Ms. Jones owns a promissory note for $50,000, paying 7% interest with payments of $600 a month and a balloon due in five years. The note is secured by a deed of trust on the property she sold. Ms. Jones wants to sell three years of the monthly payments and keep the rest. You want to buy this income stream.
What extra problems come up when you buy a “partial” instead of the entire note secured by the deed of trust or mortgage?
Five questions a partial raises
- Is it a purchase or a loan? The first problem is whether a partial counts as buying an asset from Ms. Jones or lending to Ms. Jones. Research this carefully. If it is treated as a loan, state usury laws may apply, and the penalties for usury can be harsh. Truth-in-Lending laws may also apply.
- Who owns the note? If the partial is treated as a sale, who is the owner of the note?
- Full or partial assignment? Will you take a full assignment or a partial assignment?
- Are other security documents involved? For example, are there Uniform Commercial Code filings?
- Are you a holder in due course? Since you own only part of the note, are you protected under negotiable instrument law against defenses the payor may have against Ms. Jones?
Consider buying the whole note instead
Give serious thought to buying the entire note and taking an assignment of the entire deed of trust, with a written agreement with Ms. Jones on how the money will be divided when it’s paid.
That agreement should also say what happens if the payor defaults, pays off early or makes extra payments. If these issues aren’t carefully worked out, problems dividing the money can arise because you and Ms. Jones expect different things.
Who decides to foreclose
If there is a default, who decides whether to foreclose? If you and Ms. Jones have different interests, you may reach an impasse and be unable to foreclose on your security.
Partials are subject to many pitfalls. Examine them carefully before you commit your hard-earned money to what may bring more grief than success.
