Why are payment histories so important and how they can help or hurt my investment? Why should I keep track of my borrower payments? Why should I charge late fees? Why should I not accept cash payments? Do I really need a separate bank account for my business? Read on to learn more about the importance of payment histories to your Note’s investment value!
INTRODUCTION
In the Note industry, payment histories are the clearest way to communicate the performance and the value of your investment. Since there is no central depository of trusted information, the value of your Note is determined by information you can provide. Creating a clearly defined and repeatable process for accepting payments will go a long way to guarantee the success of your Note. Conversely, if you do not follow a set process to accept payments, you can severely affect the Note value resulting in lower resale offers and/or refusal of potential buyers to even make an offer.
PAYMENT HISTORY IMPORTANCE
A payment history is defined as a documented record of borrower payments received during the life of the loan.. As mentioned above, payment histories allow the seller and buyer to have a starting point for discussion and price negotiation.
Note Value – Notes are not sold on the open market, so there is no real verifiable mechanism to compare one note to another. When attempting to identify this value, one of the first steps is to review the documented payment history. Most investors will not accept a “word of mouth” comment that the borrower is paying monthly. By following a solid payment history generation routine, will ensure the value of your Note is the highest possible!
Note Resale – As mentioned above, there is no open market for Notes. So, when you are ready to sell your Note, an investor requests a solid and verifiable payment history. This payment history can improve the value of a note as it provides proof of timely payments. A payment history is considered verified when it is either provided by a third party or is backed up by full documentation and records as outlined below.
PAYMENT HISTORY GENERATION
While the term payment history is mentioned a lot in the Note industry, it is important to define how to put together a solid payment history. Below are the steps in creating and maintaining a solid and verifiable payment history for your Note. Establishing this payment history process at closing will ensure you fully understand your Notes value and will maximize any future resale!
Safeguard Key Documents – At closing, you will receive numerous important documents. Make sure you get electronic copies of each document and put the hardcopies in a safe and secure location. For payment history, the key documents will be the actual Note and the amortization.
Payment Receipt – If the closing documents do not clearly show where to send payments, make sure you clearly communicate with the borrower the location to send payments and the different ways you will accept payments. Checks are the traditional means of loan payment. Checks are great since they provide an immediate 3rd party verifiable confirmation of payment. There will be a record from both the paying and receiving banks, with the check showing key information like payee, payor, amount, date and deposit date. Checks are the most highly regarded form of payment. Other options include money orders, wire transfers and new online banking applications. Remember, the key is to have documentation from a 3rd party.
Issues with Cash Payments – We wanted to make a special note about cash borrower payments. These are the most unreliable and least regarded form of payment in the Note industry. In a cash transaction, there is no 3rd party verification. If you choose to collect in cash, we strongly recommend that the borrower will take the cash to a branch of your bank and deposit directly into your bank account. Another means to provide documentation is to purchase a payment deposit receipt book. For each cash receipt, make sure to document the receipt date, the amount and have both the borrower and loan owner sign the receipt. Most books have carbon copies so give one to the borrower and keep the other with your safe records.
Proof of Payment – When payments are received, it is highly recommended to make a copy of the check for your records. This copy is critical in providing 3rd party verification at a future date. The copy will also allow you to document when the payment is received.
Bank Account – When a payment is received, the payment should be deposited in a bank within 1 to 2 business days. It is highly recommended that you create a separate account for your borrower payments and deposit into this account. While some people comingle with a personal account, this practice can become problematic from an accounting perspective and open your personal accounts to future inspection and scrutiny.
Amortization Update – With each payment, the Note’s amortization must be updated. There are many ways to track and update the amortization from manual ledgers to spreadsheets to software applications. Each of these methods can be used, but the key is to pick a method that you are comfortable with completing for the life of the loan. The starting point should be the amortization received at closing. Make sure that after each monthly payment, you make an entry and update the outstanding loan balance.
Late Payments – We wanted to make a special note about late payments. Often, Note holders will excuse late payments and just be happy the payment is made. This practice may hurt you in the future. First, you are training the borrower that a late payment is acceptable, regardless of the date due. Second, you are losing potential late fees that can add up over the life of the loan. And finally, a future investor comparing two Notes will always pick the Note where the borrower pays on time.
Annual Reporting – By keeping a solid payment history and making amortization updates, you will be able to produce annual reports for both borrower interest paid (IRS FORM 1098), interest, and late fee income earned (IRS FORM 1099). Not producing these reports will get you into trouble with your taxing authorities.
SUMMARY
Documented payment histories are a key item in the Note industry, giving investors the ability to review loan performance and compare to other loans. Unfortunately, many Note holders fail to keep a solid and verifiable payment history. This fact can hurt the overall value of the Note and greatly limit the potential resale of the Note. By following some basic and repeatable steps, you can build a trustworthy payment history that can improve the value of your Note.
Remember, there is no open market for Notes, so it is important that you create a solid and transparent payment history that will ensure your Notes value and future resale potential!
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