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Aaron the House

Real Estate Investing Problems Solved!


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Constructing Deals with Intention

Putting a substitution of collateral clause in a note today could be very valuable in the future.

Back in October 2009 I purchased a property from an out of state seller. It needed quite a bit of work and was in foreclosure even though he only owed about $35,000 on it. I don't remember the actual purchase price any longer, but I bought the house subject to his loan, brought in a private lender for $30,000 cash and put her in second, and gave the seller a note securing $60,000 of his equity which I put in third position. That note had not payments for 5 years, then monthly payments of $500 principal only starting on the 61st month.

Come November 2014, I mailed out his check, but it was never cashed. I then starting researching the seller to see if he might have moved or even passed away. Ultimately, I found him and got his payments all sorted out. A few weeks later, I didn't receive any rent from the tenant. I was able to contact her daughter and found out she had in fact passed away. The California market was really on fire the last few years and after comping the house, I realized it was now worth somewhere in the high $200Ks.

I did a quick rehab for resale and put it on the market for $275K. I quickly found a buyer and we opened escrow. Then it hit me; the thought of paying off that zero interest loan! I started looking around at other properties I owned and the debt attached to them. I found another nice single family house in the same city that I owed $65,000 to a hard money lender who was charging me 9.9%. This would be a perfect opportunity to move the note over and take out that high interest financing.

I contacted the seller and he was game, but he wanted a California lawyer to explain it to him to be sure he was going to be protected. I tried to explain that I was moving him from 3rd position to a first position which would give him better equity and therefore, more security. He still wanted the lawyer and wanted me to pay for it.

The first lawyer I contacted gave me a long spiel about the deal and ultimately didn't sound like a good fit. I then contacted another lawyer who also does CPA work for many real estate investors. He said he'd be happy to have a conversation with the note holder.

The first escrow closed with a sales price of $275,000. I paid off the 1st lien that had amortized down to about $25,000, and I was able to move the note over to my other rental. My interest only payments on the $65,000 loan at 9.9% were $536.25. I am now paying zero interest and getting 100% amortization for every payment I make. I'm so glad I had the foresight to include that simple substitution of collateral clause all those years ago..