The Truth About Note Servicing

"What In The World Is Note Servicing"? This is the most common question asked by attendees at the convention when visiting our booth.  To put it more bluntly what they ask is:  "So, what do you do anyway?"

I guess it's a fair question, after all, It makes sense to have your car serviced which could involve changing the oil, charging the battery, a grease or tune up or maybe a brake adjustment.  In case you're asking, the answer is: No, a note Servicer does not fix the payment, change the rate, charge the borrowers, and adjust terms.  It even makes sense to have your pool or office equipment serviced.  But, what people are really asking is "Servicing a Note" just doesn't make sense. How, in God's Green Earth does one "service a note" and what does servicing mean to the cash flow specialist and how can servicing benefit me whether I am an investor, broker or buyer?     

Sometimes they ask, "Are you a Collection Agency?" You know, someone to shape up the "no pay and slow pay", when all other means have been exhausted in law and equity.  Although the collection from the payor and distribution to the payee is part of the task and done in accordance with the terms of the contract (note) is done by the Servicer as a routine part of the "Service", it hardly scratches the surface in terms of the benefits derived from using a Servicer.         

Professional Note Servicing sounds as interesting as yesterdays news, boring as a grade Z movie and with about as much appeal as a stop sign.  But a good Servicer actually finds the task incredibly exciting, exhilarating and challenging.  The reason is quite simple:  Servicing can assist the Broker to build their own personal note portfolio and can turn a handful of chopped liver notes into a prime rib portfolio.     

Also, we deal with some of the most creative note investors on the planet. Note Servicing provides enormous benefits as it relates to non-traditional financing  as well as augment the ability of brokers and investors to implement wealth building strategies.    

First, The All Inclusive Note, sometimes called a "Wrap Around" is once again becoming the instrument of choice by many investors for all sorts of reasons; not the least of which is the ability of the investor to increase their yield by making money on the spread rather than taking back a straight second trust deed. There are other reasons to use the all inclusive as well, specifically as follows:   

These days we hear a lot about the "all inclusive" note typically written around an institutional loan.  Obviously, there are risks and rewards associated with this strategy.  However, by using an experienced and reputable note servicing company prior to transfer of the property who will notify the lender that the owner has authorized a  servicing agent to make the payments and that all subsequent payments will be made by the servicing company, will mitigate an enormous migraine. Additionally, the new owner (trustor/payor/borrower) can rest assured their payment will be made to the underlying.     

For land developers, the privately financed "all inclusive" note and trust deed, is a flexible tool allowing the entrepreneurial developer to use their hard cash for infrastructure development or even selling lots without pouring capital and/or profits immediately back to the seller.  The Servicer becomes a valuable conduit by which the developer can accomplish this strategy while protecting the underlying beneficiary.  Using a Servicer is often the determining factor of whether the deal will go through or not.   

Now, how can the Servicer help the Note Broker develop their own personal Note Portfolio without investing cash of their own?   

As you know there has been an explosion in the cash flow industry over the past ten years.  Millions of dollars of income streams are purchased daily and some of this income stream of notes, contracts, leases, receivables, etc., could be and needs to be kept by the broker by purchasing "partials".  The calculations affording the Broker to keep a piece of the income stream are often "daunting" to the Broker. Often, rather than get involved in these complex calculations, they let the opportunity of a lifetime pass them by.  An experienced Servicer with a background in investments can enable even a fairly new Note Broker to succeed in this strategy. Here is an example:  

You have an opportunity to purchase a note with a value of $150,000 and you cannot locate a single investor with this amount readily available.  However, it is perfectly feasible to locate ten investors with $15,000 each.  In fact you, as the broker could be one of the investors by building a portion of the discount as your portion of the investment. 

This is a simple example of how you can either originate or purchase a note at a discount to yield 12%.  Considering the returns available in the money market today using alternative investments, this type of example is perfectly do-able. The note in this example will pay $1,500 in interest only; if each investor were to receive a 9% return on their $15,000 they would receive $112.50 each month as interest on the investment.  So you would receive $1,500 and pay out  $1,125 and keep $375 for yourself.  Not a bad return for having nothing invested. 

The Servicer is a "team player" with the Note Investor and Administrator/Custodian for the successful implementation of the Self Directed IRA.      

Unless exempt, the Investor holding a Note or other cash flow in their self directed IRA cannot have constructive receipt of the cash flow. The Servicer therefore, acts as the accommodator for the Originator and IRA Custodian/Administrator by receiving the payments and disbursing into the Investors IRA Account.  Additionally, the Servicer provides the necessary "third party authority" for enforcement of the terms of the note and satisfies the beneficiaries (investors) obligations to the Payor.  Risk management is also provided through impounding for taxes and insurance.   

The Servicer is worth their weight in gold when used to satisfy statutory reporting requirements for fractionated notes.  

We have noticed a proliferation of Note Brokers directing their attention and efforts towards creating an LLC or other entity for the purpose of pooling funds for the purchase of notes. These multi-investor notes typically carry with them the obligations and requirement of statutory reporting for fractionated notes. This requirement and responsibility passed on to the Servicer can alleviate an enormous burden from the Broker in addition to providing third party authority.       

There are many other roles a Servicer fills to make the cash flow professional more successful. Not the least of which is to enforce the terms of the note, provide payment coupons and receipts, statutory annual accounting, IRS year end reporting, forcing insurance when necessary and saving the note investor time to do what they do best, and reduce their overhead by saving them capital typically used for investing in software, hardware and employee training. This is just a small sample to give you an insight into the more non-traditional benefits of using an experienced and aggressive Note Servicing Provider.

COPYRIGHT  2002, 2006 by Roberta M. Standen - ALL RIGHTS RESERVED  
This article cannot be reprinted without the express permission of the Author - 11-06