Posted by John Behle on October 09, 2007 at 12:50:50:
There are few potential problems. Here are the ones that come to mind.
Losing position. Substantially altering a note could be done in a manner that you could lose your position or jeopardize it. So, first rule is never cancel out a note and create a new one if possible.
Losing established time period. You may have a secure note that was recorded three years ago and then lose that time period by substantially altering the note or by canceling the old note and creating a new note. Then issues like bankruptcy can affect you more painfully. Recent transactions have the potential to be overturned or set aside by the bankruptcy court.
“Buyer Remorse” - you could run into the possibility that the note payor, one of their relatives or someone might think the transaction was not beneficial for them. Pretty remote, but possible.
Paying too much. You should alway buy a note based on what it is worth now, not what it might be worth if it were altered or fixed. Only if you have it tied up and secured contractually can you consider paying more.
Example. We had a note that was a great LTV, seasoned for several years and a great payment history. A good note, but they wanted more for it than I was willing to pay. It had 28 years to go under a full amortization, so mathematically it wasn’t worth even 50% of face.
But something jumped out at me. The property was for sale and the note had a due on sale clause. So, it could go as long as 28 years, but could go as short as 28 days. Even though I know the chance of this note going the full 28 years is remote, I can’t buy based on possibilities - that is speculation.
The property was for sale and not selling because of the DOS clause. The thought hit me that the DOS clause was a problem for everyone. So, I could offer to take the clause out in exchange for a five year balloon. Also, a raised rate, raised payment, or graduated payment would also be a good trade off.
So, you can change a note to make it more valuable before you buy it.
As far as other risks, nothing else comes to mind at the moment and these ones I have pointed out are rare, theoretical risks. I haven’t had problems with them though I have avoided the first two right from the start.