Why do I need to keep copies of payments? Where is the original paperwork associated with my Note? Borrower just called and said they had a fire, is the insurance current? I need to contact my borrower, why can I not reach them? To avoid these pitfalls and many others, develop a process to complete key maintenance items to ensure the success of your Note!
INTRODUCTION
While collecting monthly payments from your Note is best part of Note investing, there are certain maintenance activities that should be done throughout the year to ensure your investment continues to be successful in the long term. At the beginning of the year, the focus is on IRS driven reporting.
In the 2nd half of the year, it is good to go through a quick checklist of actions including accounting, taxes, insurance, property inspections, and borrower information. While each action is relatively easy to complete, many investors wait years to complete these items only to discover their investment performance has suffered.
Take a few minutes and go through the following items every year to ensure the long-term success of your investment!
CHECKLIST ITEMS
Amortization
The amortization allows you to quickly understand the value of your investment. At closing, you most likely received a copy of the amortization for the entire length of the loan. This is a key document to hold. During the life of the loan, the monthly amount of interest paid decreases while the amount applied to principle will increase. There are many ways to track using a manual ledger, a spread sheet or a software application. Take the time at closing to understand the amortization schedule and decide how you will track over the life of the loan.
Payments
When you receive monthly payments, there are a few key steps that you should complete. When a payment is received, ensure that you are tracking the date received from the borrower. If receiving checks or money orders, make a copy before depositing. If collecting cash (not recommended), buy a receipt book and start providing a receipt coupon for every payment. While not required, it is highly recommended that you have a separate bank account for depositing payments.
Each payment has two parts: Interest and Principal. The interest is important to track so you understand how much money you are making annually. Unfortunately, this amount must be added to your tax return. In addition, this amount must be report to the borrower annually on the IRS FORM 1098. The principle amount is used to reduce the overall balance of your borrower’s loan, often referred to as the unpaid balance (UPB). This number will be key if you ever want to sell your loan or if the borrower wants to pay off the loan.
Property Taxes
All property is taxed by local taxing jurisdiction, normally counties. While different in every state, there will be two important dates: the assessment and due date. Make sure you understand both dates (put them in your calendar for easy reminders). The assessment is the date where the taxing authority states the annual value of the underlying property. There is normally a period allowed for appeals to dispute the valuation before the actual bill is received. The due date will be the date that the property tax must be paid. Some jurisdictions or taxing districts will give a discount if you pay early but the due date is the key date to watch.
To check payment status, you will need to contact your local taxing authority. Most authorities have online access to this information. Although the payment status is very easy to check, it is the most frequent issue found when we review Notes. If the taxes are not paid, then the taxing authority will sell the delinquent balance to investors at a negotiated interest rate, and a lien is placed against the property. Depending on the jurisdiction, if the taxes are not paid, the property can be sold at auction and your Note investment will be completely wiped out, leaving you with nothing more than paperwork with no value!
Insurance
Property and hazard insurance is the key safeguard against unknown risks and peril. Most mortgages require the borrower to maintain this insurance to protect both them and you against the forces of nature. Most policies are reviewed and renewed annually. Make sure you note the policy’s effective date and add the renewal date to your calendar. You should require the borrower to provide an updated policy each year and then verify you, as the loan holder, are named on the declaration page.
Property Inspection
The appearance of the property can tell a lot about how well the borrower is maintaining the home. Often, a simple drive by can provide valuable insight and can also give updates about the surrounding neighborhood. The visual inspection can be done by a 3rd party but remind them they cannot enter the property or the lot. If the property appears to be neglected or run down, make a courtesy call to the borrower and to better understand the situation. Adding a maintenance clause to the initial mortgage is a good idea. It is good practice to check if there are any code violations.
Protect Documents
Often after settlement, Note holders are so happy to close they do not pay attention to the paperwork. Make sure you have hard copies of all documents and ensure they are put into a safe and secure location (like a fireproof safe or a bank lock box). In addition, make sure to get electronic copies of each document individually and store them in an easy to access location. These electronic copies will be valuable during the life of the loan when times arise that you need to provide information quickly!
Borrower Information
Borrowers move homes, change phones and emails all the time. A good practice is to reach out to the borrower and check in. This step will ensure an open line of communication if needed in the future and ensure you know how to reach the borrower in the event of an emergency.
Servicers and Escrow
While not required, these two maintenance items will make managing your Note significantly easier.
Servicers are certified companies that handle all borrower communication while handling the payments, amortization, property taxes, insurance, escrow and tax reporting. For a small fee, Servicers will manage the basic administrative tasks necessary to maintain your Note and send monthly payments to your bank account. See the following article (How can a Servicer help to maintain my Note and free up my time? ) to learn more about Servicers.
Escrow is a concept of collecting annualized payments in monthly installments. This escrow amount will be added to the borrower’s monthly payments for such items as insurance and property taxes. In the initial mortgage, an escrow clause must be added before you can collect escrow in the monthly payments. The escrow amount must be clearly identified, with detailed reporting and holding funds are required. Each state does have different regulations so be sure to check before starting to collect escrow.
SUMMARY
As with an investment, a seller financed Note requires ongoing management and attention. Whether you choose to self-manage or use a Servicer, the items listed above are keys steps that must be taken to ensure the long-term success of your Note. We cannot emphasize enough how important these steps are to maintain the value of your Note and protect your investment!
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MEETING
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