As the firm that advises the top crowd funders in the space, we consider
ourselves experts in the crowdfunding / borrower dependent note structures.
We should. We created them. As an investor, you may be wondering about
them and if they are a good investment? Like any good investment, you
should be aware of the risks and rewards. Let’s dig into them now.
Borrower Payment Dependent Notes in General
Borrower Payment Dependent Notes (BPDN) are mortgage-backed debt obligations
that allow investors to participate in the performance of certain real
estate loans. The notes are tied to a corresponding borrower loan from
a particular broker, and the amount of earnings are directly linked to
borrower payments. Although the investor shares in a percentage of the
payments collected on the mortgage note, he may not hold a security interest
in the deed of trust.
Unlike where an investor provides a peer-to-peer loan or direct private
money, many BPDNs are issued as an unsecured note guaranteed by the mortgage
broker rather than secured by the property. The broker uses investor capital
to make loans and then provides a note based on that loan’s payment
performance. If all goes well and the borrower is a solid, A-paper client,
the investor will receive payments every month, and a better than a market
rate of return on their money.
Risks Associated with BPDNs
Issues can arise when the company that sold the loan runs into financial
problems and files for bankruptcy protection under Chapter 11. Recent
cases have shown that once a company, such as a broker or private lending
institution, goes into receivership, the court could hand the assets over
to a court-appointed trustee, who can then freeze the assets and whom
That note which was paying on time and looked like such a good investment
may now be considered an asset of the broker to be sold off to satisfy
the firm's secured creditors. If not properly titled, the investor
could be left in a holding pattern until the bankruptcy is settled. This
process could drag on for months or even years, and may result in the
loss of part or all of the investment.
The law now requires that the BRE or Department of Business Oversight license
any person who sells financial instruments tied to mortgage loans. Other
protections address issues that could potentially cause severe losses
to investors including: 1) The broker must vest ownership interest of
the mortgage note into the investors name under official records; 2) A
mortgage broker must notify the BRE if it borrows money from its clients;
3) A licensed agent must verify the investment as being suitable for the
investor before providing an offer; 4) Most importantly, brokers are instructed
to establish a trust account to oversee client funds, and ensure compliance
with BRE reporting and audit requirements.
The Bottom Line – What to Look For
When considering an investment in BPDNs, savvy investors should research
how the entity offering the notes conducts business; whether they are
licensed real estate brokers who have the note serviced and disbursed
by a third party escrow, and if they secure the investor’s interest
in the collateral with a deed of trust. By following the same rules that
accompany other real estate investments, legitimate brokers will ensure
the investor’s money is secure, and that their client’s interest
in the investment can be recovered in the event the their company experiences
Comparison Versus LendingClub and Prosper
You may be wondering how this compares to Lending Club and Prosper. Here
is a quick chart that compares them:
None or Collateralized by the Notes
Real Estate (look for LTV for Lender to recover and thereby pay borrower
of BPDN) and Credit Score
State mortgage license/regulated
3-7% based on Credit Score
8%+ depending on collateral and yield negotiated with Borrower
Should you have any questions regarding BPDNs, give us a call. We helped
advise the largest crowd funders in the nation and we can advise you on
them as well.
Contact Geraci Law Firm at (949) 298-8050 today, or
contact Anthony Geraci directly
for more information.