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

Buying and Selling Notes – What is the Current Property Value?

One of the considerations when buying and selling mortgage notes is knowing the current value of the home. After all, the property is the collateral and knowing its true value will greatly affect how much an investor will pay for a note.

Historically this process was a bit easier, when everything was in an “up” market.  But with property values still on the downside or just recovering, it is often difficult to put a (safe) number on it. At least one that everyone agrees on.

Although there are excellent programs on the Internet that help the average consumer to get an idea of value, they are not always accurate. The actual value of a property can be determined in a couple of credible ways.

Often, note investors get what they call a “drive by” appraisal or valuation.

Usually performed by a licensed appraiser, the report will  include other sales or comps in the area. The main difference is a “drive- by” evaluation does not require the appraiser to have access to the interior of the property. The appraiser actually drives by and takes pictures from the street for the report.

Some investors are using what is called a Broker Price Opinion (BPO) – an evaluation based on the advice of a real estate agent or broker. They are often very similar comparable to a “drive by” and at a lower cost but do not follow the strict guidelines of a certified appraiser.

The note buyer may even require a full interior appraisal to get comfortable with the value. This might be the case when there are substantial improvements to verify or there’s concern over the property condition.

The actual approved or preferred method will be up to the individual investor.  While they are buying the mortgage note and not the property itself, the value is still important in deciding risk, investment to value (ITV), and the price they will pay to purchase the remaining payments.

Top 5 Ways to Buy Mortgage Notes

One of the things that make buying and selling notes so appealing is the multitude of ways an investor can purchase a note.

Frankly, you are limited only by your imagination. Well, maybe imagination and reaching a desired yield.

Here is a quick look at calculating the cash flow business that even those with math phobias will like.

The Top 5 Ways to Buy Cash Flow Notes

1. FULL – A full is just that. Buying the entire note.

If the seller has 322 payments remaining, the investor purchases all 322. The full purchase is the most popular way to buy mortgage notes.

Even though it may not be the best choice for a seller, many sellers just want to be completely done with the note.

2. PARTIAL – Anytime an investor purchases something other than a Full it’s referred to as a “Partial.”

Typically when someone uses the term “Partial” we are talking about purchasing the next immediate “X” Number of Payments. This can be any number of payments.

The most common partial purchases are 60 months, 120 months, and 180 months.

If the investor purchases the next 60 payments, the promissory note reverts back to the seller on payment 61. The seller, at their discretion, may choose to sell more payments or keep the remaining payments.

3. PAYMENTS ONLY – This type of partial purchase involves a balloon mortgage note where the seller is due a large balloon payment at the end.

For example, the note holder is to receive 120 more monthly payments and then a balloon payment of $50,000.

“Payments only” would be when the investor purchases just the remaining 120 monthly payments but none of the balloon payment. The seller of the note would retain future possession of the balloon.

4. SPLIT BALLOON – Very much like the “payments only” option except in this case the investor purchases all of the monthly payments (120) and a portion of the balloon.

For example, the investor purchases all the remaining 120 payments and $30,000 of the balloon payment.

This would leave the seller the remaining $20,000 due of the balloon payment.

The seller and investor have effectively “split” the balloon ($30,000 to the investor, $20,000 to the note holder).

5. SPLIT PAYMENTS – In this type of partial, the investor purchases a portion of each monthly payment.

It is typically reserved for when the seller of the note is receiving a sizeable amount each month (although it really could be implanted at any time).

For example, let’s say the note holder is due 145 payments of $2,500.00 each month.

The investor may elect to purchase $1,750 of each month. This would leave the remaining $750.00 each month for the seller of the note.

Typically the payer mails the full $2,500 each month to the investor and then the note investor forwards the $750 to the seller. This avoids confusion among the payer of the note as well as helps the investor make sure the note is being paid in full each month.

The “amount” of each monthly payment that is purchased is completely up to the agreement of the investor and seller. It just needs to be worth the extra handling efforts.

MAKING THE CHOICE

As you can see, there’s more than one way to buy mortgage notes. Matter of fact, there may just be literally hundreds of ways to purchase notes since many of the methods can be used in combination with each other (including Reverse and Split Disbursement partials)

As long as the deal can fit into the best financial calculator, there is a mathematical way to purchase the note.

So which method is best?

The best method is dictated by the needs of the note seller and how best to meet that need while still protecting the yield and exposure requirements of the investor.