In last month's issue of The Note Professor Newsletter we discussed purchasing wrap notes where the underlying note would be paid off at the time of purchase. By paying off the underlying note, the Note Buyer is sheltered from the due on sale clause, as well as being in first position.

However, there are situations where it would be advantageous to both the note seller and Note Buyer to leave the underlying lien intact and purchase the entire wrap. In my advanced notes class I teach how to purchase properties utilizing seller financing where there is no due on sales clauses, then sell the property on a wrap note. The same technique can be applied to an institutional underlying loan with several months of seasoning, and large equity between the underlying note and property value.

For example, let's assume a property has an underlying note of $70,000 with 180 months remaining, with monthly payments of $553.56 @ 5%. The property sells for $110,000, with $10,000 down with a wrap note of $100,000 for 240 months and payments of $899.73 @ 9%.

If a Note Buyer purchases the wrap note for $80,000 and pays off the underlying note of $70,000; the wrap note seller will receive the difference of $10,000, while the Note Buyer will receive a yield of 12.34%.

Is there a way for the Note Buyer to not only increase his/her yield, and at the same time put $20,000 more money in the note seller's pocket? Yes. Why not buy the entire wrap note and leave the underlying in place? Let's see what happens.

To recap: The equity in the wrap note is $30,000 (The difference between $100,000 wrap note and the $70,000 underlying note). The payment on the wrap note is $899.73 from which we must subtract the payment of $553.56 made to the underlying. The remainder of $346.17 is the cash flow the wrap note holder will receive for 180 months. For the next 60 months, the wrap note holder will receive the entire $899.73, since the wrap note's term is for 240 months and the underlying note will have been paid in full. Now that the groundwork has been made, we can have a little fun, and make it profitable for both the wrap note holder and the Note Buyer.

Remember, the wrap note holder has $30,000 equity in his/her wrap note; the difference between the $100,000 wrap note and the $70,000 underlying note What if the Note Buyer gave the wrap holder his/her entire $30,000 equity? In other words, the Note Buyer would purchase the entire wrap note for $30,000, leaving the underlying note in place.

Is there any doubt the wrap note seller comes out better by receiving $30,000 instead of $10,000; a very happy camper.

What of the Note Buyer? What is his/her position in purchasing the entire wrap note and leaving the underlying in place? Since the cash flow the Note Buyer will receive is irregular in that he/she will receive the difference between the wrap note payments and the underlying note payments of $346.17 for 180 months, then for 60 months receive the full $899.73, we must perform Internal Rate of Return calculations to determine the Note Buyer's yield. Rather than going into lengthily calculations on a financial calculator, I use TValue, which gives me the answer instantly. (If you would like a $27 discount on TValue, CONTACT ME and I will tell you who to contact.) By purchasing the entire wrap note and leaving the underlying in place the Note Buyer will enjoy a yield of 14.38% rather than 12.34%.

So far we have a WIN/WIN situation where the wrap note seller receives $20,000 more than the traditional method of purchasing a wrap note, while the Note Buyer increases his/her yields by almost 2%.

The benefits to the Note Buyer continue. Because the underlying note pays off faster than the wrap note, the Note Buyer's equity in the wrap note increases for 180 months until the underlying note is paid off.

Let's examine this phenomenon by illustrating an example of what happens if property owner sells the property after 84 months and both the underlying note and the wrap note are paid off.

Looking at the amortization schedule of the wrap note, after 84 months we find the balance $82,567.43. Likewise the balance of the underlying note is $43,724.62. After the underlying note is paid off, we subtract the underlying payoff from the wrap note balance. This figure, $38,842.81, is payoff amount for the wrap note. Did you notice the Note Buyer started with $30,000 equity in his/her wrap note, but after seven years, the equity increased by $8,842.81. So how did the Note Buyer come out?

N = 84 (Number of months until payoff
I/YR= 16.14
PV = -$30,000 (Amount Paid for Wrap Note)
PMT = $346.17 (Cash Flow Received After Making Underlying Payment
FV = $38,842.81

Space is getting short for this newsletter, so I do not have time to show the calculations, but the yield on an early payoff purchasing the wrap in the traditional way is $13.77.

Conclusion: Purchasing a wrap note and leaving the underlying in place has advantages. First, it can give the note seller more money for his/her equity. It can benefit the Note Buyer by producing higher yields. Because the underlying often pays off faster than the wrap note, the Note Buyer will enjoy an increase in equity until the underlying note matures.

Are there risks involved in purchasing a wrap note and leaving the underlying note in place? Of course, especially if there is an institutional mortgage on the property. However, many seller financed notes can be made "safe" prior to purchasing the wrap. This is a subject I address in my Advanced Notes Class.

The purpose of this article is to point out methods to increase your yield, if you think outside the box. Purchasing the wrap and leaving the underlying in place is just another arrow for your quiver of note investing techniques.

If you have questions or comments, be sure to CONTACT ME I get the topics for my newsletters from your input.

Copyright © H&P Capital Investments LLC
All rights reserved
Tom Henderson
a.k.a. THE NOTE PROFESSOR

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In the April 2015 issue I pointed out how Social Security is a wealth redistribution system and cannot sustain itself. Rather than acknowledging the program is unsustainable, a Republican politician suggested to have a means test, and of course for us to work longer before receiving any benefits. It appears our politicians want to apply these "solutions" to the economy as a whole.

For example, Jeb Bush suggested the solution to our economic chaos is to work longer.

"My aspiration for the country and I believe we can achieve it, is 4 percent growth as far as the eye can see. Which means we have to be a lot more productive, workforce participation has to rise from its all-time modern lows. It means that people need to work longer hours and, through their productivity, gain more income for their families. That's the only way we're going to get out of this rut that we're in."

I want to emphasize his assertion that working longer hours is "the only way to get out of the rut we're in". It appears wealth redistribution programs, including Obamacare, have become acceptable to both political parties.

Rather than realizing our economic system is not a free market system and the "rut" we are in is a direct result of government intervention in the market place. We are asked to believe if we just work longer, our economic problems will be solved.

Later when confronted with his statement, Bush tried to explain what he meant:

"You can take it out of context all you want, but high sustained growth means people work 40 hours rather than 30 hours and that by our success they have disposable income for their families to decide how they want to spend it rather than standing in line and being dependent upon government."

I could write a column for a year on false assumptions of this statement. However, I will concentrate on two of issues.

By his "clarification" statement, Bush has further demonstrated his belief in a collectivist economic system, as well as completely ignored two important elements of a collectivist system.

To begin, it should be recognized that free markets have no goals; but merely follow economic laws. On the other hand, a collectivist system does have goals, no matter how unrealistic, yet also must follow economic laws.

In a free market, jobs are a result of individuals producing goods or services to be consumed and paid for by other individuals who produce other goods and services. When economic laws, such as the laws of supply and demand, are allowed to function without interference from politicians, the price system will determine what will be produced and at what price.

When individuals are allowed to produce freely, the result is ALL of the economy grows not just specific industries. Jobs are the result of economic growth, not the cause of economic growth as politicians of both parties will have you believe.

Contrast this to a collectivist economic system where politicians will control the economy by redistributing wealth. It should be noted the wealth redistribution comes in many forms. Direct payments to corporations, foreign nations and individuals, price supports, price controls, protective regulations, and barriers to entry into the market, just to name a few. All of the above are forms of consumption without production that must be funded in some manner by taxation.

Just as important is the fact that in a free market system wealth redistribution, which includes corporations, industries, foreign nations and individuals are not in place.

What Jeb Bush completely ignores is the collectivist system of economics requires government to take money away from workers in the form of taxes to fund the politicians' pet projects and to give favor their power base. He completely omits that many of those who are working 40 hours a week have to work longer by taking second jobs because of taxes being taken out of their salaries.

Working 40 hours a week does not necessarily translate in more disposable income, when the worker is living under collectivist economic system funded by a progressive income tax. It has been said if we eliminate all wealth redistribution programs of government, our disposable income would rise to the point where we could work three days a week and have the same buying power of working 5 days a week under our present system. To say it another way, it is government spending on wealth redistribution programs that is shrinking disposable income. By working longer, the coffers of government increase, but not necessarily disposable income.

Along the same lines, here is a dandy of a quote from Lindsey Graham.

"I'm going to ask [people] to give up a little bit to make sure the system doesn't fail--if we don't, the baby boomers are going to wipe out Social Security and Medicare. We'll become Greece."

To begin, there will be no "asking" to give up "a little", it will be taken. Politicians are good with this type of language. Instead of saying, "We politicians need more money so we are going to raise your taxes", they will use phrases like "ask you to contribute", "pay your fair share" or "shared sacrifice" to mask forcibly taking more of your earnings. As a side note politicians will never reduce their pensions.

More to the point, I can think of no better example that epitomizes how politicians think, and their intentional deceptive tactics when trying to persuade us that they are actually trying to do what is best for us, while at the same time shifting blame to something else than Graham's explanation of why we need to "give up a little". I quote, "--if we don't the baby boomers are going to wipe out Social Security and Medicare."

For Graham, and other politicians, it was not the wealth redistribution programs of Social Security and Medicare, nor the politicians making promises that you could not pay that is the problem. But rather it is those evil, mean baby boomers who are going to wipe out they system. And of course, the system must be protected at all costs.

Rather than acknowledging that Social Security and Medicare are wealth redistribution programs, which are unsustainable, and are therefore destined to fail, they scapegoat baby boomers as the ones who are going to wipe out these programs. Why are all collectivist systems destined to fail? Because collectivism is based on the principle of consumption without production.

Because consumption cannot exceed production, the end game for all collectivist systems is for politicians to attack a straw enemy, such as the baby boomers, and not the system itself. In the end game, both Jeb Bush and Lindsey Graham are correct. The producers are going to have to produce more, work longer and "asked" to give up a little. Look for phrases like "shared sacrifice", "fair share", "civic duty", "good of the country", and the ole stand by "the right thing to do" being used more and more by our politicians. Hearing these phrases is an indication we are at the beginning of the end game of a system than cannot be sustained. The problem is not production, or work more to produce more, it is government consumption.

If you have a comment or a topic you would like discussed, CONTACT ME It is from your input I get many of my topics.

Copyright © H&P Capital Investments LLC
All rights reserved
Tom Henderson
a.k.a. THE NOTE PROFESSOR

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