Should I Carry Back An Owner Financed Note?

If you are selling real estate, especially in this market, you might be approached by someone asking if you are willing to “Owner Finance” or consider a “Seller Carry-Back” note.

Here are a few guidelines to consider…

How Do You Make Money When Owner Financing?

The whole concept behind seller financing is that you are acting like the bank. While that carries risk of receiving payment, you can also get a great return on your money.

I tend to recommend that if you are going to carry back a note, the face rate (interest rate) should start at 10%.

Many potential buyers will tell you that banks will lend to them much lower – well, if that is the case, then they can get the loan at the bank – it needs to be worth your while to carry back a note (financially speaking).

If someone wants a lower rate, look for a larger down payment. This also helps lower your risk of taking back the property due to non-payment.

For example, the minimum down payment I like to see is 10%. That would get you a note written at 10% interest.

If someone were willing to put down 20%-25% then I would consider creating the note at a rate or 9% or even 8%. – More equity equals a safer note.

Selling Your Owner Financed Note Later

In addition to getting a good return on your note, you may have the flexibility to sell the note at a later date if your financial circumstances change. How you create the note in the beginning can go a long way towards better pricing. Here is the short list of items to consider.

1. The bigger the down payment the better. Buyers are much less likely to walk away from a property with real equity.

2. The “discount” in selling your note is caused by several variables. One such variable is the difference between the face rate of the note and what the investor wants to earn. The higher your interest rates the better.

3. The shorter the term of the note the better – but not too short. A 15 to 20 year note is great. A seven-year note with a big balloon is not. There is too high of a risk the buyer won’t be able to refinance and the balloon will not be paid.

4.  Check out the credit history and income of the buyer. Find out upfront if the buyer can afford the monthly payments or  has troubles making any payments on time.

5. Have the monthly payments go through a third-party servicing center. This will provide a potential investor with a great payment history.

6.  Get the documents prepared by an attorney or licensed closing agent. You want to be sure that you have a secured lien against the property and keep in compliance with any legal issues.

Although every deal is different (property, buyers, area, etc), the above will give you a good place to start and help you make a good financial decision for you and your family.

For more information on owner financed notes you might want to check out:

10 Advantages to Using the Seller Carry Back

Disadvantages to Seller Financing

21 Insider Secrets You Must Know Before Selling a Mortgage Note

Is For Sale By Owner The Best Place to Find Notes?

One of the most common items new note brokers run into is they start seeing the “For Sale By Owner” or FSBO signs pop up around them.

Granted, those signs have always been popping up, but now that you are in the note business you begin to see some additional opportunities.

But are they good opportunities?

The existence of a “For Sale By Owner” sign does not necessarily equal a potential cash flow note deal.

If anything, it may be a distraction.

Let me explain.

1.  “For Sale By Owner” does not mean the seller is willing to owner finance. It just means that they are attempting to sell the house without using the services of a Realtor. It could be they are trying to make a few extra bucks. If that is the case, they will most likely not be interested in carrying back a note (and then selling that note at a discount).

2. “For Sale By Owner” does not mean they have the ability to carry back a note. In other words, there is no guarantee the seller has enough equity to make for a viable note sale. It is more likely they have a large underlying lien (bank loan) that they need to pay off. Could be another reason they are trying to cut out a Real Estate Agent and keep the fee.

3.  Sometimes the reason someone is selling “By Owner” is that they did not believe the real value their home was worth. A real estate professional may have told them what the value was, but the seller is trying to sell for more than that (above the fair market value).

4.  Just because the property is for sale by owner, does not mean that the potential buyer has any need for owner financing. The sale could end up involving a bank loan or even a cash sale. In either case, there never would be a private note created; to be later purchased/brokered.

5.  At this point, there are very few Note Buyers that are interested in a “simultaneous closing.” A simo is where the Funder purchases the note without any seasoning (or payments having been made). Many people want money now – which is why they are more apt to take a slightly lower cash offer than deal with the hassle of selling a note later.

It is not that “For Sale By Owner” properties do not have the potential to be notes – some do. But most do not.

Do you want to spend your valuable time looking for notes that are already in existence or do you want to spend your time looking for deals that may be created.

I spent a lot of time with “For Sale By Owners” when I was first starting out.

It was a great experience builder and my best financial calculator got quite the workout. But in the end, I would guess I only closed 1 out of 100 people that I actually spoke with. (1 out of 500 that I contacted and never heard back from). And that was during a time that simultaneous closings were popular – those numbers would be even less now! (See the article Selling Mortgage Notes: Where Have All the Simos Gone?).

If you do come across a “For Sale By Owner,” it is a good idea to simply let them know what you do.

Don’t spend a lot of time – again a note may never be created. Send the seller a card or direct them to a an article on your note business website. Keep them on your radar and see if the property sells with some sort of owner financing. If it does, now you have something to work with. Or improve your odds by targeting sellers that have already indicated they have an interest in offering seller financing (see the article Finding Mortgage Notes with Reverse Ad Marketing).

Focusing your marketing efforts looking for existing notes (as opposed to notes that may be created) will always yield better results…and profits!

Self-Directed IRA Custodians Sued by Investors

Watch out note buyers!  The self-directed retirement account, a popular vehicle for purchasing notes, is under attack!

Tired of dismal returns in the stock market many investors turned to buying real estate, private mortgage notes, and other alternative cash flows.

They combined the power of high returns and compounding interest with the tax advantages of the IRA, Roth, Solo 401k, and other retirement accounts.

The self-directed IRA has a designated custodian that handles the paperwork and other administrative duties for the retirement account. Now these custodians are being sued by disgruntled investors reports the Wall Street Journal. Read more

One of Our Favorite Note Buyer Purchases

One of the best investments we made as a note buyer happened a bit by accident.

In 2008, we were contacted by a potential seller of a real estate note secured by productive farmland. He wanted to sell payments from his note to pay off his credit card debt.

The details were roughly as follows: Read more

Do Some Investors Pay Par Pricing When Buying Mortgage Notes?

Recently we received a question in the Finding Cash Flow Notes training course related to “par pricing” or “discount” when buying mortgage notes.

First off, here is the Note Broker Question…

Hello and thank you two for all your help. My question is why would a note investor pay par for a note?

I’ve been speaking with a person who helps their clients use OWC (Owner Will Carry). I was informed they are working with a note investor that is willing to buy a note for par.

I don’t understand why an investor would do that since they aren’t making any return. Do you have any insight into this?

And Now The Note Buyer Answer:

It is not impossible for a note investor to pay par, just very rare.

First off, there are some costs to close the deal (appraisal, title, recording fees, etc). So at the very least there is a discount to cover those expenses.

Let’s say it cost the note buyer $1,500 in closing costs. They are going to at least discount the note $1,500 to help cover those costs.

That said, the only reason an investor would pay par is that they are happy with the face rate of the promissory note as their return.

If they buy a note that has the face rate of 12%, they will earn 12% on their money (minus the closing costs).

Par Pricing Example When Buying Mortgage Notes

For example, let’s say someone has the following note (with an acceptable LTV and ITV):

• 200 payments remaining
• $525.00 monthly payment
• $40,576.92 – Current Balance
• 14% face rate

If an investor purchased the above note for par (100 cents on the dollar) they would pay $40,576.92.

Now, let’s assume the investor had $1,500 in closing cost (that they did not pass on to the seller of the note). The investor’s “real” return would look like this….

• 200 payments remaining
• $525.00 monthly payment
• $42,076.92 – Amount Invested ($40,576.92 Purchase Price + $1,500 Closing Costs)
• 13.33% Rate of Return

So, if an investor were to pay “par” for the 14% note, after paying closing costs, the investor would still realize a yield of over 13%. Not a bad return.

The reason you don’t see this often is threefold:

1. There are very few notes written at a rate private mortgage investors want to earn;
2. If the note pays off right away a note buyer wants to at least recoup their costs since they won’t be able to earn a return over time; and
3. Most sellers will accept some reasonable level of discount or pay costs.

There are many ways to get closer to par pricing that don’t involve a “full purchase.” Front-end partials, split partials, and even staged payouts are several options, but those are topics for another day (or check out the Mastering Partials Module in the Finding Cash Flow Notes Training)!

Additional Articles on Discounting Mortgage Notes

How Partials Reduce Note Discount When Selling Mortgages

Calculating Cash Flow Notes for LTV and ITV

What is the Face Rate of a Note?

What’s Your Discount?

 

Buying and Selling Notes for Residual Income

Here’s one reason to love real estate notes… surprise payoffs! For years we have been talking about the benefits of keeping some payments as residual income when buying, selling, or brokering notes.

This is not just theory – it really works.

Need proof? Just last month we were fortunate enough to get one of those surprise payoff checks for $57,569.28!  And that was on a note we sold back in May of 2000.

Now before you start thinking this is some sort of easy overnight riches please understand that this does NOT happen on every deal.  In fact the average note broker fee is about 3-6% of the amount invested by the note buyer. (Check out How Much Money Will I Make in the Note Business for more on this topic.)

But when you combine the power of interest with time and the partial purchase there is an opportunity to earn residual income. How is this possible? Well here are the details from the initial note sale followed by the payoff update. Read more

Will 2012 Be The Year For Real Estate Notes?

To understand the current market for real estate notes it helps to go back in time.

Years ago the country was in a financial crisis. Gas was expensive. There were numerous political battles in Washington, DC. Houses were not selling. Interest rates were high.

Wait…what? Read more

Charging Late Fees on Notes

Successfully owning or buying cash flow notes requires a solid plan for collecting and servicing the payments.  But what happens when the note payments are late?  John Moren, a 25+ year veteran of the note business, explains the issues with charging late fees on notes. 

In speaking with our NoteSmith loan servicing software users, I sense a lot of confusion and unnecessary creativity concerning late fees around the country. Here are some issues we have seen over the last few years.

Definition of late fees:

A late fee is a small, state sanctioned fee you collect as reimbursement for the nuisance of processing a late payment. Most states limit the fee to 4 or 5% of the installment amount. It is a one time, flat fee.

Late fee versus interest:

IRS Publication 1099 (www.IRS.gov) is the instruction booklet for completing Form 1098, which summarizes a borrower’s annual mortgage interest deduction. That publication allows deducting late fees along with interest “unless the late charges are for a specific mortgage service.” A late fee of $10 on a $200 monthly payment easily can be construed as a specific service, that is, sending a late letter or making a collection call. But what about a late fee of $5 per day? First of all, this is not a single fee and violates most state law about charging more than one late fee per periodic payment. It also has a time component to it making the charge sound more like interest than a flat fee. After all, isn’t interest really just a charge per day? If you are looking for an incentive for your payors to make timely payments, a tax deductible late charge is not the way to go.

Unconscionable fees:

We received a software question concerning a monthly payment amount of $253.06 which carried a late fee of $150.00 after 4 days. I do not know the state this was in, the collateral, or whether the payor was a natural person or a corporation (corporate payors generally can be legally and financially gouged without typical retail consumer protection). If this note ever makes it into court, a skilled attorney could have a field day with it. To answer their question, one of our support people wanted to call back and ask for the person who would be left behind when the rest of the office was in jail! We bit our tongues and faxed back politely, but more on this note later.

Pyramiding of late fees:

Imagine you were holding a note that required monthly payments of $965.56. One July, you receive a check for the mortgage payment in the amount of $956.65. As a conscientious investor, you accept this partial payment, add your typical 4% late charge of $38.62, and wait patiently for the next payment. On August 1, you receive a payment for the next month of the normally expected $965.56. Still being conscientious, you apply the first $8.91 to the close out the July payment and the next $38.62 to zero the late fees owed. Now the August payment is almost fifty dollars short, so you charge another late fee. This is called “pyramiding of late fees” and, although it appears to be statistically correct, is illegal in all states of which we are aware. The reason is that one short payment caused two late fees. It does not matter if it was caused by a clerical error, a late payment, an insufficient amount, or an insufficient check, you can charge only one late fee per late payment.

Increasing income without pyramiding:

Almost all notes specify that the order payments will be applied is first to costs of collection, next to interest, and the remainder to reduce principal. Let’s again use a $200 monthly payment where about $170 pays the interest, about $30 goes to principal, and there is a $10 late fee after 10 days. Of course, the payor is 15 days late but sends you $200. We’ve seen servicers apply the first $170 to interest and the remaining $30 to principal. The late fee is accrued as if they expect to collect it someday. Instead, the first $10 needs to go to the late fee, which never can bear interest, then the next $170 to interest, leaving only $20 for principal reduction. The next month, interest will be higher than expected because of the principal shortfall.

Increasing income with pyramiding:

Continuing with the same scenario, the servicer still has a choice to make. Do they close out the month or not? According to the terms of the note, the above payment is a partial payment. If the month is not closed, then $10 is still owed. When the payor makes the next $200 payment, even if it’s on time, the first $10 goes to close out the previous month and this payment is now $10 short-and subject to a late fee if not paid within the 10 day grace period. This seems to be pyramiding, because each subsequent “timely” payment ends up with a late fee. Only one late fee is charged per payment. Payments are not timely unless the entire payment is received timely. Check with your state law before attempting to service a loan in this manner. If your law prohibits pyramiding, and if this scenario matches their description of it, then take your $200, apply the payment appropriately, and close out the month even though you have not collected all that is owed for that period. You will collect all the principal owed to you, plus interest, when the note pays off.

Grace periods:

The whole notion of late fees opens up a legal can of worms and here is the argument. Since the payor has a grace period of 10 days, the note specifically states that it is acceptable to pay at least 10 days late. Further, it implies permission to pay even later since the late fee is the payment in full for the right to make a payment after the grace period expires. Some of our software customers do not write late fees into their notes because they are afraid it may inhibit foreclosure efforts.

Late fees are not the punishment:

Punishment is designed to modify behavior. A late fee is not the big stick, foreclosure is. A late fee is merely reimbursement of the costs of collection. The threat of foreclosure is the punishment that forces timely payment. Going back to late fee accruals, if you have been shorted repeatedly on the principal necessary to amortize the loan, you are in a foreclosable situation. If you have been politely applying the payments first to interest and principal, while accruing non-interest bearing late fees, it is doubtful whether you could foreclose. Would you rather go before the clerk of the court-or the court itself-with outstanding principal or outstanding late fees?

“Good clauses do not make good notes, good payors do.”

I heard that once at a Jimmy Napier seminar and I have been encouraging investors to upgrade their portfolios ever since. All the creativity, punishment, and coercing you can muster is in vain if the payor does not have the financial ability-or the mental desire–to make a payment. Remember the $253.06 payment with the $150.00 late fee? The payor paid the whole amount, $403.06, and the check bounced.

Written by John W. Moren, President of Princeton Investments, Inc., publisher of the original NoteSmith loan servicing software since 1988, copyright C 2012 by Princeton Investments, Inc.

The NoteSmith family of loan servicing software tracks mortgage notes, discounted notes, leases, rent, and other cash flows. Loan originators, mortgage lenders, note buyers, real estate investors, attorneys, accountants, and charitable organizations know that NoteSmith products were created for them and by them.

Evaluate a Cash Flow Note In 60 Seconds or Less

Ever feel like you spend too much time determining if you have a viable seller financed cash flow note to either broker or keep for yourself?

Not me. I tend to look over a real estate note and make a pretty rapid decision.

So, how do I do it?

First off, I tend to go for the big stuff first. You know, 30,000 foot level. It is easy to get caught up in the details that won’t really matter when it comes times to make a decision.

But let me back up for just a minute and explain what I mean by… Read more

What Private Note Buyers Can Learn from MERS

Note Buyers take notice; a U.S. Bankruptcy Judge has now ruled MERS’s business practices are unlawful.

Heard of robo-signing, burger king kids, and attorneys promising to stop foreclosure?  Well that’s all part of the MERS mortgage lending mess and it just got a lot harder than calling for a cleanup on aisle 5.

What’s the impact?  L. Randall Wray, Professor of Economics, wrote this:

“United States Bankruptcy Judge Robert Grossman has ruled that MERS’s business practices are unlawful. He explicitly acknowledged that this ruling sets a precedent that has far-reaching implications for half of the mortgages in this country. MERS is dead. The banks are in big trouble. And all foreclosures should be stopped immediately while the legislative branch comes up with a solution.”

Source: For all the details including a great explanation of MERS be sure to read the full Huffington Post article at New York’s U.S. Bankruptcy Court Rules MERS’s Business Model Is Illegal.

So What Can Note Buyers Learn From MERS?

It reads like a refresher course in Note Buying 101:

• Get the original promissory note,
• Get it endorsed,
• Get an Assignment of the Mortgage or Deed of Trust
• Get the Assignment recorded in the County Records
• Make sure the chain of endorsements matches the chain of assignments, and
• Keep all the originals together in a safe place.

Why?

Well you can use these items to prove ownership, collect payments, enforce your rights, foreclose in the event of default, or defend against any claims.

In legal lingo it grants you the power of 4 magical words… Holder In Due Course.

This was common practice when I started buying notes for the insurance company in 1988.  When going out on my own in 1997 I used the same note buyer criteria.

Of course not every note fits my buying parameters (and I’m not Oprah, Warren Buffet, or Mark Zuckerberg with seemingly unending supplies of funds) so some notes get referred to other investors.  Most investors follow the same Note Buying 101 closing requirements… most but not all.

I can still remember the first time we got to closing on a deal being placed with outside funds only to discover the original note was lost and to my astonishment the investor said,

“That’s ok we will just have the seller sign this lost note affidavit.”

Normally a lost note means a frantic search by the seller followed by calls to the original closing or servicing agent to track down the original. As a last resort option we get the payer/buyer involved to execute a duplicate note and affidavit along with the seller’s affidavit.

But just the seller?

That was certainly easier… but not safer.

You see this investor was placing seller-financed notes into a conduit for mortgage-backed securities and it wasn’t required.  Next assignments started getting executed in blank and after closing we noticed the investor wasn’t recording some assignments.

Now that sounds like 4 letters that will haunt mortgage lenders for years…. MERS

Fortunately on notes purchased in-house we followed the Note Buying 101 steps.  These are the same steps taught in our Finding Cash Flow Notes training course and in articles here at Note Investor including Note Buyers Demand Original Promissory Note and Understanding Note Endorsements.

It’s safe to say that if private note buyers are still around today they are following these guidelines and have used solid legal counsel. (Author’s note: I am not an attorney so unable to give legal advice but encourage you to get some before buying notes.)

Whether note buyer, broker, or seller it is essential to know where the original note is located and keep an unbroken chain of title for smooth closings.

While the death of MERS will surely hurt the mortgage lending world the boomerang effect will be an increased need for alternative financing, note buyer services, and private investors.

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