Seth: Hey, everybody, how's it going? This is Seth Williams and you're listening to the REtipster podcast.

Today, I'm talking with my new friend Eric Scharaga. Eric is the founder of Damen Capital Fund, a purchaser of residential and vacant land notes. And a little bit about Eric's background. Before he started focusing full-time on notes and land, Eric worked for 23 years as a high school teacher and in 2001 he started investing in rental properties, purchasing and rehabbing single-family homes with the dream of becoming a full-time investor.

And after 13 years of dealing with the constant stresses of landlording, he came to the realization, as many of us do, that he just wasn't going to achieve his goal of financial freedom through rental properties.

In 2016, while still working full-time, Eric transitioned to the more stable and passive cash flow of notes. And since 2016, he's purchased over 500 notes, including residential performing, non-performing active bankruptcy, and vacant land.

Eric is also the author of the book Lienlord, an introduction to the power of note investing. I will include a link to that in the show notes for this episode, by the way, if you want to check it out. Eric is passionate about personal finance and financial freedom and he enjoys introducing land investors to the importance of seller financing.

And before we get into this conversation, I'll just do a quick disclaimer. Neither Eric nor I are attorneys, CPAs, or financial advisors. We don't provide legal tax or financial advice. And in this conversation, we're just sharing Eric's experiences as an investor. And we encourage you to seek out professional advice before you make any of your own investment decisions.

So, Eric, welcome to the show. How are you doing?

Eric: Thanks, Seth. I'm doing really well. Thanks for having me. I'm excited to join you today.

Seth: Other than what I just said there, maybe you can tell us a little bit more about your story to kind of flesh out the details. So you mentioned that you were a teacher. Anything else notable about your career background and when and how did you get into land and how did you get into this sub-niche of land? I know there are a lot of people out there listening that may be land flippers, but they're not all that comfortable or even familiar with this idea of investing in notes. So, how did that come to fruition?

Eric: Well, I love the note space. And I found the note space after 13 years as a frustrated landlord, which I know is very common for landlords. And it just got to the point that it was just so stressful for me and so many holidays that were interrupted with issues with rental properties. And I love notes because it really truly is a passive real estate investment.

I came across the land space and I thought, “What an awesome opportunity to create seller finance notes.” And it really is. I love the land space but I really love the opportunity in the land space to seller finance. And I realized that not all land investors are interested in holding seller finance notes.

I originally got involved because I wanted to purchase the notes, but a lot of what I was looking at really wasn't scalable. They just had too many issues. And so, I decided to create a program in which I purchased loans, seller finance land notes at closing for 80% of the purchase price. And in addition to that, I provide a lot of guidance to investors who want to offer seller financing but might not want to hold a $400/month note when they can cash out and have an extra $20,000 that they can put into their business.

Seth: Yeah. So, it sounds like there are a lot of land investors who have gotten involved with seller financing and this kind of thing could appeal to them because they basically just want their money faster, right? They don't want to wait for years to collect all the payments and move on. They want to keep their cash working. And those are kind of the people that would be an ideal fit for what you're talking about, right?

Eric: Yeah, absolutely. Land investors do really well but the land business is very cash-intensive. And these two types of investments are very complementary. It's a great idea to offer seller financing even if you don't want to keep the notes and then to work with a note buyer who would like that cash payment who isn't involved in the day-to-day marketing and negotiations of a land business. There are some really important features, though, if you are going to originate your own note of closing that you should keep in mind before you go through the process.

Seth: Yeah. I was going to ask you about that because earlier, just a minute ago, you mentioned that you started looking at notes that weren't saleable, that there were issues with them. So, what kinds of issues were there? What makes a note problematic and what is it that you are looking for to say, “Yes, this is a slam dunk, let's do it?”

Eric: Yeah. A lot of them were self-serviced, which is an issue because if I purchased the loan and the buyer down the road disputes the balance, I'm going to have a major issue there and it wasn't worth the headaches.

Seth: When you say self-service, you mean the person who originated that note, they're actually collecting the payments themselves? The person sends checks or something directly to them?

Eric: Exactly, exactly. The other issue is that a lot of them were land contracts and I just was not comfortable with the language in the land contracts. So, really what I have is kind of an overview of what I think that anyone who's interested in selling land with financing should keep in mind. And really what it comes down to is there are issues regarding the specific property, issues with the borrower, specific loan terms that you should adhere to, and then the process that I recommend that you follow.

Seth: Yeah. And we're totally going to get into that because that sounds super interesting.

I'm curious, though, on that issue of somebody who is servicing loans themselves. It sounds like the problem inherent in that is that when a person services their own loans, could that be okay if they were able to provide very thorough documentation of every payment received and when it was received and a paper trail of everything? Would that resolve the issue, or is there some other problem about servicing your own loans that makes that an issue?

Eric: Well, one of the issues, and I suspect that people don't frequently charge interest because, at the end of the year, they have to provide a 1099 to the borrower, a statement of the interest paid for the year. But I always recommend the use of a servicer because you have really a third party that's professional, that's going to have advanced software that they're using, that's also licensed in the different states to service loans. And it's just a much cleaner way to handle the payments.

I do suppose, though, if you had very thorough records, that it would be just fine. But there are steps that you can take in selling your loan to confirm the balance of the loan prior to the sale.

Seth: Okay. When you say loan servicing company, you do not mean software, correct? Say if somebody was using ZimpleMoney or GeekPay or something like that. Is that not good enough, or could that work?

Eric: It'll work. It's okay. But I'm a big fan of using loan servicers just because they're going to interface with the borrower. They're going to collect the payments, they're going to main retain the records, they're going to send out the interest statements to both you and the borrower at the end of the year. They're also licensed in the states that they operate. In my opinion, it's the best $20 a month that you're going to spend. It's a very low-margin business for them and it's a lot of responsibility for them.

And ultimately, if you structure it the right way, the buyer is going to end up paying that monthly loan servicing fee. So it's well worth, in my opinion, using a servicer.

Seth: Yeah. And I would agree. In my experience with loan servicing companies it is kind of a surprising value when you consider just the job that human involvement is there and they just type up every loose end, it feels like. And maybe there are certain loan servicing companies that are good and certain ones that are bad or something like that.

But I'm curious, in your experience, it sounds like you've worked with one or two of them. Is there any particular one or two or three that you're like, “Yeah, this is a good one, go here?”

Eric: Yeah. The ones that I use the most are BIFI Loan Servicing and Madison Management. I've used most of them. They all have their pros and cons. And FCI is great. The only thing that I like more about Madison or BIFI is that you can get someone on the phone, and that's a little harder at FCI. That's more of an email-based structure. So, for the beginning investor, it's really nice to just be able to call in and speak to someone.

Seth: Yeah. And I believe Madison is licensed everywhere, right? In most of the 50 states, is that true?

Eric: Yeah, they're licensed in most states. For servicers, it's expensive to get the license so they just have to kind of look at it from a cost-benefit perspective. If they don't have very many loans in that state, it's probably not worth them getting licensed because the licensure process is just extremely arduous and painful. But in most states, they're licensed.

Seth: I agree with you. I think it's the way to go as well, but it feels like a lot of land investors don't do this. They're either self-servicing or they're using some kind of software. And even the software, I guess it's been a while since I've looked at the pricing on all the options out there, but I don't think it's that far off from what a loan servicing company would be. Why don't people just default to always using a loan servicer, especially if you can put a servicing fee on your borrower to pay for that cost anyway?

Eric: Yeah, I'm not sure. It's probably just the knowledge issue. They don't know that it's an option. And I think that if they knew about it, if they knew how great it was, they would probably move more in that direction. And it really improves the saleability of the loan when you have it professionally serviced because the servicer is going to keep track of all payments, including the date and the amount from the very first payment, and you're going to have that to be able to show a prospective buyer.

Seth: Yeah. If anybody out there is curious about some potential options for loan servicing companies, aside from the ones that Eric just mentioned, I've got a blog post listing out a number of them around the country. I'll be sure to include a link to that in the show notes for this episode. Again, retipster.com/151.

Some of them are licensed in a single state and they may be the best one for that one state, but others are licensed in most places around the country. So, it's a good thing to be aware of for sure.

Eric: Oh, I was just going to say once you get to about 10 or 15 notes, it becomes overwhelming to do it yourself or to just use software. And considering the notes that I have in my portfolio, I really do very little when it comes to… I mean, I have to do my own bookkeeping. I don't do it, I outsource that.

But in terms of the day-to-day payments and collections and oversight for the individual loan, I just check a portal. That’s the other great thing about a servicer is that they're going to have a portal that you're going to be able to look at on a daily basis, see the payments come in, you can download reports. It's just really awesome.

Seth: Can those loan servicers accept credit cards as payments, or is it like ACH or mailing in a check?

Eric: I don't believe that they do. There may be some type of, I'm thinking that like what if the payment was recalled or there may be some law that regulates credit card payments for that. The ones that I work with, I don't think that they do. It's just ACH or you can mail in a check or they can take a payment through their website. The really nice thing is if a borrower sets up ACH and it's just done every month automatically.

Seth: Yeah. That makes sense. I was curious, I don't know if any of those loan services do that.

Eric: One other really cool thing about servicing is that some servicers actually report to the credit bureaus. They're online with them and if a borrower misses payments, that's going to be sent to the credit bureaus as well; on the flip side, if they're making regular payments, that's going to be reported as well.

Seth: Cool. Do you know which ones do that off the top of your head?

Eric: I know Madison does that. I'm not sure about the other ones.

Seth: Okay. So, what is a typical deal size that you work with in terms of the value of the property, the amount of the balance owing, the amount that you ultimately pay? What's an average or a normal size deal for you?

Eric: I look for sales prices between $25,000 and $150,000 if I'm purchasing it at closing. If it's already been originated, I'm buying it like a year or two years down the line. I'm pretty open in terms of balance. In terms of value, I typically don't go below like $20,000 or $25,000.

Seth: What percentage of the deals that you do are ones that you helped originate and you bought it at closing versus maybe it's been out there for a couple of years and then you're taking over?

Eric: For land deals, I would say right now about 65% of the notes that I buy, I'm actually buying at closing. Whereas 35% I purchase them once they've been originated maybe a year, two years later.

But those actually typically are more involved deals just because I'm required to look at and process so many different parts. Just the underwriting is more involved and the process is more involved, especially if you're dealing with land contracts. Because in a land contract, you're not just transferring the loan, you're also required to transfer the property. So, you're assigning the land contract and you're also deeding the property. It just is a little more complicated.

Seth: For those ones that do exist, what do you have to look at? Is it actually more stuff you have to do in underwriting or if you actually help originate the thing, you can sort of form it from day one, whereas if it's already established, you may have to pay for the sins of that person who sold the property if they did something wrong. So, what exactly are you looking at in terms of “This is a good deal” or “It's not a good deal?”

Eric: Yeah. The first thing I'm looking at is the property. I want to make sure that it meets my parameters because I look at each deal through the lens of the worst-case scenario. So, if this borrower defaults, do I want to take this property back? Is this something that I'm confident that I can resell? Is it an estate that I operate in?

I look at the investment to value. That's very important to me. So, what am I purchasing the loan for versus what is the property worth? And I don't like to exceed 70% investment to value. I look at the borrower. What is a borrower using the property for? Is there a credit report? What's the borrower's credit score? What was the down payment involved? Was there any down payment?

I tend to shy away just categorically from the no money down, no credit check loans just because those have such a high default rate. I would rather be in the lending business. I don't really want to be in the default business and having to resell properties. So, I tend to shy away from those. I look at the pay history. I'm looking at the terms and how I'm doing a yield calculation to see where I want to be at in terms of my annual return.

I'm looking at the paperwork carefully. Is it a note mortgage versus a land contract? If it's a land contract, how are they dealing with default? Is it just very generally worded? Is it in a state that regulates land contracts and is that not addressed in the actual paperwork?

So, there are a lot of potential problems there that could make a deal a lot more complicated. Regarding land contracts, more and more states are kind of cracking down on them. Florida, for example, whether you have a land contract or a note mortgage, you have to foreclose either way. So, there's just that knowledge of how states individually deal with land contracts.

Seth: When you say cracking down on them, what does that mean? Are they changing the laws to make it harder?

Eric: There was a lot of predatory abuse of land contracts after 2008 in which investors were buying pools of REO properties and selling them with land contracts. But these land contracts were just very predatory in nature. There was a lot of complaining. State's attorney generals started cracking down. They went after some of the worst offenders but then they started changing the laws. I know that some states change the laws so that if the land contract runs for more than five years or if a buyer puts down more than 20%, you have to foreclose.

I think that in my opinion, I'm not the biggest fan of land contracts. I actually prefer notes and mortgages just because it's a much cleaner process. The property is not in your name so you don't have that liability. And in a lot of the states in which we work, the process for foreclosure is not that difficult. It's non-judicial, it doesn't even have to go through the court system and it might just be three to four months to take the property back.

And the other issue with a land contract is if you are recording a memorandum of agreement or if you have an angry buyer who decides to put a lien on the property after you take it back from them, that's going to be a major issue that's going to require litigation to clear that title.

Seth: Yeah. So, if you see that a deal has a land contract, is that an automatic no for you? What would need to be true for you to say yes to a land contract?

Eric: I still buy them, I just look at them more carefully and I'm going to discount them more heavily just because of the potential for problems. But honestly, a lot of the times after I purchase them I'll just go to the buyer and say, “Would you be interested in actually converting this right now to a note mortgage?” Because buyers really would prefer to have the property in their name versus having the property deeded to them after they make the last payment.

Seth: What about a note with a deed of trust? And I only ask just because I haven't heard you mention that yet, but is that a no-no, or is that okay? What are your thoughts on that?

Eric: I say mortgage but mortgage and deed of trust are used synonymously. They're just different instruments in different states. So, the deed of trust is typically not always used in states that don't require a judicial foreclosure process.

Seth: Yeah, and the deed of trust, if I understand it right, is that the foreclosure process is more of an auction process. The trustee needs to sell that thing to somebody else. You don't necessarily get the property back but it's auctioned off and then you collect the money from that. Is that accurate or am I misunderstanding that?

Eric: Yes, the foreclosure process that's true in all states. Going through a foreclosure does not entitle you to the property. It entitles you to have an auction to publicly sell the property for what you are owed plus your expenses. So, if no one bids on the property, your minimum bid what you're owed, then it becomes an REO and then it returns to you and you get the deed, you take it back. But in a lot of cases, if you have a low balance, someone will purchase the property at the foreclosure sale.

Seth: That issue with land contracts, because I think the reason a lot of people use them, whether this is valid reasoning or not, is this idea that “Oh, yeah, the deed is staying in my name as the seller.” But even if that's true, the minute you sign the land contract and the borrower pays you anything, they now have an equitable interest in that property. You have to go through the proper channels to get them out of there if they stop paying. It doesn't actually make it any easier. It may technically still be yours but the same wrinkles kind of need to be ironed out either way. Would you agree?

Eric: Yes, absolutely. The other thing that really scares me about land contracts is that since you own the property, if someone is injured on the property or if there are city fines, that is your responsibility. If somebody's out there riding a motorcycle and falls off and breaks their leg, you are going to get sued.

I think that people typically believe that since they've sold it on land contract, they're no longer responsible. But an attorney is going to look at who is on the deed, who's the owner and that's who's going to be sued in that lawsuit. So you absolutely have to have liability insurance that covers you as the owner that the buyer pays for. And I use a company called NREIG. They have a specific policy liability policy for land investors and it's about 20 to $25 a month.

Seth: Yeah, actually, I discovered them this past year and did a little video on how to do that. I'll include that in the show notes too but I haven't researched this to death but it seemed like kind of a no-brainer. Just the easiest process. And it is set up specifically, especially land flippers whose inventory is always changing. They make it super easy to take it off. You don't have to pay for a year at a time and that kind of thing.

Eric: Yeah, I highly recommend them. I use them in my business. But you are 100% correct. I think that people assume that with a land contract since they own it, that they're just going to send a letter to the buyer stating, “You've defaulted, I'm keeping your money, you are done.” I mean, you can do that but that could open up a huge can of worms for you title-wise down the line.

The thing that I prefer about the note mortgage or deed of trust is that it's a well-established process in every state with very clear state laws and everybody knows what to do. Everybody knows how to handle a foreclosure, which is with a land contract, unless you're in the state of Michigan, in most cases the process is less clear. Michigan is the state that I know of that has a pretty clear, well-established procedure for land contracts.

Seth: Yeah. The interesting thing about Michigan is that there is a pretty clear process to go through and it works if that defaulting borrower is responsive and actually responds to you and does stuff. But if they just ghost you and pretend that they didn't hear from you, you still got to go through all these motions to get them off anyway. And I've got firsthand experience with that. So, there are still holes in it. It's interesting.

And you're mentioning with the mortgage and the note, if you're in a non-judicial foreclosure state, are you saying there's a way to foreclose or clear it all up with a mortgage if it's a non-judicial foreclosure state? You wouldn't have to go to court for that?

Eric: Correct. Usually, what they do, the first step is that through an attorney you send the borrower a notice of default, a demand letter, and then they record a notice of default. And then, a certain amount of time goes by and then they record a notice of sale which sets the date when the property will be sold if the default is not cured. And then on that date, they're going to, depending on the state and the state's procedures and the county procedures, they're going to hold a public sale.

The nice thing about the foreclosure is that if there are other liens on the property and you're in first position, those will be cleared off at the sale with some exceptions. I know it doesn't clear off some liens, property taxes that are owed, IRS liens, although that's not really that scary of an issue in most cases, and we tend not to see that in the land industry.

Seth: Yeah. With IRS liens those fall off, is it 120 days after it changes title or something like that? Do you know anything about that?

Eric: Yeah, typically, I believe that you need to file something with the IRS and then they will look into it and I think that they have a certain amount of time to establish their interest in the property if they choose to do so.

Seth: Okay. So let's say you're trying to take over an existing note that maybe was originated a couple of years ago. Are there closing costs involved with this? Does it need to go with your title or anything like that? Or is this an under-the-table transaction? How does that work and what kind of costs are involved with taking over one of these existing notes?

Eric: It depends on whether it's a note and mortgage or a land contract. With a land contract, it's going to be more complicated because you really should pull title. And it raises the issue of the owner's policy when it was provided by the title insurance company. Most people are just transferring these via quick claim deed and when that happens, you're essentially waiving your right to that title insurance policy because you're transferring the property. So, you should always pull title on a property before you transfer it, before you transfer the note, see what's on the title.

If you're transferring a note and mortgage, it's very inexpensive. It's maybe $100 because all you really need is the assignment of mortgage or deed of trust and an allonge which transfers the note. And the assignment will be recorded. It's just a public statement that there's a new owner for this loan and establishes you as the new owner and the allonge transfers the note. And then you really only have the cost for transferring servicing and title report if you choose to do that.

So, it's a very easy, simple process. With the land contracts it's a little more difficult just because you have to generate a deed, transfer the property, you should put title. You need to decide whether you want an additional title insurance policy, which most people choose not to get.

What I usually do is, and be very careful with this, the norm in the industry is to wire the money directly to the seller. Some people feel uncomfortable with that and there are companies or attorneys that you can use to escrow the transaction who will basically take the documents from the seller, the money from the buyer, make sure everything's there, and then handle the transaction.

Seth: So, in going back to what you're saying, if you're using a mortgage, it's about $100 in terms of closing costs. And that's assuming you're just wiring the money directly to the seller and not using one of these intermediary companies. Is that right?

Eric: Correct. It's very fast and easy.

Seth: And the reason you wouldn't want to look at title because what if something came up in the past couple of years and that affects your collateral and you wouldn't know unless you did a title search?

Eric: I always pull title. You find all kinds of things on title. The scariest thing that you might find was that the mortgage was never recorded or it wasn't recorded correctly and there is no lien on the property. So, in that situation, you have an unsecured note and it's just really a safeguard to make sure that there's nothing there that could interfere with your rights to the property as collateral if a buyer does default.

Seth: I know if you're buying from one of these notes that was originated a couple of years ago, say it's a vacant lot. Are these really well-established land investors that you're buying them from? Because I know a lot of land flippers out there do not know how to do this right. They're not going through the right motions. So, who are these people? I assume they know what they're doing right because they must have done it good enough to justify you buying it. Are these big nationwide outfits or what kind of person would you buy it from?

Eric: No, I just buy from all individual investors. Some people know the procedures better than others. If it's a complete kind of a nightmare or if it's really messy, I'll just say I think you should just hang on to this one. No, I would say that people do their best on these, but there's definitely things that they miss just because it's not their first business. Their first business is land investment and seller financing is really a different type of business with different requirements.

Seth: Yeah, that's interesting. I'm glad you pointed that out because you're right, it kind of is a different business. You're in the business of lending essentially, which is not necessarily the same thing as finding land deals and selling land deals. It's a new type of specialty that you're entering into. I don't think a lot of people look at it that way, but that is the reality I think. And the result is a lot of people, since they don't treat it like a whole new business, they kind of screw it up and they don't really make sure that they're dotting all their Is and crossing their Ts and doing it accurately and completely.

So, it also makes me wonder what type of land investor or real estate investor, in general, should or shouldn't even be dabbling in seller financing? There are probably people out there who are doing this and they shouldn't be because they don’t know what they're doing and they're not willing to figure it out and do it right.

The thing is, you can go for a while screwing it up without realizing that you're doing it wrong, without getting stung. It's kind of a broad open-ended question, but is there anything a person could do to ask themselves to figure out, “Should I be doing this or not?” How would a person self-evaluate that? Any ideas?

Eric: I would encourage everyone to do it. I think, especially in this market, it's a great idea. The caveat is you need the right people advising you on how to do it. So if you are going to do it, don't try to do it on your own with a template that you found online. Engage an attorney who specifically specializes in lending.

I think people tend to go toward real estate attorneys, but they are not necessarily experts in lending. So, I would find a lending attorney and they're not really known as lending attorneys. I think that they're known more as creditors’ rights and foreclosure attorneys. Those are the people that you want because they're absolute experts in the lending laws in your state and they will guide you on whether you want to use a land contract, mortgage and deed or deed of trust, the terms, whether you're violating USRI laws, Dodd-Frank considerations. I mean, they're absolute experts.

So it's well worth it, in my opinion, to engage an expert attorney in your state and have them walk you through the process, guide you through the paperwork, provide you with the necessary paperwork. Those are really the people that you need. Don't do it on your own.

Seth: Yeah, that's kind of a golden nugget. I don't even think I knew that after all these years. Usually, in my brain, I'm thinking a real estate attorney, but you're right. I've talked to plenty of them and they'll disagree with each other and they give conflicting advice and probably because they don't really do that, it's sort of a different specialty that isn't really captured in that real estate attorney title.

So if you're going to try to Google the right attorney, you would Google something like creditors right and foreclosure attorney. Is that kind of the keyword you would use for that?

Eric: Yeah, there's actually a website called Legal League 100 and it is a list of creditors rights and foreclosure attorneys in all 50 states. The problem is that these tend to be very large firms that work for banks, so it might be a little more difficult to speak to someone because these used to be foreclosure mills, they're a lot less busy now. It kind of depends on the individual state. Some of the states are much more complicated than others, but the reason that I like the foreclosure attorneys is that if anything goes wrong with the loan, these are the people who are experts at handling the default because that's their business.

Seth: I'm curious, how many different states do you do this in, and are there specific ones where it's like, “No, I will never do it in that state because it's a huge hassle?”

Eric: Yeah, that's a great question. I work in most states. There are some states that I'm not wild about. I've worked in almost all 50 states. The only ones that I do not work in are New York, New Jersey, Pennsylvania, and Georgia. I don't work in Pennsylvania and Georgia just because they have a lot of kind of very anti-lender tendencies. They don't like lenders who purchase loans operating in the state or owning loans without being licensed. And the licensure is just very difficult to get. It's more designed for banks.

And New York, it's just they have a lot of laws there regarding lending that I don't really want to have to adhere to. New Jersey is similar. It’s not as bad, but it's just a very small state. Typically if you look at the map of non-judicial foreclosure versus judicial foreclosure, in the west, you have mainly non-judicial states and in the Midwest and east you have mainly judicial states with some exceptions.

Seth: So, what percentage of your deals end up being land versus buildings? Are you intentionally trying to go after one or the other? What's the breakdown on that?

Eric: I do both. Traditionally, I've done owner-occupied single-family and condo traditional residential loans. And I was buying all kinds of stuff. Non-performing junior liens, performing loans, loans in active bankruptcy. I moved into land just because I saw it as a really great opportunity for another source of notes. I do both.

Right now, I would say I'm probably 80% land. Part of that is because during COVID, the interest rates got stole low that when those loans entered the secondary market, there really wasn't much yield to get out of them. That's going to change, though, because now rates are climbing again and when those loans enter the secondary market, there will be better yields.

Seth: So, you think you go back to houses more in the future?

Eric: I don't know. I love doing land deals so I will probably do both.

Seth: Now, these situations where you're buying an existing note, where are you finding these people? Is there some community or something or is this just a massive networking effort to always be on the lookout? If somebody wanted to start buying some of these seasoned notes, where should they go to start doing that?

Eric: It depends on whether you want to buy residential or land. Residential, I purchase mainly from contacts that I've developed with larger funds. I met people at conferences, I met people through word of mouth. I saw their name in paperwork that I received and reached out to them. It's a lot of networking.

With land, it's almost entirely based on my reaching out to people and asking them if they are interested in a seller finance note buyer or if they have loans that they'd like to sell. There is one exchange that I know that's popular with both land investors and residential note sellers. And that's Paperstack.

Seth: You've ever done anything there?

Eric: I've never purchased nor sold a loan on Papestack. I just use my existing relationships on both the buy side and the sell side, although I don't really sell that often.

Seth: Gotcha.

I know we talked a little bit earlier about how you break down a deal to look at it in terms of like the property, it's a loan to value, is the property itself good enough, and then the borrower looking at their credit score and their down payment and looking at the terms, what kind of loan document was used and the annual return.

So, dive in more specifically into that. Maybe we start at the property itself. The 70% loan to value thing, that's easy enough to understand, but in terms of what makes a property good enough, or what it's used for. What does make it good enough? Is there certain zoning? How would you evaluate, “Yes, I would be okay repossessing this property because it's useful for X and Y and Z?” How do you make that decision?

Eric: I'm looking at the same things that every other land investor is looking at. I'm looking for legal access, I'm looking at the topography. I'm looking at the water or wetlands. I'm looking at what is it zoned for versus what is the likely use for it through the lens of if I had to take this property back, could I resell it, could I resell it with terms?

I don't normally call the county or get involved in kind of the secondary level due diligence. I kind of rely on the owner or the seller for that to provide that information to me. I may reach out to some realtors for valuation if it's a market where there just isn't much on either on the market or that has sold recently.

So, ultimately it comes down to what's the likely price and if I had to take it back, could I resell it at a certain price?

Seth: Yeah. And looking at the borrower, say if you were working directly with a land investor to originate a deal, like you really don't have any history to look at with regard to that single note, what does make a good borrower? And this is kind of like Underwriting 101 kind of stuff, but just out of curiosity, what kind of credit score are you looking for? What's the minimum down payment you want to see? Any thoughts on that?

Eric: Yes. In my program, I do not require what's called a full doc loan origination. So, I am not looking at their income versus their liabilities. It is simply credit score and down payment. Actually, it's pretty similar to buying a car and actually the price ranges are in that similar realm.

I have a kind of matrix that I use. The minimum score for 20% down is 660, which is kind of like a C rating. And then from there, it goes to 25% down, 30% down and it keeps increasing as the credit score decreases. That is more risky, not including a full underwriting of the borrower and their assets and liabilities. It's also easier and faster though to get the deals done.

My biggest concerns with the borrower are credit score and down payment. I do require a larger down payment. And that's part of the reason why I don't recommend that anyone does a deal with a zero down payment. Down payment is extremely important to preventing default, in my opinion.

Seth: Interesting.

Eric: There are massive industries that are based entirely around that credit score. I know people will say that it is important, but in my opinion, that's what I'm basing the decision on. I think it's also important to look at what's on the credit report.

Unfortunately, people will have typically pretty good credit, but then it's sad, they'll get sick, they'll have all kinds of medical bills that they don't pay and that really destroys their credit score. I heard a statistic that the number one reason for bankruptcy in the United States is medical debt. So, I think it's important to look at the report itself more than just the credit score.

Seth: Yeah. On the thing you were mentioning about the lower the credit score goes, the higher the down payment you require. Is there any cut-off point at which you're just like, “No, sorry, it's too low, the answer is no.” Or could it be like, I don't even know what the lowest is, but could it be down to zero or whatever that bottom out is and say, “Yeah, that's fine, just make an 80% down payment?” I'm trying to ask a ridiculous question just to understand what is the actual limit for that.

Eric: Yeah, I never say no. I will take any credit score, but you'd be looking at a 50% down payment, which is really high and most people are unwilling to do.

Seth: And the reason you're okay with that is because, say if they just never even make the first payment, it's okay because you have full access to this piece of collateral that you've already collected or that you're only in for a lower amount of money so that the value is there for you to cash in on if you have to. Is that right?

Eric: Correct. In that situation, I doubt that that would happen just because somebody's put down such a massive down payment. I don't think that they would immediately default, but a year down the line, if they default, I feel like my investment in that property would be low enough that I would feel comfortable handling the default.

Seth: If you were dealing with an Amish person who doesn't have a credit score, you just lost a huge portion of what you would look at to make that decision. Would that be a deal killer or no?

Eric: No. There's a thing called ITIN. Are you familiar with ITIN loans?

Seth: Oh, is that I-T-I-N? Without a social security number?

Eric: Yes.

Seth: Yeah. Okay, I got you.

Eric: Yes. There are people in the United States who do not have social security numbers, who use ITINs to purchase property and the big banks allow this. I have never seen it, but I would not say no to it. I would allow an ITIN purchase, it would just require a higher down payment.

Seth: Okay. I'm liking how it seems like there's always a way as long as something comes into.

Eric: There's always a way.

Seth: Yeah. Yeah. That's cool.

Eric: There's always a way. It's a matter of will the buyer or the borrower be willing to agree to it.

Seth: Based on what we've talked about so far, it sounds like the person's sources of income, you don't even look at that, that doesn't matter to you.

Eric: I don't. Now, let me say that regarding Dodd-Frank. Even though land is exempted from Dodd-Frank, if someone is going to be living on the property day one, first I would say consult an attorney about whether or not this is required. But I think it's probably a good idea for you to run that scenario through a full underwriting. If somebody is buying the property as recreational land or hunting land or is just going to go there on the weekends, that's an investment and I'm comfortable in that situation not doing the full documentation of full underwriting.

But again, if somebody is saying, “I'm going to live there, that's going to be my primary residence”, you're probably smart to A) consult an attorney and B) call the underwriter.

Seth: Eric, you talked about this annual return a little bit earlier about what you're hoping to get out of a note investment. Is there a range of what you're looking to get out of this? How do you know when it's worth your time and money to invest it in a note like this?

Eric: I use a financial calculator to calculate yield. And the technical term is yield to maturity. It's a measure of what your investment is returning to you each year that you hold it. I base my yield based on the risk of that loan. So, I would say that the vast majority of my purchases yield anywhere from 14% up to 20%.

Seth: Okay, that's helpful. What kind of payment terms do you want to see? How long should the amortization schedule be? Are we talking like 1, 3, 5, 10, 30 years? How long is normal I guess? And then, for the instances where you kind of jump into an existing one, how much more is there left to go before the thing matures and is paid off?

Eric: Yeah, that's a great question. My advice for that is to always go with as short a term as possible because that will really improve or reduce the discount required when you sell your loan. The other thing that I recommend is to go with about a 9.9% to 10% interest rate because interest rate and term are the two most important parts of the discount when you go to sell the loan.

If you have a 3% interest rate, it's called a coupon rate and you want to sell it at a 12% yield, you can see that you're going to take a huge reduction in the loan balance to get that up to 12%.

The other thing that I like to see is the 2% rule. I don't always see this, but it's nice. My purchase price, whatever my purchase price is, I like to see the payment as 2% per month of that purchase price. But ultimately, what I'm doing is, I'm just crunching the numbers in a financial calculator based on my risk assessment and what I would like to achieve. And it's going to spit out a purchase price that is my offer.

Seth: Yeah, it's interesting just thinking as I hear you talking. A while back I created this spreadsheet where you could basically plug in the value of a property and it would spit out five different scenarios for how you could make an offer to a seller. One of them would be just a super discounted cash offer and then the other four would be different combinations of seller financing where that seller is financing it to you as the buyer. And the beauty of it is that you can ultimately pay anything for a property if the person's just willing to finance it for terms that are favorable enough to you. And it kind of sounds like a similar concept to this where we mentioned earlier, the credit score can be terrible as long as you're willing to have a big enough down payment.

It'd be interesting to create some kind of a similar spreadsheet. Maybe you even have one where you can plug in any scenario and it would just tell you this is what has to give. If this problem exists, this is how you fill it in by asking for this concession. Do you think it was possible to create that kind of thing? It seems like it could.

Eric: I have a credit matrix that is a combination of credit score and down payment required. But absolutely, that's how I bid the loans, is just based on what do I think the risk is and what do I think is an appropriate yield and then what purchase price will translate into that yield.

Seth: Yeah, this question is kind of going back in time on what we were talking about earlier regarding the loan servicing and collection of payments. So, if you take over an existing note and say they're using software or something, can you switch over to your loan servicer of choice at that point? Or is it kind of like, “Nope, sorry, this is the track it's on, this is how you got to finish it?"

Eric: That's what I always do. I have it transferred. You need to send out a servicing transfer letter to the borrower, informing them that moving forward their payments will be collected by the servicer. And it's just a matter of transferring. They need a copy of all the loan documents, they need to know the balance, the monthly payment, late fee, all that information. And it's a little more complicated than just the servicer-to-servicer transfer, but I highly recommend that.

Seth: Got you. Okay. And I guess going back to what we were talking about in terms of finding ways to remedy what would otherwise be bad lending decisions just by asking for a higher down payment or whatnot. In those scenarios where this borrower clearly has some problems, there's reason to be concerned and that's why you fill in the gaps by asking for these additional things.

I have to assume if you're doing that, you come across borrowers who default on their payments after you take over the loan, right? How common would that be after you're doing all this proper groundwork to make sure it's a good credit and something that's going to actually pay over time?

Eric: In my experience, it's relatively low. I don't think I have had a borrower yet ever who just… Well, okay, I take that back. Maybe a couple. Who just stopped paying and just walked away. That's extremely rare.

Seth: Like immediately after you take over?

Eric: No, I've never had that. I had that actually in one situation, but it was complicated because it involved a bankruptcy and the individual decided that they didn't want to continue in their bankruptcy plan. But it's exceedingly rare and I do believe that that is really tied to down payment. When somebody hands over $15,000, the likelihood that they're just going to walk away with a decent credit score of 660 or above is low to the point that I am comfortable purchasing those loans. Because if it does happen, I'm comfortable with the default process. But it's rare.

Seth: Sure. I have to assume you're ready for it. If somebody defaults, you know exactly what to do. You're not scared of that. You just follow the appropriate process to get that done. I guess you said it's relatively uncommon. I don’t know how many deals a year like this you're doing, but if you're doing just for round numbers a hundred of these per year, is it like maybe five of those you have to worry about that or 10 or one or none? I don't know. What would you say?

Eric: Under 10%. Probably more along the lines of 5%.

Seth: Okay. And does that ever become a problem where you hit a snag and you can't resolve it or it takes way longer than you expect or it's more expensive than you thought it would be? Or do you pretty much have your process ironed out so that there are no surprises in that process?

Eric: Yes, you never know what a borrower is going to do during the foreclosure process. Most of the time with land, they're just probably going to walk away. A lot of times you can convince them to do what's called a deed in lieu of foreclosure and just say, “Hey I'll give you some money if you just deed the property back to me.” If it has a clear title, that's an option.

But if a borrower really wants to keep the property they might hire an attorney, they might fight the foreclosure, they might file bankruptcy. There's a lot of things that could happen. In land, it's relatively rare because most of the time they're not living on the land so they're probably more likely to either just give it back or do a deed in lieu of foreclosure.

Seth: Yeah. Isn't that kind of the same thing? Giving it back in deed and lieu of foreclosure?

Eric: Yes. Same thing.

Seth: Just want to make sure I wasn't missing anything. Because I agree, that sounds like by far the easiest wrinkle-free way to do it just to clearly mop it up and you're done.

So, when you try to pursue that, I'm assuming that's probably your first default way that you try to resolve this. The first step is to say, “Hey, can you just deed it back to me?” And assuming that's true, what percentage of the time do they actually do that? They don't ghost you, they're willing to do it. And what do you have to pay them to get them to do that for you?

Eric: I would say about $500. But the other issue here is that a borrower is personally guaranteeing this loan and if they default, you can obtain what's called a deficiency judgment against the borrower, which is a judgment that they did not fulfill their terms of the loan and that deficiency judgment could attach to their primary residents now or it could attach to real estate that they own in the future.

Seth: Interesting.

Eric: That tends to be a very powerful motivator in these situations in order to get the borrower to cooperate.

Seth: It sounds like $500. Does that usually work?

Eric: On the face level, I would say no. People tend not to respond but I think that the encouragement of the issue of a deficiency judgment, nobody wants that. That makes the borrower much more likely to cooperate.

Seth: That's interesting because I know probably the biggest frustrations I've ever had with seller financing are when I'm trying to communicate with this borrower about anything, whether it's about this or something else and they're just not responsive. It's like they've vanished from the face of the earth and I can't get anything out of them because it just makes it harder for everybody.

So, when you say that “No, they don't do that,” does that mean they're not responsive or does that mean they hear you, they're just saying, “No, I'm not going to comply, I'm not going to do what you want?” And how do you convince a person to do this? Is there a certain letter template that you use where you talk about this deficiency judgment or a certain verbal conversation you have on the phone? What is most effective in getting people to just work with you?

Eric: I don't recommend that you ever call borrowers on the phone. That's the job for the servicer. I'll also say that a deficiency judgment is not an option with a land contract. That is only an option with a loan only.

The way that I would handle it is, in my experience, there's a very clear process. Once the borrower reaches 90 days delinquent, you're going to send a demand letter saying that you're now in default. You need to cure the default within 30 days and this is the amount. If you don't cure the default, the foreclosure is going to be filed.

I would also include with a note mortgage, that deficiency language in the demand letter and I would have the servicer try to communicate with them. But that does happen. Frequently, borrowers just completely go dark and they refuse to communicate and that's part of the business. That happens.

Seth: Okay. If somebody is of the frame of mind where it's like, “I don't ever want to have to deal with foreclosure stuff with chasing borrowers around to pay what they're supposed to pay me. I just want total surety that I'm going to get my money. This is going to be a passive hands-off investment.” What do they need to prioritize when they're underwriting these deals? Are they just looking for the best possible credit score and high down payment, that kind of thing? Just make sure that's as good as it can possibly be. Acknowledging that they're probably going to walk away from a lot of opportunities that aren't perfect. Is that what you'd recommend?

Eric: The big four for me are pay history, credit score, down payment, and investment to value. If all of those line up, you're probably fine, but there are no guarantees in life. I think that in my experience, you're going to have a lot more issues with the no credit check, no money down land contracts than you are going to have with a higher down payment and a higher credit score.

Seth: Are there any states that come to mind that have a particularly easy foreclosure process or repossession or auction process or whatever?

Eric: Texas is probably the easiest.

Seth: That's if you're not using a land contract, right?

Eric: Yeah. They're not friendly to land contracts and that makes sense because their foreclosure process is like three months or less. It's just so fast. There's no reason to use land contracts in Texas. And if you speak to an attorney, they'll tell you don't use a land contract. The Western states, Arizona, Colorado. Washington is fine, California is fine. All of those states have a pretty fast foreclosure process. Non-judicial.

Seth: And when you buy these notes or help originate them, do you ever resell them again or is it your goal to just ride them out until they're paid off?

Eric: I don't usually resell them. Sometimes lately, I've been selling some of my older residential loans to free up some capital for more land purchases. But I'm not in the business of brokering these, which would be just basically not fund it, just kind of broker it to another party. And actually, a lot of the note buyers that you will likely meet in the industry are not actually funding it with their own capital, they're just trying to broker it to another party.

So, keep that in mind if you're trying to sell your loans. One of the first questions that you should ask is, “Are you going to be purchasing this or are you going to be brokering this?”

Seth: Yeah. How much does a note broker make from each broker deal?

Eric: I would say a couple thousand. Unless you're a very high-level institutional broker. And there are some institutional brokers that specialize in being the goal between huge funds and banks. Individual loans, I would say not very much. I'm not even sure that it's a feasible business.

Seth: And I know we've talked a little bit about your note-buying program. Is there anything else worth talking about with that? It sounds like a really good way for somebody who's never really understood how to do seller financing correctly. It sounds like a good way to get educated on that just because it sounds like you help them make sure everything is lining up correctly.

But if somebody does want to get involved with what you're doing in terms of “I want to offer seller financing to make this thing sell faster, but I don't want to actually play that game long term.” Anything else worth mentioning about how that works or who that's ideal for?

Eric: Yeah. I created the program because I really do believe that land investors can sell their land much faster and for more money if they offer seller financing. But most people, they would rather have the cash, they don't want to hold a note. They don't really want to have to worry about originating the note and then selling it down the road. So I created this program in which I purchased seller finance land notes for 80% of the sales price at closing. And I basically handle everything. I oversee all the paperwork, I oversee the process.

The only thing that you have to do is just market the property with just a couple of parameters. It's designed to be super simple, super easy, super transparent, no negotiation. You know exactly what you're going to get upfront. And I've had really great success with it so far. People have been really happy with the program just because there are a bunch of things that you need to keep in mind when you're doing an origination and I kind of oversee that in the background for you.

Seth: Got you.

Eric: I vet the buyers. I do review the properties to make sure that there are properties that I'm comfortable with, but I handle the credit check and the whole process.

Seth: It sounds like you probably have a lot of repeat business. It's probably certain land investors or real estate investors that just you do stuff with them again and again and again. Is that accurate?

Eric: Yes.

Seth: If we had done that kind of thing together, I'm sure that's how it would work. When you find a good source of business that can help you with something, it's like why not do that again and again if it's working?

Now I get a note here to talk about The Power of Zero by David McKnight. This is a book that I have not read but sounds like there's something about this that's significantly worth talking about. Did you want to get into that at all?

Eric: Yeah. I really believe that the biggest enemy for land investors is not really any type of specific market. I think that the thing that we should be most concerned about is taxes. And I read The Power of Zero by David McKnight and the premise of the book is that taxes in the future are going to be much, much higher than they are now and you should be taking some specific steps to mitigate your tax liability now before the taxes get out of control.

And typically, what happens with land investors is that they're paying taxes every year over and over and over on the same money. And one of the suggestions that he makes in the book is the idea of the solo 401(k). I have employed the strategy and it's really been a game-changer for me.

So, what I have is a self-directed checkbook solo 401(k) that is a Roth account, which means that I pay taxes on the money before it goes into the account and then I never pay taxes on it again. What I do is, in 2023, I'm going to contribute $66,000 after tax for myself, $66,000 for my wife. And what I do is my company pays me and that money goes through a payroll processor, I pay taxes on it so that I have records that the taxes were paid in case I'm ever audited. And then that money goes into my solo 401(k). I self-direct it so I can spend it on whatever I want to within reason.

Now, you can't run a business in your IRA, like you can't flip land in your IRA and never pay taxes. That would subject you to what's called UBIT tax. You have to be purchasing investments that are more passive, that you are not actively involved in on a day-to-day basis.

Now, with that said, if you're interested in this, I highly recommend that you consult with a tax advisor or an attorney to come up with a plan for what you can invest in. But it is such a huge amount of money that you can contribute into these accounts that it really is an amazing strategy. I think it's probably the best game in town. You do need to be self-employed either full-time or part-time. The other caveat is that you cannot have any full-time employees. You can have part-time employees and you can't have independent contractors. But for me, it's just been a huge opportunity.

Seth: Yeah, and there's probably a lot of people in the REtipster audience that kind of fit that profile and it sounds like if you just scan the average person in the general population, a lot of people wouldn't. But we're looking at land investors or real estate investors who are at least somehow self-employed without any full-time employees. The closest comparable thing I can think of to this is the self-directed Roth IRA, which I've done a bit of.

But the big drawback with that, it works similarly in that you put after-tax dollars into it, but you're limited. I don't even know what the current amount is, but it's definitely not $66,000. It's way, way less than that and you can't get to it until you're 59 and a half because it's a retirement account. That age restriction, does that apply to the solo 401(k) as well or when can you actually take the money out?

Eric: I would rather not say because I'm not an expert on that. I don't believe that is the case. I believe that the age is lower.

Seth: Yeah. Something I heard you mentioned earlier when you were talking about the solo 401(k) is that you were talking about the self-directed IRA, you said that that can't be used as a business, it has to be more passive in nature. Is that a rule or is that just a practical guidance thing? It doesn't make as much sense to do it that way?

Eric: If you want to run a business in your IRA, you will be subject to UBIT tax. And I'm not a tax professional but my understanding is that UBIT tax is around 37% that you would have to pay. So, it's probably not the best entity or situation for land flipping, but for more passive investments it really provides you an amazing opportunity to go tax-free moving forward. You might want to have your normal land business and then there's just so many other opportunities that you could get involved in for other great investments that are more passive, that you can use your solo 401(k) for.

Seth: Yeah. Again, not tax advice at all, but I just did a Google search and I asked “When can you take money out of a solo 401(k)?” and it says, “Participants can withdraw funds at any time after the age of 59 and a half.” Again, I don’t know if that's right or not, that's just Google. But I know that is something that I find very annoying about a self-directed Roth IRA, like a big drawback to doing that because you can't get the money. I mean, yeah, you're saving a lot on taxes, but if you can't use the money anytime soon, it's like, “Okay, well, yippee, it's great for me, assuming I live that long.”

But it sounds like with the solo 401(k), especially one that is a checkbook self-directed 401(k), it's a lot easier to actually move the money instead of getting a custodian involved and all the hoops you have to jump through for that. And also just being able to put so much more into a fund that thing from the get-go. I know that was a huge thing that slowed up the process with the self-directed Roth IRA. But either way, a great tool to know about if you want to not pay a whole lot of taxes long term.

Eric: And the other nice thing is that the setup costs are very low. I think I may have paid $500 to start it. So, for me, it's really been a game changer. I highly recommend it, especially to those younger listeners out there who haven't really started thinking about that yet. It's a great opportunity.

Seth: Yeah. And I assume that's something that you employ with this note-buying business, right?

Eric: Correct.

Seth: I'm trying to think, is there any, I don't know, software, or anything that you use that's vital to you in this kind of note-buying business, whether it's to keep track of stuff? It sounds like you do your own accounting, that kind of thing. But it's a fairly different business than one who flips land. A lot of land flippers who might be listening to this, they kind of know the land world. But if somebody ever does want to get into this note space, are there any crucial resources that are just amazingly useful to you?

Eric: Yeah, absolutely. I use a financial calculator called T-Value. I use it every day. It's probably the best $60 a year that I spend. It's a financial calculator and amortization schedule creator.

I use Pipedrive. Pipedrive is a CRM that I kind of organize my notes in. It's not really designed for that so it probably isn't the best fit.

I use QuickBooks for my accounting.

And I just have a lot of forms in Excel. I keep track of my notes in Excel. I keep track of my documents in Word and that's pretty much it. I'll be honest with you, I'm kind of a lousy marketer. Lousy with data. I'm not that great of a land investor, honestly, but this I can do.

Seth: Yeah. Okay, cool. Well, if people want to find out more about you or work with you or have questions or want to reach out to you, anything like that, you're not obligated to share this stuff, but if you want to, what would be the best way to follow you or get a hold of you?

Eric: So you can email me. My email is eric@damencapital.com.

Seth: Cool. Well, Eric, thank you very much for talking with me. It's been very informative. It's been awesome to get to know you a little bit better. I hope your business continues to grow and do well. And you sound like an awesome resource for people to learn more about how to do this properly. Because I know there's a lot of, I don’t know if it's misinformation or just not a full awareness of how to do it quite right, but it's guys like you that can help people bridge the gap and figure this out. So, I appreciate your time.

Eric: Yeah, thanks so much for having me. It was awesome. If you come across anyone who has any questions, just send them my direction. I'm happy to help people in any way I can. And I will be at Dave's conference next May. So, we'll get to meet then.

Seth: Yeah, I can't wait for it. It'll be a lot of fun. Thanks again, Eric, and hopefully, we'll talk again soon.

Eric: Thank you so much, Seth. Have a great day.

Seth: Thanks. You too.