Posted by John Behle on October 19, 1998 at 12:39:09:
Early payoff is the primary reason I use the compensating note technique for partials. If I buy the whole note and give part cash and part note, I can end up keeping early payoffs if it is set up correctly.
If the only collateral available is the note you are purchasing, then a substitution of collateral clause can serve the purpose. So, I get notice the note is going to pay off and I arrange to substitute some other note or collateral. If another note was not readily available, arrange a simultaneous closing and use the pay off money to buy a larger note.
I have found that it is much. much easier to arrange a substitution of collateral from the very beginning. When the seller of a note or property is needing to sell, they are motivated. Giving them other collateral from the very beginning isn’t that hard of a challenge. Coming to them later - after you have solved their problem and taken away their need to be flexible - doesn’t work as smoothly.
So, here’s an example I structured with a client. A note holder needed $4000 to pay taxes. Their note was $10,600 with payments for 6 years then a balloon. My investor and I arranged $4000 cash and a note against one of the investors condos - due in 6 years at the same time as the balloon. Nothing in an early payoff of the note purchased requires any early payoff of the note on the condo.
By the way, it freed up “dead equity” in the condo and actually made it more saleable with this attractive second (easy interest, no payment for 6 years).
The note purchased is free and clear and can be sold, traded, improved, paid early, etc. I view an early payoff as selling the note at a better yield to the best buyer possible - the payor.
The average long term note pays off in as little as a 4-7 year average. A little discount or even paying the costs for a new loan very readily encourages an even earlier payoff. Even ugly notes always have one potential buyer - the payor. It’s amazing how little sellers or even brokers try to broker the note to the payor. Of course, there are ways to protect yourself from getting a “commission-dectomy” done to you by the payor and beneficiary.