Archive for January, 2011
Mr. Note Seller, Sorry… I Need to Come First
January 14th, 2011 categories: Seller Financing, Selling Your Note, The Note Business
I guess I’m no different than anyone else… I want to be first. I hope I’m the first person you’ll call when you’re putting an owner financed deal together or you have a note to sell, but I definitely need to be in 1st lien position when I buy a note.
The situation I’m going to describe kinda blindsided me. It was so unexpected that I didn’t get to the bottom of it until after both note seller and myself had already put some effort into putting a deal together. We could have saved ourselves some time if I’d simply thought to ask one more tiny question in the interview process.
Here’s how I thought the deal was shaping up with a note holder that sold a property 4 months ago:
- Sales price: $47,500
- Down payment: $1,000
- Credit score of payor: 600
- Note amount: $46,500
- Interest rate: 8%
- Amortized over: 120
- Due in 60 (some pluses, some minuses)
- Monthly payment: $564.17
Because of the low down payment & credit score, there was no way that I could buy the whole note, so I offered to buy a partial.
I would buy the next 55 payments for $19,500 and leave the balloon to the note holder.
- $19,500 (proceeds from sale of 55 payments)
- $28,200 (balloon amount left for the note seller)
- $47,700 total to seller (for a note with a $45,473 balance)
He thought that sounded great and we were off to the races. Then, I get all of his documents. He had failed to mention that there was a $22,000 bank loan against the property that he had wrapped with his seller carry back transaction.
When I called to verify that he would be bringing in funds to close ($22,000 less the $19,500 = $2,500 to pay off the first) he said,
“Whoa, now wait a minute! Why would I sell a note just to have money go out of my pocket at closing? The point is that I need some cash right now.”
Somehow he thought that I would pay him $19,500 and stay behind the $22,000 first, which he would, of course, continue make payments on.
Uh… I don’t think so.
That would put my combined investment-to-value (ITV) at 87%! No way!!! Where’s the equity to protect me in the case of default? And statistically speaking, there’s a fairly good chance of default from a buyer with less-than-average credit and who doesn’t have much skin in the game (low down payment).
“Well,” I told him, “you could save yourself the negative cash flow for now (his mortgage payment to the bank was $1,071 each month, and he was only collecting $564 from his buyer/payor) and then have a nice $28,200 coming to you in 4 1/2 years”.
That just wasn’t going to work for him, so our deal fell apart.
To all you note sellers out there… us note buyers have to manage risk well in order to buy your note, and a big part of that is limiting ITV: Investment To Value. I usually don’t want my investment in the deal to represent more than 50-60% of the value of the underlying collateral, and I’m a prima donna… I HAVE to be in 1st position!
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Many Note Buyers Won’t Buy a Contract for Deed
January 7th, 2011 categories: Seller Financing, Selling Your Note, The Note Business
[youtube]http://www.youtube.com/watch?v=Vxr6duZLw7w[/youtube]
I’m not sure why people use a contract for deed (CFD):
- it doesn’t get around the due on sale clause
- it doesn’t help the seller defer capital gains
- the buyer (vendee) has an equitable interest, so you’ll have to foreclose if they default
- the seller who is still on title can potentially encumber the property
- the seller’s (vendor’s… and possibly the vendee’s) bankruptcies, liens, judgments and probate issues will affect title
- the note buyers who will pay the most for a cash flow would usually rather have a note & mortgage, or a note & deed of trust… the contract for deed will have to be converted in order for the note holder to be able to sell their note
Unless there are some extenuating circumstances, I would never use a contract for deed. If there’s a small down payment, then use a title holding land trust instead… more protections and advantages all around.
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Why Do I Need Insurance and Pay History When I Want to Sell My Note?
January 5th, 2011 categories: Seller Financing, Selling Your Note, The Note Business
[youtube]http://www.youtube.com/watch?v=xQphcoX8w2U[/youtube]
When you want to sell a real estate note and mortgage (or note & deed of trust, or a contract for deed), you need to be able to prove that you have an investment that is performing, and the way you do that is by keeping an accurate pay history.
Save photos of canceled checks, bank statements, etc., anything that will prove that the Payor pays you on time each month. This helps support the value of your note. Most people should be using a note servicing company to keep track of payments, 1098′s & 1099′s.
The value of a note is also heavily dependent on the collateral securing the note. That’s why insurance is so important. If there is no hazard insurance, and the property burns down, the value of the note goes up in flames with the stucco.
In the event of catastrophe, the note payor will probably quit making the payments, and then you’ll have to foreclose just to have the right to pay for a demolition so you can sell raw land and recoup a tiny bit of your investment, if you’re very very lucky.
So, the lesson of the above video if you’re a note holder, or thinking of offering owner financing on a property you currently own:
- Keep an accurate pay history (paper trail)
- Make sure the buyer/payor keeps renewing hazard insurance each year and that you’re listed as Loss Payee or Additional Insured
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