There is a reason real estate investors can make money by picking up cheap defaulted property from the banks.  Banks need to get rid of those foreclosure properties.

You may think that negotiating with banks in order to get them to give you a discount on their property is practically impossible!  It is possible and real estate investment deals go through with the bank every day.  Here’s why.

Why You can Get Discounts on Default Properties
Banks are rated in their ability to work out deals with homeowner in default.  That means they are rated for how much cash they hold in reserve to cover each mortgage should it default and how well they work with the homeowner in order to keep a property from foreclosing.  Some banks may hold as much as 8 times the default mortgage in cash reserve, which for a standard $100,000 mortgage is as much as $800,000.  They are required by law to cover that mortgage in case it goes sour. The banks can’t use this money, invest this money and they certainly can’t use the property.  It just sits there tied up for as long as that mortgage is in their books.

So a bank will accept a short sale on a property or a mortgage note purchase primarily because of the reserves they are required to set aside.  They want that money freed up so they can invest that reserve money and make profits. 

Your best deals come from the bank right before the end of their fiscal year or right before their auditing. 

How eager the Banks are to get rid of Default Properties!
A particular real estate investor was interested in a small home in default.  The investor began discussions with the bank that held the homeowner’s mortgage to see if they could negotiate a deal.  He was holding out for a sale price of $37,500 on this property and he wanted to make the sale as a note purchase.  The bank was being difficult.  They didn’t want to sell the property that low and they wanted a short sale deal on this property.  The deal didn’t work out all three parties went their separate ways.

About 6 months later the bank calls the real estate investor back up to see if he is still interested in buying the property.  They were willing to let him have his previous price of $37,500 and let him have the property mortgage through a note purchase.  In fact the bank needed to do a note purchase. 

They had foreclosed on the homeowner during those 6 months, but neglected to show up at the sheriff’s sale.  This naturally messed up their foreclosure. 

The only way they could sell the property was by a note purchase.  There may have been a lot of investors interested in this property, but because the investor had been holding out for a note purchase six months prior the bank remembered him and called him up to see if he was still interested in investing that property.  Even better the investor saw what a pinch the bank was in and managed to negotiate an even lower sale price on the note purchase of $30,000.

Banks are not in the real estate business, they are in the money lending business.  The only use foreclosure as a last resort to recover some of their money.  This process takes a long time though and it’s messy.  Banks are much more willing to sell the property, work with the homeowner or take discounted short sales and note purchase deals to recover their loan.

When working with a bank on a short sale you may find that the bank is insisting on the right to file for a deficiency judgment against the homeowner for the write-off amount.  However, it is possible to stop the banks from filing a deficiency judgment!

The homeowner can end up in trouble even when you work with them to purchase that foreclosure property.  There are many steps to the arrangement of a real estate investment deal, so it’s easy to forget a few little details, such as the deficiency judgment!

Lots of times in a short sale, the bank will agree to your offer, saying, ‘alright, we’ll take your deal and sell you the property for $60,000, but we’re still going to get a judgment against the homeowner for the remaining mortgage debt.”  This debt on a mortgage of say $100,000 can be $40,000 that the homeowner will still be responsible for in the face of a court ordered deficiency judgment. 

A deficiency judgment basically says that the homeowner is still responsible for the remainder of a mortgage to the bank, when that bank sells the property for less than the mortgage.  Banks are required by law to either get a deficiency judgment on the property or send the homeowner a 1099 Form showing the bank’s write-off of $40,000 as income for the homeowner.  There are ways to deal with the 1099 Form so that the homeowners on the foreclosure property don’t have to pay taxes on that ‘income’.  However, a deficiency judgment can attach itself to the homeowner’s new property mortgage if they get another home and can remain with the homeowners for up to 2 years. 

It’s very important to negotiate with the banks to also keep them from filing that deficiency judgment when the property sale goes through.  Sometimes you’ll come across a bank that just insists on filing for that deficiency judgment.  They may have their reasons, but it is a big problem for your homeowners and your deal. 

Stop the Deficiency Judgment by Becoming the Bank
You can avoid this deficiency judgment for the homeowners by buying the mortgage note from the bank instead of the property.  This way you become the bank because you hold the mortgage.  Changing the short sale deal to a note purchase is a simple matter and all you need to do is get the bank’s agreement on the deal.

If you are the bank, you have the right to decide if you will be sending the homeowners a 1099 Form or if you will be getting a deficiency judgment against them.  Which way do you think you’ll go?

Of course, you’ll opt to send the homeowners a 1099 form instead of getting the deficiency judgment. A big part of foreclosure investing means working with the homeowners and helping them out of a problem mortgage.  Plus, it’s a lot less work to send the 1099 Form.

You may feel that you need a lot of capital before you can start investing in mortgage notes.  However, it’s possible to use someone else’s money to make the deal go through and still get your profits!

Mortgage notes are a great way to invest in property and make an even higher return that with other types of property investment.  Plus, there is a way you can buy a homeowner mortgage using someone else’s money.

How to Find the Money
When you are working as a property invester with a mortgage owner to buy their mortgage from them, you’ll have the owner sign a “Note Purchase Agreement” to lock them into selling you the mortgage to a property for a certain amount of money. 

In this note purchase agreement, make sure that you include a certain period of time for due diligence.  This is to allow you to get your trait report and head down to the court house to check for any other liens on the property.  Make sure that your due diligence period is between 45-60 days to give you plenty of time.

While you are carrying out due diligence, you will also be looking for another real estate investor to give you cash to buy that mortgage note.  There are plenty of places to find investors, one mortgage investor in particular goes to her local real estate investing club.  Here she gets a chance to present potential mortgage note purchase deals and get investors. 

So, you attend your local club and meet a real estate investor who is looking for a 14% percent return on her investment. 

Quick Tip:  The investment and the return are inversely proportional.  The less money you invest, the more money you make on your return. 

How it Works Out
Say, you are buying someone’s $87,000 mortgage note for $70,000, that means you’ve just earned $17,000 profit in the long run.  That’s about a 24% return on your investment.  All you need to do to continue making money without spending your own is find another real estate investor who is looking to invest their money and get a slightly lower rate of return.

At the real estate club, you meet just such an investor.  She only wants a 14% return on her money investment for the property mortgage. 

So, you buy the mortgage note from the owner at $70,000, then turn around and sell it to the investor for $74,820.  That leaves about $4,000 in profits for you to pocket from your involvement in the deal.  The investor is going to make a profit too, because her mortgage note is worth $87,000 even though she only paid about $74,000.

By looking for your own investor for your mortgage note purchase you can still make money on the differences in percentage.  You’ve got to pay careful attention to the percent of return for yourself, the mortgage owner and your investor, but you can make money by setting up the sale!

You may come across properties with multiple mortgages in your real estate investing.  These property deals can be a real hassle, but it is possible to negotiate with the multiple mortgage holders.

Sometimes you’ll come across properties in your real estate investing that have multiple mortgages.  In order to get your discounted sale on this property you’ll often need to negotiate with each mortgage holder separately.  This can get difficult.

Negotiating with the First Mortgage Holder
Usually it becomes a real hassle when you negotiate a short sale deal with the first mortgage holder, which is often the bank.  The bank may say, okay we’ll let you purchase this property for $60,000 and we’ll take a $45,000 write off on the mortgage.  However, since we’re taking such a big write off, we’ll only let the second mortgage holder take a $1,000 for their claim to the property. 

Remember, when it comes to property sales, its first come, and first serve.  The first mortgage or lien holder on that property gets control of that property, that mortgage and gets to say what everyone else behind him gets for their claim.  This may be all of the cash or it may be none. 

As you can imagine the second mortgage holder won’t take too kindly to this deal.  They’ll probably hold up the short sale by telling you that they won’t sell unless they get $5,000 for their claim, instead of the $1,000 that the bank wants them to take.  Many real estate investors stay well clear of properties with multiple mortgages, but it’s possible to make the deal work.

How to Get around this Conflict
You could spend your time as a go between for the different mortgage holders, trying to get everyone to get along.  Or you can just make a note purchase! 

Rather than making a note purchase for the first mortgage you buy the note on the second mortgage!  That’s right, go ahead and pay the second mortgage holder the desired $5,000 for their position as second mortgage holder.  You become the bank again and willingly accept $1,000 for the short sale.  Thus, the deal can close and you don’t have to waste valuable time being the bank’s gopher.

Any time you run into an obstacle in a deal, you should ask yourself, ‘what would happen if I bought the note?’   Can’t get the second mortgage holder to accept the bank’s offer?  Buy their note!  The bank won’t let you give the default property holder a little cash for their trouble?  Buy the note!  It’s an amazingly easy way to think outside the box and still make your money.

The homeowner can’t have a clean get away after a short sale on their defaulted property sale.  They’ll have to face the possibility of a judgment for the remainder of the mortgage or having to deal with the IRS!

When you are negotiating a short sale or note purchase through the bank on a defaulted property it’s easy to overlook the possibility of a mortgage judgment being filed against the homeowner after the sale.  It can be common practice for a bank to file a judgment against homeowners fro the remainder of a mortgage after a property has been sold for less than its mortgage.

A typical short sale involves negotiating with the bank to let you buy a property at a lower price than what is left owed on the mortgage to the homeowners.  This allows you to pick up a property cheap, the bank to unload a mortgage that the homeowners just can’t make payments on and the homeowners to get out from under a mortgage that’s downing downhill fast.

What Happens after the Short Sale?
Sometimes you’ll find that the homeowners don’t get away from this deal as Scott-free, as they were led to believe.  The bank may say okay, we’ll let you buy this mortgage or this property for say $60,000 when the homeowners still owe $100,000, but we’re also going to court later on to get a judgment against the homeowner. 

This judgment against the homeowner basically says that the now former homeowner still owes the bank $40,000, which was the amount of the write-off the bank took on the sale of that property to you.  That judgment will remain attached to the homeowner for 2 years and can really mess up their ability to get into a new home.  It can also attach to another house that the homeowner buys after selling you the property.  So the homeowner automatically gets a $40,000 debt tacked onto their other mortgage.

The bank can also decide not get a deficiency judgment against the homeowner for the write-off on that defaulted property.  While you are negotiating with the bank for that property you can also negotiate with them to not get that mortgage judgment against the homeowner.  When the bank doesn’t get a judgment, it is required to send out a 1099 form to the homeowner.  This 1099 form shows the $40,000 write-off by the bank as income for the homeowner for that year. 

What to Do about the 1099 Form?
As you can imagine, most homeowners will be terrified by this possibility.  Either they get a deficiency judgment against them for the remainder of the mortgage or the IRS views that $40,000 write-off as income.  Be sure to tell the homeowner, that when they get this 1099 Form they need to see their CPA or someone who is certified to do their taxes. 

The CPA will be able to tell them how to work with the IRS, so that this 1099 isn’t shown as income.  The homeowner may qualify for an ‘exclusion’ from the 1099 for selling their own home if they have lived in that home for the past 2 out of 5 years. 

In addition, there is a Form 982 that the homeowners may be able to fill out that shows they are ‘insolvent’ and have no funds from this sale. If they qualify through this form the IRS may not require them to pay taxes on that $40,000 write-off. 

Don’t blame the banks for this little predicament that can pop up and ruin the homeowner’s deal.  They are required by law to get a judgment against the homeowner or to send out a 1099 form to the homeowner.  Just make sure that you lee the homeowner know in advance that if they take the short sale or note purchase deal they will face one of these two possibilities.