One of the best things about creating seller-financed notes is the long-term cash flow. But eventually everyone runs out of capital to keep doing more deals.
You’ve got two basic options: sell the note, or borrow against it. Selling gets you cashed out, but you lose the asset. Borrowing against it — through what’s called a hypothecation — lets you recapitalize while keeping the note and its upside in your portfolio.
What is a hypothecation?
A hypothecation is a loan secured by your note instead of a piece of property. You pledge the note and its underlying mortgage as collateral, take a loan against it, and use that capital to go do your next deal. You keep ownership, you keep the servicing, and you keep collecting payments. Banks lend against equipment and receivables all the time — a performing mortgage note secured by real estate is excellent collateral.
How it works in practice
Say you sold a property for $200,000 on seller finance with 10% down and created a note at 9% interest. Your borrower is making steady payments. You take a loan from a lender against that note at a lower rate, structure the payments so there’s a spread, and now you’ve freed up capital to go acquire your next property — all while keeping the note and levering up your return.
What lenders want to see
If you want to borrow from a bank — which is where you’ll get the lowest cost of capital — they’re going to want to see high-quality paper. That means a solid borrower with good credit, a reasonable loan-to-value ratio, and a loan that’s fully Dodd-Frank compliant with proper underwriting documentation. That’s exactly what we help with at Call The Underwriter. The notes we underwrite are built to be not just compliant and enforceable, but bankable — which gives you more options down the road when it’s time to recapitalize.
If a bank isn’t an option, private money lenders are the alternative — often through self-directed IRAs and individual investors. They’ll typically want 8-10% interest, so the spread needs to be wide enough to support it.
The bottom line
Hypothecation is one of the most powerful tools for scaling a note business without giving up your assets. But it starts with creating the right kind of note in the first place. If you’re thinking about how to structure your notes for maximum flexibility, we’re always happy to talk through it.