect example would be one lender I recall working with who, on his very first loan, received the first few payments a few days late, and every single time the borrower diligently paid the required maximum late charge. These late charges boosted the lenders yield considerably, but he still made about a dozen phone calls to me for each late payment. This guy really went bananas! I felt sorry for him. He was approaching a nervous breakdown even though his loan was very secure, no risk was at hand!

The loan was a $50,000 first on a $100,000 property and at no time was his $50,000 investment ever in jeopardy. Even if the borrower had refused to pay altogether, he could have gone through foreclosure and in less than six months taken the property back and probably made over 100% interest on his investment instead of 15%, even if he chose to sell the house for below market value for a quick sale.

The borrower continued to make late payments and the lender continued to call me every night that the payment was not received to tell me it had not arrived yet, and I continued to explain to him that his position was secure, and he continued to worry more and more until I finally concluded that notes and deeds of trust were just simply not for him. The other 100 investors accept the little headaches in exchange for the high yields.

In the end a friend referred him to an investment broker who suggested he buy something I'm not familiar with called Ginnie Maes (at a much lower yield, 7% as I remember it). Now he worries about his Ginnie Maes but he's calling the stock broker everyday not me, thank goodness! Trust deeds are not for everyone, this is a fact.

I later discovered that this lender actually had a much smaller investment portfolio than he had originally told me and that he was depending solely on only this interest income alone to live on. He had broken the rule of diversification. Instead of loaning only 10% to 20% of his trust deed portfolio portion on any one particular deed of trust, he had lent closer to 50% of his total investment portfolio all on one note and it was affecting his peace of mind, not to mention his marriage. Because he depended on the interest income he couldn't afford to deal with a borrower who was late, particularly since that payment represented 50% of his entire income. Understanding the facts and following the rules can sometimes eliminate unnecessary worry.

Worry can be the straw that breaks the camel's back! If you know that your investment is very well secured and you've been treating every deal as though you were going to have to take the property back, and you're confident that you've established an accurate value of the property, and you're confident in your title insurance coverage, and you've put the investment to the checklist test and it has passed that too, then there shouldn't be great cause for continuous worry. The best investor worries a little as a little worry is healthy, but at the same time the investor can put an end to that worry immediately because he recognizes that the nearly 2 to 1 real estate collateral makes his loan very secure.

Another excellent example of unnecessary worry is the story of an investor I met about ten years ago. We had a wonderful relationship and he funded many loans through me. I really enjoyed working with him, however, he was what I considered to be overly cautious. Now don't get me wrong, a little bit cautious is good, but overly cautious is not. He scrutinized every word of every sentence and every item like no one I had ever met before or since. He stayed awake nights worrying about why one word was used in the fine print rather than another and nit-picked at all the irrelevant points, and missed most of the relevant points. I had never seen anything like it. I liked him a lot though, or I would not have continued offering my free brokerage services to him.

Sadly he later passed away and his wife had to take over where he left off on his trust deed investments. She initially wanted to phase it out slowly as the notes came due because she didn't know anything about it. Later after a small amount of exposure to trust deeds she decided to try funding a few loans through me herself. She has since become one of my best and easiest to work with investors. She has developed confidence now and she never seems to worry excessively or needlessly. She has actually become, in my opinion, a much better investor than her husband was, realizing that there is no large dangerous risk of loss but instead only the realistic risk that she might someday have to redeem a home in foreclosure and hire a painter and a realtor to fix it up for resale. As you know, I like to compare investing to driving. There are rules to follow cautiously in order to survive on the highway, but an overly nervous, neurotic, or scared to death driver in a panic can be as dangerous or even more dangerous than an overly confident one. Worry a little, it's healthy and necessary. Use a little caution, it's healthy, but above all, follow the rules and be patient, you will get there safely.

The major point here is that there is a great deal of excitement and fun to be had investing in notes and trust deeds, in my opinion, if you do a little homework. Don't let it be overshadowed by worry which can only come from doubt. Erase that doubt and remember, "Worry is like a rocking chair, it gives you something to do but it doesn't get you anywhere!" Instead, expend that same valuable energy checking the vital signs of each trust deed with the easy checklist in this book and you will know whether or not any trust deed is good or bad! Don't worry! Be happy! Oh yeah, and follow the rules! Also, start noticing how much equity lending is constantly going on around you every day.
 

TRUST DEEDS

A trust deed is a signed and notarized legal document, a piece of paper that secures the note and loan you make to a particular piece of property. The deed of trust shows the borrowers name(s), the lenders name(s), the loan amount, and the property that the loan is against. The trust deed contains a "power of sale clause", this clause gives the title company (the trustee) the power to sell the property for you, the lender, in the event that the borrower doesn't repay the loan as agreed. The trust deed is recorded and made a matter of record in the County (public records) where the property is located. The trust deed is signed by the borrower(s) and notarized, and specifies the parties, the amount, and a legal description of the particular parts of real estate securing the loan.

Accompanying the trust deed is a note, a promissory note, or a written promise to pay a certain sum of money to a certain person on a certain date. The note also states the interest rate and other terms of the loan. The note is signed by the borrower(s). There are many types of notes in many shapes, lengths and sizes.

The borrower is called the "Trustor" and the lender is called the "Beneficiary". It's easy to remember who the beneficiary is because he "benefits" from the payments on the loan. It's easy to remember who the trustor is because he's the one you "trusted" to pay the money back! That's how I remember them.

What determines the position of a new note and trust deed, a first, a second, a third or even a fourth? Do you know? It is determined only by the date and the time that trust deed was recorded. If I own my property free and clear today and at 2:30 in the afternoon I gave you a note and trust deed for $10,000 and at 2:45 you recorded it, but at 2:43 I had given someone else a note and trust deed and they had recorded it at that precise moment (2:43), then the very first note I gave out would become what? It would be a second because the position is only determined by the date and time of the recording of the deed of trust. That's why it is so, so, important for you to always receive title insurance and transact your business through a bona fide and reputable title company to protect you. (The position of existing note can be altered thru the use of a subordination agreement.)

If I gave you a note and deed of trust on my house last year, and I owned the house free, and clear and you never recorded the deed of trust, and I gave someone else a note and deed of trust today and they recorded it today, your note would be a second and their note would be a first because theirs was the first one recorded. This is why you never make loans without going through a bona fide, reputable, title company. The title company is your "Trustee", the middle man. Always use a title company and get title insurance guaranteeing your loans actual position.
 

LOAN TO VALUE RATIO (LTV)

LTV, loan to value ratio, is the ratio between the total of loans (your loan and any loans ahead of you only) divided by the value of the property.

Example:

On a $100,000.00 house we have only one loan, a first of $50,000.00, or 50 cents on the dollar, or 50% loan to value ratio. The loan represents 50% of the overall value of the home.

If you had to foreclose and take back the house and sell it quick for $90,000.00 what would the return on your investment have been?
($90K take away $50K = $40K divided by 50% invested or 80% profit.)
 

Example:

What LTV would you have if you had a $25,000.00 second on a $100,00.00 home hat had a $10,000.00 third on it?

In this case you need to know how much the first is because, in figuring your loan to value ratio, any loans ahead of yours must also be considered. In this case we will say that the first is also $25,000.00 bringing the total of your loan and all the loans ahead of you, the loan amounts you are concerned with, to $50,000.00. So, again, we have a 50% LTV. Remember the hard cold fact is that you don't care about how many people are behind you in the soup line, but you are very concerned about any of those ahead of you.

1)If the house was worth $50,000.00 and the first was $25,000.00, what would the first's LTV ratio be? (50%)

If you held the $25,000.00 second, what would your LTV ratio be? (100%)

Would we ever make this loan? (No)

Would you make this loan? (No)

3)If the house was worth $150K and you were asked to purchase the existing $10K third which supposedly represented no more than a 60% L.T.V. ratio, how much is the largest possible allowable amount the first could be?

($150K value multiplied by 60% L.T.V.= $90K allowed maximum in total loans (first, second and third) minus $35K (total of existing second and third) = $25K)

The first must be no larger than $25K or no deal.

In this example we have a vacant lot worth $60K.

The borrower owes $10,000 and the lot is worth a solid $60K. He wants whatever the maximum is that you will give him. We don't like vacant land seconds and we only lend 1/3 on land so....
(33 1/3% LTV x $60K lot = $20K total maximum loan commitment.
We would be willing to lend him a new $20,000.00 first on the lot if he will pay off the existing $10,000.00 first in escrow. He will net only $10,000.00 less his costs after paying off the first. We don't fund seconds on vacant land.
 

ESTABLISHING VALUE

Obviously, you would never be able to establish a single loan to value ratio in terms of dollars without first establishing the actual market value of the real estate collateral in terms of dollars because: LTV = total loans divided by value.

Broker and investor, should arrive at an accurate market value for each property used as collateral and it should be a value that you have complete confidence in. This doesn't mean that you always have to get an MAI or an FHA appraisal. It doesn't even mean that an expensive written appraisal is always necessary. But it does mean you must always establish a value that you have full faith and confidence in and not based on any single one appraisal. Know, in your own mind, what you would be willing to pay for the property if you should ever have to take it back. There are several different ways of arriving at the fair market value of a property and a professional appraisal is usually only one. I will, however, go over some of the more popular approaches to value available to you.

An FHA appraisal is probably one of the most conservative and accurate appraisals you can get on improved property. If you want a very strong indication of the value of a single family home, order an FHA appraisal. They not only tell you the value of the home but will also make recommendations as to what the house needs to bring it up to local codes, etc. However, I've seen FHA appraisals take up to six weeks, and longer, to obtain, and they're not cheap. You can purchase a comprehensive FHA appraisal without necessarily pursuing FHA financing.

From my experience, the next most accurate appraisal would be a VA appraisal. Because it's purpose is for a Veteran to obtain a government guaranteed loan and the government wants to help them, the VA appraisal always seems, in my opinion, just slightly more liberal than the FHA appraisal. When I was selling real estate, VA appraisers always seemed to be willing to bend a percent or two as a courtesy to meet the contract price of the house, whereas FHA appraisers would not.

Conventional appraisals are usually unavailable unless the borrower is or was going for a conventional loan and had obtained a copy of one and already has it in his possession. Sometimes a local appraiser will not have FHA or VA authorization but has a reputation for providing a good appraisal.

Last of the most common written appraisals is obtained from an independent appraiser. Most appraisers are very diligent and very accurate and very thorough in their appraisal of a property, but there are a few who are not, and those are the ones to look out for. I've seen these unreliables appraise a pole barn for $35.00 per square foot when $5.00 to $10.00 would have been much more accurate. The appraisal is really no better than the comparable properties listed, sold, and outlined in it and you can checkup on these comps. yourself if skeptical. You can drive by.

Don't feel that you have to have an appraisal just for the sake of being able to say you have an appraisal, and don't ever rely solely on any one appraisal of value. Also don't think you have to be an expert appraiser yourself. Be flexible, be smart, be thorough and be safe. If you would be willing (after investigating the market) to pay the appraised price for the property, that's a very good indication that the market value is realistic. Learn some of the following simple steps toward evaluating a property yourself so you will never have to nervously rely on someone else's opinion alone. With the checklist you'll always remember to check this stuff. None of it can slip by you so long as you use the checklist in this book at every closing.

There are three very good ways to determine for yourself how accurate the appraised value of most any conforming property is. Weird or unusual (nonconforming) property should be avoided.

#1 If the property has sold or changed hands in the last eighteen months, use that value as the value of the property. We are also willing to add for all subsequent cash improvements if any were made. This would be the number one method. After all, what better comparable sale can you get than the subject property itself?

#2 The second way is to check on other comparable properties in the area that have actually sold and closed escrow, actual sales only, asking prices are of little or no value. Sales that have closed escrow are called "comps", and comps are what appraisers use to make their appraisal by adjusting up or down for a smaller garage or lack of a pool, etc. If you can find the same or similar house with the same or similar floor plan that sold around the corner, use the sale price of that home and adjust either up or down when comparing it to the house you are trying to evaluate, take away for what the comp may have that the house you are evaluating does not have and vice versa. Never use the asking price or listed price of homes for sale not yet sold in the area, they may be unrealistic. Only compare actual sales that have closed escrow. If you have to add or subtract for adjustments that's fine, just be accurate, factual, thorough and realistic.

#3 The last and third way is to estimate in your own mind your own thumbnail appraisal of what it would cost to replace those improvements on that particular parcel of property. This is very simple, if you check with at least five local contractors asking them what the cost of a standard, basic home per square foot is you will be able to come up with an average figure to multiply by the square footage of the home you are trying to evaluate. In this case we are talking about the improvements only and you will have to resort to comps for the land value to add to this. Also, give consideration to extras that may not be included in the basic square foot cost figure such as upgraded fixtures, a pool, landscaping, decks, workshop, etc.

Your broker can help you with this, and befriending appraisers and local real estate professionals that need your services as well can be very helpful. What the home has sold or changed hands for in the last 18 months is obviously the best way for you to be assured of the value. The second way is through checking into comparable sales in the area. The third way is to calculate the cost to replace the home. 1, 2, 3, ways you can use to check the accuracy of an existing appraisal and confidently establish value in your own mind. Always insist on an appraisal and then always establish your own opinion of value to be used in arriving at the suitable loan commitment to offer.

If a borrower produces an appraisal, check on it, question it. Never just accept a stated property value without establishing in your own mind a confidence in that value. The value you accept could be the price you may have to sell the property for to recoup your costs after foreclosure! And, if too unrealistically high, you could be in serious trouble. Think of it as though you will have to buy every single property in foreclosure for the value you have accepted, and by the very nature of this approach the chances of you ever having to foreclose will be greatly reduced and should a foreclosure happen to occur, the property's real market value can never come as a shock to you. Build your own collection of good comps to refer to if you can.
If you are unable to confidently place a value on a property then I suggest that you pass on that deal, as there are a dozen more to replace it if you are making yourself available.

I would like to add that even the best, most accurate appraisal is still, at best, nothing more than an approximation or one mans' opinion of value because there are so many variables and unknown factors that can affect value, i.e., terms, motivation, interest rates, etc. In loaning up to 60% of the value, I have found that even if the estimate of value is off by 5 or 10%, you will still have plenty of loan security.
 

THE 50-60 RULE

Single family homes . . .

When arranging loans on prime single family houses I feel that my "50-60 Rule", as I call it, works best.

When you're considering loaning on a nice single family dwelling, the property is prime and in a good location, and there is no question but that this is a first quality, desirable property, then the 50-60 rule says you can loan up to 60% of the market value of that property not 60% of their equity but 60% of the homes value, so long as it is owner occupied. Non owner occupied may reduce your commitment to 50% or 55% LTV.

When you're looking at a not so desirable improved property, say it's too far from town, or a bit too run down, or maybe it's just a strange floor plan or funny shape, but you still want to lend on it, then you will not want to exceed 50% LTV, (loan to value ratio), of the value of the property. Don't exceed 50% loan to value ratio on less than primo or prime quality houses.

Loan up to 60% of the value on REALLY good IMPROVED single family property and stay at or below 50% of the value if there is any reason to feel this is not prime property, or any spot in between. A sliding scale from 50% LTV to 60% LTV.

Commercial real estate and vacant land or unimproved property are a totally different story altogether and I will cover that in great detail for you later. We arrange loans for up to 1/3 or 33.3% LTV ratio on vacant land, lots or even improved commercial property and never more, unless you actually want to buy it for more.

Again, I am talking about loan to value ratio or LTV. The LTV is the loan amount in relation to the value of the property. Don't ever forget that if you are doing a loan in a junior position you must always figure the amount of any loans ahead of you added to the amount you are loaning and then divide that total by the market value to determine the LTV.

Cast the 50-60 rule in stone, tattoo it on your arm if you must, but don't forget it, don't break it, lest you want to own some property around town by way of foreclosure! At 60% LTV there's even a little built in room for error and you'll still never probably have to take one back.
 

Vacant land . . .

With respect to lending against real estate other than single family residences, i.e., commercial real estate and vacant land or unimproved property, we use a different rule altogether. I will arrange first trust deeds only (no junior TD's) on commercial property and vacant land, and even then only up to one third of the actual market value of the property, unless it is a parcel that I feel I wouldn't mind owning myself, then occasionally I'll sometimes go up to 40% or 50% LTV maximum.

33.3% is the rule for all vacant land. If you want to be assured you will never have to take back vacant land then never go over 33.3% LTV and you'll never have any trouble. Remember, you can't normally collect rent on vacant land and it's hard to sell!

Example:
Lot F is worth $30,000.00. The owner approaches you for a loan. Having verified the $30,000.00 value of the lot, how much will you loan? $10,000.00 is the answer if you are playing it perfectly safe. If this is a piece of land that you wouldn't mind owning because it adjoins your own parcel and you've always wanted it, then you might even consider stretching it to $15,000.00. Of course there is always a third choice, if you dislike the land for any reason you simply say "Thank you, I'm not interested" and there will be 10 other deals to pick from in it's place! Also, we have a $30,000.00 minimum, so I would pass on Lot F.

Loaning only one third on vacant land won't cut out prospects either because a borrower can always get somebody else to loan money behind you, and we don't care how much money is behind us ever, we only care about our loan and all loans ahead or in front of us from now on. Remember, loans behind you are almost a form of additional insurance, in my opinion, because they will be wiped off completely if you should have to foreclose unless they pay you off. To me, that's almost like having another borrower on the hook to you. I feel loans behind mine are a plus or a bonus, but never confuse them with loans that are ahead of or senior to your loan.

On raw land however, make sure you're in first position at no more than 33.3% to 50% LTV and you'll be the first in line to be paid off if the deal ever sours and gets to the court house steps. If the borrower scoffs at your 33.3 % loan offer, don't fret, there's a dozen more who will jump at it if you are making yourself available.
 

TITLE INSURANCE

A guy who began riding a motorcycle decided to buy a helmet. He went to a motorcycle shop and found several helmets, all with different price tags. " Which helmet should I buy?" he asked. The salesperson replied, "Well, if you got a $5.00 head then you buy a $5.00 helmet." . . . . What's your head worth?

Title insurance to you, an investor, is much like the helmet to the motorcycle rider. Eventually, it may save your life. I happen to think my head is worth a great deal, so I would buy the very best helmet, the most expensive helmet on the market. When I broker a loan on a piece of property, I insist on the very best, most comprehensive and usually most expensive title insurance available, the A.L.T.A. policy. Here in northern California, title insurance is always paid for by the borrower, costing the lender nothing.

There are two basic types of title insurance available to you. One is C.L.T.A. standard coverage and the other more extensive "Rolls Royce" coverage is the A.L.T.A. policy. Both of these title policies will cover against loss or damage as a result of defects or liens or encumbrances in the title, lack of right of access to and from the land, and the un-enforceability or invalidity of your note and trust deed. With title insurance you are assured of the position of your note and trust deed, and you are assured that the property you have loaned on does indeed belong to the person you loaned the money to and that you are covered as to any loss due to these matters. In addition, with the A.L.T.A. policy you will be covered against everything else like encroachments and mechanics liens. There are also additional endorsements available to cover, for instance, placement of a new foundation, mechanics lien coverage, or just about anything else you can think of.

I always insist on complete lenders A.L.T.A. coverage for every lender on every loan I broker, it really is the Rolls Royce of coverage or the best coverage available. A.L.T.A. coverage is what savings and loans and banks get for themselves so why shouldn't you? Sometimes it's difficult for a private individual to get A.L.T.A. policies, but if you're working with a broker who has enough business going through a title company, they can usually get A.L.T.A. coverage in most counties....I've proven that myself.

Never make a loan to anyone without the entire transaction and all money being handled through an independent escrow by a reputable title company. And NEVER make a loan to anyone without a policy of title insurance on that property issued by a reputable title company through escrow by a reputable title officer at the close of every loan escrow. Hundreds of investors are ripped off every year by thinking they're getting a first loan when the loan is actually a 3rd, 4th, even 5th loan. This cannot happen if you obtain title insurance every time.

One large trust deed investment firm in the bay area went into bankruptcy. It seems they were selling investors seconds on property that were really thirds, fourths, and even fifths! There were millions of dollars involved. Apparently, not even one of these investors insisted on their own title insurance policy, if they had they would have received a preliminary report showing the status of the property and they would have seen in the report the items they were not being told about. Later, I heard the same man bilked investors a second time, in the same state, by starting another company with another name!

So again, always insist on the best coverage possible and always check the pre-lim (preliminary title report.) This is an early report, provided by the title company for you, telling all items of record for your information.

Whenever approached by borrowers and investors alike I always insist we use my title company or usually won't be as motivated to do the deal. Over a period of years the title company I use has learned to draw my papers the way I want them. They know how I like my deals structured and, true to the old adage "practice makes perfect", they don't seem to forget anything. For me to try to do an escrow with a brand new escrow company that has no idea who I am or what I want would just not be worth it, especially in the complex area I currently specialize.

A good escrow agent can also prove to be another good form of insurance. If you have an escrow agent that you feel confident working with, and that you know understands how you operate (having worked with you before), and that you trust and are comfortable with, then you can relax and let her do her job without losing a lot of sleep. Of course it takes some time and effort to build that kind of relationship, but once you have you can rest assured that your best interest will be at hand. My escrow person was the vice president of the company and she never made a single mistake on a single document in any of the hundreds of escrows she has done for me and her assistant is equally as dependable. Try to get into the habit of using one company only and the deals will get easier and easier as time goes by.

CLTA vs ALTA TITLE COVERAGE
 

What the heck is an ALTA lenders policy of title insurance?

As a safer trust deed investor you should always demand that your broker provide you with a full extended ALTA lenders title policy with no deletions! Brad Evans Real Estate Loans investors are given full extended ALTA title policies with no deletions on all trust deed investments brokered (plus a foundation endorsement and a potential ALTA rewrite where necessary on all construction loans).

What the heck does that mean??

There are generally two types of title insurance policies used. CLTA (California Land Title Association) is insuring against loss including attorney fees (up to the purchase price for as long as he owns the property) due to all matters of record, fraud and forgery, and it assures that title is being vested in the person shown on the policy.

The ALTA (American Land Title Association) policy covers the same items as the CLTA policy as well as many additional risks such as unrecorded mechanic's liens, assessments, encumbrances, encroachments, easements, water rights, mining claims, patent reservations, conflicts of boundary lines, shortages in area access to and from the land and other visible matter, as the title company performs a physical inspection before it issues an ALTA policy.

Institutional lenders (as well as Brad Evans) demand an ALTA policy as it insures the lender against loss for the entire length of the loan and against the un-enforceability or invalidity of the note and deed of trust.

Some ALTA policies will list deletions. The most common deletions may exclude mechanics liens on construction loans with broken priority, i.e. any construction was started before loan escrow recorded. Some ALTA policies list so many deletions they begin to resemble the more limited coverage CLTA policies provide.

You can see why it is so important for you as a lender to obtain the most protection available. You can also see that if your coverage is called ALTA but has deletions you may really only be getting the equivalent of CLTA coverage. Always obtain the maximum title insurance coverage available.

Excerpts from "California Title Insurance Practice" by John L. Hosack:

COVERAGE

The ALTA loan policy insures the lender against loss or damage up the policy limit, plus costs and attorneys fees incurred under the policy that are caused by (1) title being vested in a person other than the one shown in the policy, (2) title defects, (3) liens and encumbrances, (4) lack of a right of access to the land, (5) marketability of title, (6) prior mechanics' liens, and street improvement assessment liens. In addition, the policy insures the priority and validity of the lender's lien on the property, except to the extent that the insured encumbrance is invalid or unenforceable due to usury, the effect of any consumer credit protection, or truth in-lending laws.

In addition, policy coverage is extended to the following matters that are ordinarily excluded from the CLTA standard coverage policy: off-record defects, liens, encumbrances, easements, and encroachments; rights of parties in possession or rights discoverable by inquiry of parties in possession and not shown on the public records; water rights, mining claims, and patent reservations, and discrepancies or conflicts in boundary lines and shortages in areas that are not reflected in the public records.
 

EXCEPTIONS TO COVERAGE

The primary difference between the ALTA loan policy and the CLTA Standard Coverage Policy is the omission of the standard exceptions contained in Schedule B, Part I of the CLTA policy. No standard exceptions are set out in the ALTA loan policy. Instead, the title insurer will list specific matters that constitute exceptions to the coverage of the lender's lien.

Matters that constitute defects, liens, or encumbrances on the title and that would be subordinate to the insured lien are set forth in Schedule B, Part II of the ALTA loan policy. In most cases, such matters would be listed in the preliminary title report issued by the insurer before closing of the transaction and issuance of the policy and the lender would require them to be deleted from the policy.
 

FIRE INSURANCE

When loaning on improved property there is always the threat that the improvements will burn and unless you have a fire policy in force you'll have a loan secured by ashes.

Never, under any circumstances, make a note and deed of trust on improved property without fire insurance coverage adequate to cover the full replacement of the improvements, investigate to be certain it's adequate. Ask for more coverage if necessary. See that the policy is paid for a year in advance, collected in escrow. If not collected in escrow, there is the possibility the payments won't get made and the policy will cancel. Make certain that you are named in the policy as loss payee when you close the deal.

The policy will lapse or cancel if time runs out or the payments aren't made. I always have my title company collect for a full year in advance in escrow, but sometimes even this isn't enough safeguard. What if the note is written for more than one year, and when the first year passes the borrower has the option of going to monthly payments on his fire insurance? It's up to you to stay abreast of fire insurance. In my opinion, lack of fire insurance poses the biggest single potential threat in trust deed investing. You should always be notified, as loss payee, by the insurance company, of any pending changes or interruption of the policy as required by law. Don't take the notices lightly, be sure to follow up and see to it that you remain named as loss payee and that the insurance stays in force.

I brokered a $20,000.00 note and deed of trust funded by a friend of mine. A few months into the loan term on a Sunday afternoon I received a phone call from him. "Brad," he said, "did you see this mornings paper where the house I have the $20,000.00 note on burned to the ground? The only thing left is the lot!" He wasn't worried about his investment, however, because he had a copy of the fire policy on the house listing him as loss payee. It happens, don't ever believe you can get by, even briefly, without fire insurance. You sure wouldn't want to hear one day that a place you were going to get insurance on had burned down and now it's too late!
There was an incident where a borrower allowed the original policy to run out and did not renew it. The investor received notice that the policy was approaching the cancellation date. He notified me right away and I chased it down. The borrower had decided to go to a new insurance company when it was time to renew and failed to have the investor named on the new policy. This was easily remedied, but if the investor had not taken heed of the notice he had received and if the house had burned down without him being named, there would have been a problem. Fire insurance is on the checklist.
 

LATE FEES

In accordance with California law the maximum allowable late fee you can levy is still a topic of debate among lawyers and title companies. I understand the maximum is 10% of the payment amount due on payments received no less than ten days late on non owner occupied property and 7% or less of the payment amount received late on owner occupied property. I have always used a 6% late fee after 10 days late on owner occupied property feeling that this is a fair amount. Consult your title company, broker, and lawyer for their policy however, as my figures may be incorrect in your area.
 
 
 

ACCELERATION

An acceleration clause can be put in the note and deed of trust that states that the entire principal sum will be due and payable in full if this party should sell, convey, further encumber, in whole or in part, the property securing the note and deed of trust.

An acceleration clause is more or less a "due on sale" clause that can be extended to "due if you get a second loan", "due if you transfer title", etc.

Generally, I believe that if there is not an acceleration clause in the note, it is a loan that CAN be assumed. If there is an acceleration clause, it is a loan that CANNOT be assumed legally without the lender's permission.

I am not a lawyer and hesitate to trying to recite case histories regarding acceleration clauses and which loans are and which loans aren't *callable, and if I did, the information would be boring and you wouldn't be any more enlightened about acceleration clauses than you will be once you've read this.

I always include an acceleration clause in all notes and deeds of trust I broker as standard policy, then there is no question as to what the intent is. We don't want anyone to assume any loan without going back through the broker for many reasons. If the new borrower looks O.K. and will have some equity in the property and is not going to negatively affect our security interest in any way, for a small and reasonable fee the investor may be willing to allow the loan to be assumed for the balance of time remaining on the note.
 
 
 
 
 
 

* To demand immediate payment in full of principle and interest is to "call"
a loan.
 

LOAN POINTS AND YIELDS

NOTE: Although we used to share a portion of the loan fees paid by the borrowers with the private investor(s) funding the loan as an added incentive, and may in the future do that again, we have currently suspended that practice. Brokers needing to attract new investors may find offering to share points an attractive incentive.

A "point" is another term for one percent. The reason a point is not referred to as a percent is because the interest rate is expressed in percentages. Points are sometimes given as bonus interest over and above the notes specified face interest rate. Interest is always calculated annually for every year of the note and points are only calculated and collected once, usually at the close of escrow.

Loan fees are always expressed in loan points, one percent each, and sometimes shared between the broker and the investor. Points will increase yield considerably.

For example, if you had funded a $100,000.00 note that was paying a total of 15% interest you would collect $15,000.00 annually. $100,000.00 X 15% = $15,000.00. Now, if in addition to that you had also collected one point from your generous broker on this $100,000.00 note, or $1,000.00, you can see where your yield would be greater than 15%, it would be 16% if the loan lasted 1 year. 17% annual yield would be realized by you if the loan was paid off in 6 months.

Yields can be a little less confusing if you learn to think in terms of time. Yields are expressed annually. When I say a note yielded 16%, I mean annually; whether the note was for two years, twenty years, or only one week.

Adding up all your profits (interest, points and late charges received) on a loan and expressing that annually is the key. One way of doing this is simply by dividing what you got by the total days of the loan (to get a per day return) and multiplying that by 365 days to arrive at a yearly return. And lastly, divide that annual dollar return by exactly the principal amount you lent to arrive at the actual annual percent yielded on this particular loan. Much like figuring gas mileage.

(Total profits received) divided by (total days) times (365) divided by (the original investment) will equal your exact percent annual yield on that particular investment.

Let's look only at points for a moment, when accompanying a note bearing 15% interest per annum.

One point on a one year note is equal to one percent and if spread over one year (expressed annually) increases the yield one percent.

(1 point) divided by (l year) = (l%) + (15% interest) = (16%. yield)

One point on a two year note is still equal to one percent of the loan amount but spread over a loan term of two years expressed annually increases the yield by only one half of one percent. Why? We now must divide that point by two (two years) in order to express the same point annually.

(1 point) divided by (2 years) = (.5%) + (15% interest) = (15.5% yield)

One point on a six month note is also still equal to one percent of the loan amount, but now we only have one half of a year loan term to spread it over. So in this case we multiply times two and find that this same loan point now increased the yield by two percent, expressed annually.

(1 point) divided by (.5 year) = (2%) + (15% interest) = (17% yield)

Based on the above examples, the highest yield can be attained by getting the most points possible spread over the shortest loan period possible. I would like to also mention here that you can see why I never object to early payoffs because spreading the points over the shortened loan period can also increase the yield dramatically.

Again we will use the example of a $100,000.00 note paying 15% interest for one year. Had I brokered this note for you I would have charged the borrower a loan fee of say, five points and shared them with you. We'll say I gave you two points, each point being equal to one percent of the principal amount of the loan, or two thousand dollars. This means that there is 15% interest, or $15,000.00, plus two points, or 2%, or $2,000.00, for a total of $17,000.00. This is a one year note, so expressed annually, this note has a yield to you of 17%.

If the same $100,000.00 note paying 15% interest were instead lent for a period of two years and you collected two points, your annual yield would be 16%. Why? Because the note is collecting 15% interest each year for two years, but it only collects the points once and therefore the two points must be divided by the two years then added to the interest rate to arrive at the annual yield. By the same token, had this been a six month note the yield would have been 19%!! You see, two points for six months are the same as four points for one year, just the way two points for two years are the same as one point for one year, we are expressing points annually or determining what they look like, in one year brackets, spread over the term of the loan. POP QUIZ; You have funded a $100,000.00 note paying 15% interest, written for two years and you collected two points. You have calculated your yield as 16%. Nine months into this loan the borrower wins the lottery and pays you off! Now what does your yield look like? Obviously you must recalculate and squeeze those points into a nine month period now rather than spreading them over two years as was the original plan. So, what is your yield? 15% interest collected for nine months plus two points expressed annually brings your yield to 18%!! Expressed annually we have to squeeze two points into three fourths of one year giving them the annual value of three percent.

If you missed this question you will still be able to spend the two points! This brings to mind the subject of a pre-payment penalty. I, personally, do not believe in charging a pre-payment penalty on a note where the investor is going to receive points. As you can see in the above pop quiz, if a borrower pays you off early your yield is increased substantially without having added a pre-payment penalty.

The amount of interest you charge for your money is usually not determined by anything such as prime rate or what the banks are charging. The interest rate on private money, or hard money financing, is really based mostly on supply and demand. If we have an excess of money available on our "funds available" board, we sometimes must offer a lower interest rate and vice versa. Of course, you will have a bottom line figure in mind as to what you want your yield to be. At the time of this writing banks and S&L;'s prime lending rate is about 9% and bank loans are available for 9.5% to 10% for thirty years. Private investors are collecting as much as 11% interest on really good firsts on improved property and 12% to 12.5% on construction loans and seconds. Add in bonus loan points and private investors can yield as much as 13% to 15% on certain notes even in the current market.

Remember this, the most misunderstood item I've found concerning interest is that people forget that interest is always in arrears. When you pay your January 1st house payment, it includes interest from December lst to December 3lst. Interest goes backwards from the date paid. So every time you collect a monthly trust deed loan payment on time, it is interest for the last month preceding the payment. Interest is always paid in arrears, it's not like rent, which is paid in advance.

By now you're probably still wondering why anyone would pay high interest to you and me when bank loans are available at much lower rates. Well, there are a lot of reasons for this. Suppose a borrower just moved into the area and started a new job. The bank would not loan this borrower a dime because he would not be able to produce two or three years income tax returns placing him at his current job. In other words, a borrower must be established in a job for at least two or three years before a bank will loan to him. This same borrower may have a 50% down payment on a new house from the proceeds of the sale of his old house and you would be happy to make him a 50% loan on the new house for the period of time it takes him to get established, as long as the loan met with all the criteria of our 37 tips. He can either borrow the money from you at your rates or wait two or three years until the bank will recognize him as a good risk.

The recently divorced who has not yet established him or herself as a single head of household might also have trouble borrowing from a bank. Suppose this person is trying to sell a home acquired in the divorce settlement. We could confidently loan up to 60% of the value of the home until it sold. The borrower would more than likely be happy to pay you a higher interest rate for the privilege of being able to borrow money and get on with life without having to wait for the sale of the home. (This type of loan is sometimes referred to as a swing loan or bridge loan.)

Time is only the number one reason why people are willing to pay the higher rate of private money. Many people, especially when it's a construction loan, are in a hurry. Time is money and when someone wants to get started on a building project a few percentage points won't scare them away. A borrower may be able to qualify for a less expensive loan through a conventional lender but by the time he waits three months or more for the bank to run it's red tape, he has lost a great deal more in time than the extra $$ that a fast, private loan would have cost him. In fact, our builder/borrowers could have a house built and sold and be ready to move on to another in the three month minimum time period it would take the bank to process their loan! Time is really what we are selling. Time to get started now rather than four months from now. That as well as 99 other reasons why people need fast private money will provide you with a steady supply of borrowers meeting your criteria.
 

INCREASING YIELD

It is indeed possible for individuals to earn much more, 14%, 16%, 20%, and even up to 25% interest on trust deed investments. This is a little known fact, and one that I feel nearly all investors in trust deeds can easily realize. When other factors come into play such as early payoffs, prepaid interest, borrowing on notes and re-lending etc., etc., the sky could be the limit!

Trust deeds offer a wide variety of options to the creative, or aggressive or thrill seeking investor. I've even referred to some extremely creative financing as "kinky" financing.

If you made a loan of $l00,000.00 for one year with the note bearing 13.5% interest and your broker gave you one additional loan point (one point is equal to one percent of the loan amount) you would receive 13.5% interest on the face amount of the note, or $13,500.00, and 1 loan point, or $l,000.00 for a total of $14,500.00. You can easily see how that deal would net you 14.5% interest if the person borrowed the money and paid you back exactly on time at the end of one year. But that's usually never the case!

I have found that a large percentage of my loans are paid off early. If you're not a mathematician, you can still visualize this theoretically: Say you received as a gift from your broker one origination bonus loan point based on a loan term of one year and a borrower pays off the loan at the end of only six months, you would then be able to come back to your broker with your money to reinvest all over again in a new loan, right? Your broker could put you in a new loan at 13.5% interest and you would probably, just like before, again receive another origination loan point up front, thus, not only netting 13.5% interest for the year on the face amount of the notes, but you also received two bonus points, adding up to a total annual yield of 15.5%. This could go on and on compounded in other various ways. For instance, if you had deposited your payments received in an interest bearing account all year, 16% would have been netted; interest on interest!

I've even known people who have borrowed money against their notes at a lower rate than what they were collecting and then relent that money raising the 16% yield to 20% or more. While it can be very difficult to borrow money against notes, if you are lucky enough to find and eventually develop your own source for loans against trust deeds, it can double or even triple yields to you.

Imagine, theoretically, lending your original money out at 14.5% interest and borrowing most of it back secured only by those same trust deeds at 10% or 11%, and then reloaning that money out again at 14.5% interest! You would be picking up 14.5% interest on the original notes, and then another 4% interest on the note hypothecations, reloaning the very same dollars. At this point you might be realizing as much as 18.5% returns, borrow on the latest well secured trust deeds and on and on and you can see how the sky could be the limit.

I do not suggest you go out and try this tomorrow. I only brought up note hypothecations (borrowing against paper) as an extreme example of creativity to stretch your brain a little. It could be a very dangerous practice if multiple late paying borrowers start kicking your dominoes over, or you didn't intelligently lay out or stagger your due dates so that they owe you before you owe them.

Instead of owning their home free and clear, I've known investors who will borrow against their home tax free (as loan proceeds are not usually considered taxable income and the interest charged is usually tax deductible) at a low fixed interest rate and then loan that money out at a higher rate. They could bring in 5% or 10% clear net profit annually. Obviously, the risk in this strategy is that these investors have to continue making their loan payments on the money they borrowed against their home even if their borrower is late.

It is possible to obtain yields of 20% and more and it's not as uncommon as one might think. For example, any investor with a California real estate brokers license is exempt from usury on most real estate secured loans in excess of $20,000.00 in the state of California. This licensed real estate investor/broker could charge just about anything that the market will bear.

Suppose you had $500,000.00 to invest, and you loaned it out at 10% interest on several different loans, you could earn a minimum of $50,000 a year without touching the principal. But, picture if you did that and at the same time you had a real estate license. Now with the ability to charge loan points on your money, you could easily yield 20%, 25% or even 30% interest. The possibility of an additional $75,000 a year to you, in my opinion, might motivate you to attend any real estate school for as long as it took you to receive a real estate license. Those of you already licensed may not have realized that you already have the ability to earn double yields! By handling your own loans, you could net $125,000.00 a year brokering your own money as opposed to netting only $50,000.00 a year having someone else do it for you, which isn't too bad.
 

I knew of a man who went out and bought discounted notes and deeds of trust and then immediately resold them. He had sometimes $30,000.00 to $50,000.00 tied up for as little as five to ten days and sometimes he would make as much as $4,000.00 to $5,000.00 profit on turning a single trust deed. If you do the math necessary to express his yield annually, you will find that he earned over 100% interest on his money on some of those deals.

It's my opinion that buying discounted notes and deeds of trust is just too difficult for the beginning investor. Instead, concentrate your energies on funding brand new, fresh, notes and trust deeds.

Example: I lend your friend $10,000.00 from my pension plan because he's in a hurry and can't wait for the bank. He's willing to pay me 15% interest because I am willing to make him the loan in second position, allowing him to leave his low interest, fixed rate first loan in place. The first is so small that this second loan offers me the same amount of equity and collateral that any normal 60% LTV first trust deed would. Because I'm licensed I can charge him 3 or 4 loan origination points for this 6 month loan (multiply the points by two to find out how they increase the annual yield). We are at this point talking about a 23% yield. Through net funding the loan and reinvesting the interest payments this could easily be stretched to 24% or 25% before even considering the effects of an early payoff. If the loan was paid off early, for example at the end of three months, the yield would easily exceed 30%.

There are many, many other aggressive ways to increase yields, pre payment penalties (which we don't currently use), pre-paid interest, and more. You can increase your yield by being in a position to lend money with no monthly payments, where all the interest is due in one lump sum at the end with the balloon payment of principal; this alone can commonly command an additional percent or two of interest just simply because of the convenience. This practice would not be popular with an investor depending on monthly payments for living expenses.
We have never found it necessary to charge prepayment penalties yet as the yields are usually good enough without them. Also, I have found that advertising no prepayment penalties generates many more borrowers and a larger selection of loans. It puts you a step or two ahead of your competition.

With or without a real estate license one can aggressively pursue even higher yields. You will eventually find the methods that work best for you.

If you would like to see the effects of accelerated yields compounded annually over a number of years, it's easy to do, and fun. Using a calculator, insert the expected annual yield, we'll use 25%, plus 100% (because you'll always get your original investment back), in otherwords 125% or 1.25, now multiply that times whatever the original investment figure is, for example $100,000.00. The first time you push the "equals" button, you should get $125,000.00 which is what you really would have at the end of the first year.

1.25 times or 125% of $100,000.00 = $125,000.00.

Each time you push the "equals" button on the calculator it will reveal what the investment will grow to compounded annually. Push the "equals" button 5 times and reveal what a one time investment of $100,000.00 will grow to at 25% simple interest, compounded annually, in five years! Pushing the "equals" button ten times will reveal the ten year total. Push the "equals" button twenty times to see what $100,000.00 will grow to in twenty years. (The one time $100K investment will grow to more than 8.5 million dollars in 20 years!)

Each time you push the "equals" button, it does the same function for you once again. As long as you put the 100% plus the interest rate in first of all, multiplied by the one time investment amount, the calculator will compute your total principal and simple interest compounded annually automatically each time you press the "equals" button!

If plotted on a graph, compounded yields keep increasingly approaching a vertical path. The line on the graph starts it's climb ever so slightly and then gets steeper and steeper at a more and more rapid rate. What I'm trying to say is that it would seem logical that if $100,000.00 at 12.5% compounded annually for 20 years becomes slightly over one million dollars, then it would also seem logical that the same amount of money over that same period of time at exactly double the interest rate, would become exactly twice as much (or over two million dollars). Right?? Wrong!! It becomes closer to 9 times as much because of the dramatic effects of accelerated yields compounding annually. I can't explain why, I can only tell you that it is true that a one time investment of $100,000.00 at 25% simple interest compounded annually becomes $8,673,615.10!!! This is a mathematical phenomena! Now, get out your calculator and have fun!!

I recall one example of a loan I made a year ago to a builder and a few months later he wanted to pay it back. I said, "Why don't you keep it?" I told him for a fee I would roll the note over to another property he was in the process of purchasing. Now, you would not want to roll it onto a worthless property; you'd want to be certain that you rolled it only onto a property that passed all of the usual safety check points.

Without the builder having to come up with the money to pay me off, he netted more cash money at the close of that particular escrow. Instead of him having to pay me in dollars, he was able to pay me in paper, i.e. with an IOU on another property.

It usually isn't good practice to roll money for people on a continuous basis if they don't have the ability to repay the loan as it will snowball and get them into trouble, this is known as the loan cycle. This builder was a little bit different than the borrowers dangerously caught in a loan cycle because this particular borrower had a plan and made it attractive to me. My original investment grew to more than four times itself in a year because the client moved it from one property to another property and I charged him points each time. I was glad I was able to help finance some of the forty homes he built and sold. He made himself an approximate 1.2 million dollar profit and I was happy too!

This particular borrower built 30 of those homes in only a two-year period and made himself well over a million dollars when the market here in California was still booming in 1989. He made a tremendous amount of money starting with no money of his own, so you can see how I didn't mind making a 400% profit on a small amount of my money in a one year period. It's easy to see that investors can expect to earn far more if they get involved.

We saw how $100,000.00 "ninety timesed" itself over a 20 year period. I don't know of any mutual fund, stock, or savings account that offers this. Your stockbroker certainly will not tell you this and I can guarantee you your banker will not tell you about these compounded yields because what this does is bypass them. You can eliminate the middlemen so most of the profits can go directly to you.

Let's take another example. Suppose you have a child and you want him to go to college. You know that you will not have $75,000.00 or more it will take to send him to college fifteen years from now but you can come up with $10,000.00 now and put it away. You go for a more aggressive plan of second trust deeds with higher yields. If you stay far enough ahead of inflation you should have enough to send him to college. ($10,000 invested at 11% interest compounded annually for 15 years will return $80,623.10.)

I knew one person who had $100,000.00 worth of credit on his credit cards. I don't recommend doing this, but I'm fascinated with the extremes of creativity some very aggressive people will go to. He borrowed an incredible amount of money at 18% interest on his credit cards and put the money out at yields of 25% to 35% interest on some aggressive, but very well secured third notes and deeds of trust. He made astronomical profits on the money.

Next to owning real estate, lending against it is the best investment I know of.

Maybe, you have a technique or twist to higher yields. Let me know as I'm always interested in creative proven new ideas that work.
 

WHAT THE HECK IS SUBORDINATION?

"To subordinate or not to subordinate, that is the question!"

As defined by Webster's New World Dictionary, Second College Edition

(to) Subordinate, adj.: l. inferior to or placed below another in rank, power, importance, etc.; secondary 2. under the power or authority of another.

As defined by Brad Evans, 24 yrs. full time as a broker in the school of hard knocks.

(to) Subordinate, verb: 1. to finance shortages of up front cash needed by a buyer or borrower and finance it with your (the sellers) real estate equity. 2. to have your equity dollars take a back seat to, or voluntarily accept a junior position to a new loan being originated for another. Subordination, 1. a double sided blade or potentially dangerous tool more and more commonly being misused these days by a few buyers or builders to finance their shortages of up front cash in a transaction and finance it with your equity dollars usually in order to buy or build a home with less cash. 2. a misunderstood vehicle being more and more misused by equity skimmers and scam artists to bilk gullible or less knowledgeable people out of their real estate equity before skipping town. 3. a wonderful tool that if respected, understood and used properly, can be of great benefit to buyers, sellers, realtors and contractors alike!
 
 

SELLER SUBORDINATE?

Oftentimes a seller of a piece of property will be asked to "subordinate" as a condition of a prospective offer to purchase. The seller has to then try to intelligently weigh the pros against the cons, pluses against minuses, and assess the risks connected with that proposed request for him to subordinate all or part of his equity. A seller must first understand what subordination means and how it will affect him and exactly what the risk consists of after closing and in the future. Only then, with a good understanding of the potential risks, can he or she decide if those risks are worth taking in order to meet a buyers request.

If you have been asked to subordinate and if you are fully aware of (understand) the risks and facts and you still are not comfortable, then you could ask the borrower for sufficient additional cash resulting in a reduction of the amount you have been asked to subordinate. Also, one could require sufficient additional real estate collateral (instead of cash) to further protect remaining interests being subordinated.

Oftentimes a buyer without a lot of money to put down on a property will be willing to pay more for a particular piece of property where the seller will agree to offer subordination because it will enable him to offer the construction lender first position without having to pay cash for the land he wishes to build on. A knowledgeable buyer might be attracted to a property where a seller would agree to subordinate his equity to that buyers construction lender. A seller who agrees to subordinate his equity would In effect be giving that buyer the sellers equity to use as collateral for obtaining construction financing.
 
 

RESTRICTIONS (NOT)

The request for the use of subordination isn't always restricted to the sale of vacant land or new home building however, and does occur within many types of real estate transactions. Any type of equity position can be subordinated. For example, a motivated seller could allow property that he owns free and clear to be pledged as collateral for a construction loan to a buyer's lender. The seller carries his equity as a second at close of escrow behind the buyers new construction first loan because the buyer's construction lender requires a first position for his new construction loan that will also be placed on the property. I've even seen a bank agree to subordinate a one million dollar first loan to eleven privately funded new first position construction loans brokered by me.

Not to dwell on the topic too much longer but suppose for example I sold you a one acre parcel of land for $50,000.00 with nothing down and carried a $50,000.00 first trust deed loan for you. You probably wouldn't be able to obtain a construction loan very easily in second position especially when having no equity in the property. Now, if you could have convinced me to subordinate my $50,000 first loan, you would then be free to offer any construction lender first position. Subordinating my interest (to second position) would allow you and your lender to use my valuable land equity as though it were your own. But watch out! Assuming for a moment that I did agree to subordinate my land equity for your new construction lender in the amount of $50,000.00 what do we have? ¡v?*¿!! A $50,000.00 lot with a $50,000.00 first construction loan and a $50,000.00 second land loan on it. This obviously would be the time to require additional cash and or real estate collateral to protect my interests from winding up being secured by blue sky! With sufficient additional cash and or real estate collateral my situation could have been well enough secured and you, the buyer, equally happy as you put your deal together with a lot less cash than usual, possibly no cash and 100% financing. All is well if I require enough additional collateral. For example you gave me a first on another home you own outright worth $100K. I'm protected and you got 100% financing, didn't you? 100% financing is neither illegal or immoral. After all, every veteran in the U.S. is eligible for a no down 100% V.A. loan if he can qualify because the government guarantees repayment of V.A. loans to the lenders that fund them (like another form of the above additional collateral).
 
 

WHAT IF?

What if I decide to sell to you as described above and subordinate for you, but instead you take the construction loan proceeds and instead of improving the property (by building a nice home there, greatly increasing my collateral to more than cover both loans), you skip town? Now I've got nothing because I gave my equity position to you to give to your lender. One year after escrow closes what if then subsequently the construction lender in first position has to foreclose and take back the lot (I could have taken the lot back, but what good is a $50,000 lot with a $50,000 construction loan on it, before or ahead of mine?) When would subordination ever be good for anyone? Well, believe it or not, as much as one out of every two or three loans I've brokered in the private construction lending business on average will entail some amount of subordination on the sellers part. If misused, subordination can be a lethal mistake for a seller. With knowledgeable buyers and sellers and sufficient cash and or additional collateral to protect a subordinator however, it can oftentimes be a wonderful tool, like a piece of rope or a double edged sword.

It is very important to see to it that the loan funds from the construction loan will be used to improve the property. If there is even the slightest chance that they might not, then anyone subordinating had better adjust the cash and or additional collateral he requires upward as if the borrower had no construction loan and never will improve the property from his equity standpoint. Just suppose for a moment that you could be guaranteed through the use of a voucher system or a reliable draw system that the borrower will (must) improve the property. In that case you may want to give some consideration to a portion of the future proposed improvements. As well as asking for additional cash and or additional real estate collateral to protect his interest a subordinator should require the borrower be on a voucher system or a draw system that says that the buyer has to use each draw release to improve the property at each stage or the balance of all construction money will be applied back to his loan as a principal payment and taken away from him. If that can be obtained then a subordinator should not count on any future improvement to the property as a part of the security for his interest subordinated. If a subordinator has required sufficient cash and or additional collateral, and has verified that a voucher or draw system will be in place he is still not done. At this point if I were agreeing to subordinate I would look very close at the loan I am going to be "subordinating to". When is it due? Does it have a balloon? What's the interest rate and monthly payment amount? Will a potential rental income cover the debt service should, after all this, I still be forced to foreclose to protect my interest and take over the responsibility of the new construction loan myself? If the construction loan has a balloon payment is it so big that I could never begin to handle it financially if I had to take the property back? And, if I have to take this project back when it's only half done, can I phone up some subcontractors to finish the job, and will the balance of the construction funds be adequate to finish? The agreement to subordinate could be made with a condition giving me the right to approve or even set limits on the loan amount, interest rate, and terms of that new loan I am to be taking a back seat to.
 

ONE LAST POINT

Banks spend a lot of time checking borrowers assets, incomes, savings account balances, car loans, verifications and loads of other not so relevant information when you consider that if a borrower tomorrow turns to the bottle, gets cancer, goes broke, loses his job and falls behind, none of that above stated information will matter more than the remaining real estate equity securing the loan. In a foreclosure situation as the lender you don't get his spouse's income, his car, sailboat, savings account, or anything else but the property. So, in my opinion, if you ever plan to be a lender or a subordinator it would make good sense to educate yourself as much as you can about the collateral. If the collateral offered in any real estate transaction isn't sufficient to protect ones interests, one should require sufficient additional collateral or simply refuse the offer.
 
 

POP QUIZ:

1.Is agreeing to subordinate (as the seller of real estate) always a risky, dangerous or bad thing to do?

(A) Yes, under all circumstances.

(B) No. Subordination is always safe.

(C) If a person knows exactly what the terms are of the loan they are subordinating to and fully understands their risks and knows exactly how all of the proceeds of any loan they are subordinating to will be disbursed to improve that property, then sometimes if they can make it profitable enough to themselves to off set some unavoidable risk, it can be beneficial to all parties. (So long as there is sufficient equity to protect their investment).

3.If I agree to sell my Real Estate to you today for 50 percent down and at the same time, I agree to carry the balance of the purchase price on the note and deed of trust and subordinate to a new 50 percent first for you, how much would your down payment be?

(A) Zero

(B) 10 percent.

(C) 50 percent.

(A) Yes.

(B) No.

(A) Subordinate prior to a close of escrow.

(B) Subordinate upon a close of escrow.

(C) Subordinate after a close of escrow.

(D) All of the above.

(A) True

(B) False

(A) Be willing to pay a little more money for the property.

(B) Put up additional real estate equity as collateral.

(C) Buy a particular property sooner.

(D) All of the above.

8.If someone subordinates away their real estate equity interests blindly, what could happen?

(A) They could wind up with no real estate equity securing their junior loan.

(B) The buyer could have 125 percent financing and cash back (in his pocket) at the close of escrow.

(C) They may not benefit by foreclosing.

(D) All of the above.

(A) The subordinators risks are understood and compensated for with sufficient additional cash down and or sufficient additional collateral.

(B) If both parties are aware of their risks and fully aware of all details as to what might be required of them in order to protect each of their interests at steak.

(C) If both parties in a sale transaction can mutually, intelligently, and carefully come to an agreement to purchase that includes subordination to construction financing it could be to both their benefit.

(D) If a seller who is subordinating is confident that all money from the loan he is subordinating to can only be used to improve the subject property (because of a proven draw or voucher system). And that the loan that he has agreed to subordinate to is a loan that he himself can realistically handle the financial responsibility of should he be forced to foreclose in order to protect his remaining interest.

(E) None of the above.

(A) True

(B) False

(A) Yes, if you want to foreclose and take the property back in order to protect your remaining interest.

(B) No, never. You can't legally foreclose.

(C) You can finish the property yourself without foreclosing and be guaranteed a big profit.

(A) Have to come up with the money to pay the new construction loan off in 6 mo. unless you can extend or refinance it.

(B) If you foreclose on your junior loan before the new construction loan is due you would own the property and could then use the subject property as collateral in a effort to obtain a new first necessary to pay off the construction loan.

(C) Possibly lose all of your investment if you are unable to take over the responsibility of the senior construction loan ahead of your loan should they foreclose.

(D) All the above.

(A) Ask that the amount of your equity being subordinated be reduced by asking for more cash as a down payment or future principal payment from the buyer prior to me subordinating

(B) Ask for sufficient additional real estate equity to be provided by the buyer/ borrower as additional collateral for your loan.

(C) Demand a higher purchase price for your real estate.

(D) Require a sufficient reduction the amount of the loan you are being asked to subordinate to.

(E) Ask for any and all of the above.

(A) No. The government to some degree even guarantees 100% loans for veterans.

(B) Yes.

(A) Any transaction where a party is allowed to skim a sellers equity by financing more than 100% of his purchase price against that sellers equity and sometimes even pocketing the excess proceeds at close of escrow with no intention of repaying the loan(s).

(B) A rebate incentive on buying a new car.

Answers to pop quiz questions:
 

1) C
2) D
3) A
4) A
5) D
6) B
7) D
8) D
9) A,B,C,D
10) B
11) A
12) D
13) E
14) A
15) A
 

"WELCOME TO MONEY MATTERS"

(Transcription of live interview video hosted by Russ Powell, former CBS television news anchor.)

Welcome to Money Matters. I'm Russ Powell. In our previous interview we examined trust deeds as a means of investing safely for high yield. Today's topic is Subordination. The dictionary definition of subordination is "to make subordinate, assign to a lower order or rank, hence to be of less importance." In real estate we have a tool which is called a subordination clause, a clause in a second or junior lien permitting retention of priority for prior items, and that's a pretty complicated phrase. Once again we are calling on our resident expert, Mr. Brad Evans, to discuss subordination as it applies to real estate. Welcome aboard again, Mr. Evans.

Thank you, Russ, I am real glad to be here.

Q: Can you break down for us in laymen's language just exactly what is a subordination clause?

A: Sure, subordination can take place anytime a person has any equity in a piece of real estate or any equity in a note secured by real estate, anytime they allow that equity to be used by another individual, reducing their rank, basically, climbing out of the front seat of a car into the back seat of a car, and giving another lender, like a construction lender, the front seat position--that is really what subordination is.

T: It benefits the seller: he is going to make more interest. It benefits the seller: he is going to sell his property. It benefits the buyer because he is going to develop the piece of property. It benefits the buyer of that new piece of property because they now have a new home and everybody wins in that situation. It is basically leverage financing like you read about when one corporation buys out another or when employees of a corporation buy out the stock of a corporation, that is all leverage too, that's a form of subordination.

Q: What are the circumstances which would bring subordination about? Is it brought about by the buyer or the seller? Or can it be brought about by both?

A: Subordination is most commonly used when people want to purchase a piece of property and maybe build a home there and they don't have the cash or the assets to pay cash for the land and pay cash for the improvements, the buyer would, through the use of subordination, be able to use the seller's equity in the land to attract a construction lender.

Q: Then what would be the motivation for the seller to enter into this kind of arrangement?

A: If subordination is done properly it can enable a seller many times to attract a buyer for his lot much sooner than possibly a seller who was asking for all cash would be able to.

T: Today in the real estate business you really need to know about all different types of financing. To be competitive, much less even to survive, you really need to be well versed in all types of financing. I know that over the past 14 years there has been many occasions when private investors and private financing has come into play to put together construction packages, acquisition of lots, all types of different avenues have been made possible through the use of private investors and private money.

Q: What about the advantages for the buyer? What are the advantages for him, other than getting the use of that equity? Is there any other advantage? Another factor involved, are there monetary limits in how this can be accomplished?

A: Subordination can be a wonderful tool for a buyer of real estate because they are able to, in effect, use that seller's collateral and they are able to buy a property or build a property with less money down, less money out of their own pocket. In some cases, no money.

Q: What are some of the things that both the buyer and the seller would be looking at before they decided to take this kind of action?

A: Subordination is a double edged sword, Russ. It is something that if used properly it can be a magnificent tool for both buyers and sellers of property, but if it is used improperly, the results can be devastating for both parties.

Q: What are the specific dangers that the buyer might encounter with this type of transaction?

A: Probably the worse danger involved in subordination is over financing. A buyer may, through subordination, be able to obtain a piece of property and build a home for little or no money out of his pocket and if that buyer is in a position to make the monthly payments on the loans, that's fine. But subordination could, in effect, enable the buyer to bite off more than he can chew.

Q: What would that entail? How would he be aware of that fact going into the transaction, or would it be just an accident, or circumstances that would prevail later on that maybe he ran short of funds or something like that. What are the circumstances involved?

A: In my opinion, it would be really up to a seller to check as to whether or not the buyer had the ability to make the monthly payments or handle the monthly payments on the land and the construction loan.

Q: Is there a formula for that they would be engaged in?

A: A common formula is three to one. In other words, adding up the payments on the land and the construction loan and then multiplying that by three. The buyer should show that he can make at least that much money per month and has the ability to make the payments. Otherwise, then the seller will be in a position where he will have to take the property back and start making payments on that construction loan, and we wouldn't want that to happen.

T: I was offered full price if I would accept a subordination agreement. On the loan that I carried I received an above market interest rate and I gained certain tax advantages by subordinating rather than taking a full price sale. I should have been paid on the loan I carried six months ago. The purchaser is now bankrupt. He is in a bankruptcy proceeding and the bankruptcy court informs me that I am now an involuntary investor with this bankrupt individual, I'm not receiving my interest and the principal payment has been prolonged indefinitely. It is a very untenable situation financially. You are simply in limbo for the period of the bankruptcy proceedings.

Q: It would seem to me from what you have said so far that the man really at risk in this kind of transaction, the one who bears the most risk, is the seller. What specifically does he stand to lose in the event this thing goes sour?

A: If the seller agrees to subordinate in order to get his property sold and in effect he agrees to get out of the front seat basically and climb into the back seat and let the construction lender or whoever he is subordinating to have his front seat position. You can see, for example, that is the proceeds from that loan that he subordinated to were misused, if the buyer got the seller to subordinate through a loan on there and took the money and ran or took the money and bought candy bars with it or paid off his bills or took a wonderful trip to the Bahamas, then the seller would have this large note ahead of him that he had subordinated to, and suddenly there would be nothing to show for that--no new home on the property--and the results could be devastating. Also, that seller who climbed into the back seat would then have to make payments on that large loan that was ahead of him that he had nothing to show for. Basically, all of his equity could be gone in that property if he subordinates and isn't assured or doesn't take the steps necessary to make sure that money is used for what it is suppose to be used for.

T: Would I recommend subordination? I would, under the following set of circumstances. One: if the purchaser of the property is putting a minimum of half down on that property. Two: if the purchaser of that property is going to owner-occupy it as opposed to a speculation project. Three: if I am in a financial position to easily pay off any loans that are underneath me. Only under those circumstances would I subordinate.

Q: Isn't there some provision available whereby the seller could make sure that the money that is given for this specific purpose is used for that specific purpose?

A: There is many different ways. We wouldn't have time here to go into them. But, for example, if the seller of a lot subordinates to a construction loan that is being handled through a bank, for example, and the construction loan proceeds were doled out on draws as work progressed, then that seller who had climbed in the back seat would be assured that money would go out into the improvement of the property, and it wouldn't in any way be able to go out to the buyer's pocketbook or, you know, for some other reason or go out for the wrong thing.

Q: Are you saying then that under that set of guidelines, for example, that the money would be released periodically, like when the foundation was poured and then when the framing was done- that sort of thing?

A: Exactly, a draw system of some sort or a voucher system of some sort, so that seller who subordinates and climbs into the back seat can be assured, guaranteed without a doubt that money will be put into the project or it won't be put out at all.

Q: We've pretty well established that the seller is the one who is most at risk in this type of transaction. What are the basic things he should do to make sure that his investment is not going to go awry?

A: If the seller is asked to subordinate, probably the first thing the seller would want to do is to establish that the buyer had the ability to make the payments on the loan that the seller is asked to subordinate to, first of all. And secondly that the proceeds from the loan, that the seller is asked to subordinate to, will in fact be used to improve that property and will not be used for the buyer's personal benefit or to pay his bills off or to go into some other property.

Q: There is a way to make that possible by drafts that come out at a certain time for basic things that are done in the construction. Is that right?

A: Yes. If a person subordinates to a bank construction loan they can generally be assured the bank will dole the funds out either in draws as work progresses or in vouchers, but it would still be very important for that seller subordinating to check and see how the money is going to be handled, how it is going to be doled out, so that he could be assured that there is a draw system or a voucher system of some sort.

Q: There are obvious advantages for the buyer in this type of an arrangement. Basically, what are the advantages that accrue to the seller?

A: There is a tremendous advantage for the seller if subordination is used properly because he can attract many more buyers for his property, first of all, because it takes less money for them to get in, get started and build a home there. Also, he can ask for things like a higher interest rate in exchange for subordinating. Also, a seller could ask for maybe a large cash principal paydown on the loan in exchange for subordinating, and lastly, he could ask for a higher price, higher sales price, on his lot in exchange for subordination.

Q: What would be the motivation for a buyer to get into a subordination process when he may have to pay a higher interest rate and more money down? Why wouldn't he instead go to a commercial bank or savings and loan?

A: Picture yourself wanting to build a property, build a home. Picture yourself right now having the need to move or the need to build a new home or the desire to build a new home and you don't have enough cash right now, and you're faced with the choice of either finding a seller who will subordinate because you don't have the cash to pay cash for the land and pay cash for the construction, and so it would boil down to a choice of either you could do it now with subordination or you would have to wait until maybe some later date when you accumulated the money. Given that choice, there are plenty of people now who would hunt for subordination and want to build a home now with little cash rather than have to wait the years necessary to save up the cash to pay for the lot or the home.

T: Another valuable aspect of private money is the time frame involved. I know that we have had deals and transactions over the years that required a very quick turnaround and less or more conventional money has always taken a lot longer through the appraisal process, through the pages and pages of paperwork involved. I think that has certainly allowed me over the years to pull together many transactions in a much more timely fashion than if I had not used private money.

Q: You're saying that I have bought a piece of property and I am making monthly payments on it and this would be an expedient way for me to get into the construction of a home?

A: Exactly. If you could convince the seller o