December 27, 2010
Blast From the Past #2
The blog below was originally posted on March 24, 2008. As important as documenting your borrower's pay history was back then, it is arguably even more so now. I've inserted some December 2010 comments in parentheses.
Your borrowers have fallen on hard times and are looking to take advantage of your kindness until they can "get back on their feet." No problem - you're a nice person...but will your kindness end up taking a bite out of your backside?
Last week I discussed the impact of credit scores on the marketability of a real estate note. This week I'm going to focus on the pay history. The pay history is a good measure, for any potential investor, of the likelihood of continued payments once they buy your note.
In the privately-held note market, investors rely on the pay history to compensate for other deficiencies in the documentation; most often with regard to the lack of an application, job/income verification, etc. Keeping accurate records of the payments you receive, therefore, is paramount in order to get the best possible price for your note.
Most privately-held notes in the western United States are serviced by a 3rd-party servicer. They collect the payments, deduct a small servicing fee, and forward the rest of the payment to the noteholder. The pay history is therefore documented by a disinterested third party, and from an investor's perspective, is the most favored way to document the record of payments.
For noteholders who collect the payments themselves, we suggest they document, on an ongoing basis, the date the payment was received, the date it was due, and how much went to principal and what went to interest. To supplement the ledger, we suggest keeping your bank statements showing the monthly deposit, again to demonstrate a 3rd-party's documentation of the payment. (This third-party proof of payments is the difference between being able to sell your note and being stuck with it until maturity, especially if your borrowers have had credit challenges.)
Getting back to the opening line of this blog - what happens when your payors can't pay you on time? My advice to you - bend, but don't break. Tell them you'll extend their grace period (before you charge a late payment fee) a few days if that's all they need. If they need more time, do all you can to collect what is owed in the shortest amount of time possible. Otherwise, the value of your note to any potential investor will be severely affected by the default potential of payors who historically have trouble making their payments.
My experience has taught me that "If you give an inch, they'll take a mile." Some borrowers need almost constant reminding that making late payments is a breach of contract; or, to put it more succinctly, a broken promise. They signed a note saying they would pay you on a certain day of every month. If they don't honor that agreement, and you don't enforce it, you may very well end up with a borrower that pays only what they want, when they want to. Whether your borrower is a family friend, a relative, or just someone who seemed 'really nice' when you sold your property, be sure to follow the mantra of The Godfather..."it's not personal, it's just business." And your business is to make sure you collect that payment every month. (Remember, never negotiate anything without getting something in return. In other words, don't accept a late payment without some form of recompense from the borrower.)
Pay history makes up one-third of the 'Big Three' of privately-held notes - the other two are credit, which we've already discussed in an earlier blog, and property, which will be our focus in next week's blog. A well-documented pay history just may be the difference between an excellent offer for your note and no offer at all. Which would you rather have?
Make it a great day!
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