But what options are there for notes when a balloon is due but the buyer can’t refinance? Should the seller consider extending?

Here’s a look at a common dilemma facing sellers and note brokers. (Note: The specific details were modified for privacy protection.)

Dear Note Investor,

I was approached with a balloon payment mortgage note now due after 5 years of payments… but buyer/payer cannot come up with new financing due to market conditions for financing.

Should the note holder…

1.   Create addendum to existing note and extend payments until financing can be arranged? Or…

2.  Create addendum/rewrite to existing note for terms, interest and payments to eliminate balloon? Therefore, having a marketable note.

Here’s the existing info:

• Selling Price:  $300,000
• Down Payment:  $84,000
• First Lien:  $216,000
• Date of Note:  6/1/2005
• Terms:  360 /60 (payments based on 30 year amortization with balloon due in 5 years)
• Payment:  $1,192.76
• Balloon Amount:  $199,042 +/-
• Interest Rate:  5.25%
• Pmts paid:  60
• Pmts left:  Balloon Payment

Any advice… please?

And here’s our answer the the Balloon Payment dilemma:

Dear Note Broker,

Great to hear from you! You ask a very good question, especially in today’s economy.

You are correct. In order for this note to be purchased by an investor they would most likely need to look at a modification to extend the balloon.

There are two big unknowns on this deal that would play a major role on any note buyer’s offer:

1. the credit score of the property buyer; and

2. the current value of the property.

If the buyer can get refinancing, the seller would probably just want to extend for a couple of months.

If the buyer is unable to refinance, the seller may want to consider a modification and longer extension rather than starting foreclosure for nonpayment of the balloon mortgage.

One solution is for the seller to modify the note with monthly payments based on a 25 or 30-year amortization and keep, but extend, the balloon payment to 7-10 years from the date of modification.

They could agree to let the note fully amortize and eliminate the balloon altogether. However, this could limit the seller’s options in the long run.

By extending the balloon, the seller is not obligated to keep receiving payments for another 25-30 years. The extension provides the buyer both time and motivation to get their financial affairs in order to qualify for refinancing.

A balloon payment can also improve pricing from note investors based on the time value of money. (For more information please read: Owner Financing – Why Balloon Payments Are Good For Mortgage Notes.)

It would be to the seller’s benefit to get that interest rate increased in exchange for extending out the balloon. They should be sure any modification is prepared and recorded by a title company or attorney to be certain it follows the laws of their state and protects their first position lien holder’s interest.

I have to give the disclaimer that I can’t give financial or legal advice as that is not my licensed profession. My comments are based on what makes the note more valuable to somebody that would be purchasing the note. For specific pricing mortgage buyers will want to review the documentation along with the current property value, payment history, and credit history.

All the best,

Tracy Z. Rewey of NoteInvestor.com

Here’s how to know if it’s a firm offer or just a soft quote when going to sell a private mortgage note.

Soft Quotes

A soft quote is an initial offer made by an investor without review of the buyer or payer’s credit. Credit plays a crucial role in pricing for both yield and investment to value (ITV) parameters on owner financed real notes. A quote without a credit review will likely be revised when credit is actually reviewed.

A soft quote is provided when only a Quote Request Worksheet is submitted without any supporting documentation. When there is no legal ability to pull credit and no indication of the payer’s credit status, the investor will often assume the best.

The quote will be “subject to review of credit – assumes good credit” or “assumes a credit score of 675 or higher.” This assumption will be incorrect and too high at least 80% of the time. That means there is a high likelihood the offer will go DOWN when credit is reviewed.

Firm Offers

The best solution is to receive a firm offer by submitting sufficient documentation for the investor to pull and review credit on the payer. Each investor sets their individual criteria for the minimum documentation required to pull credit. Most will pull credit with either an authorization signed by the note holder or a copy of the note and mortgage. The copy of the Closing Statement is also useful.

A firm quote is still subject to the remainder of due diligence items but pricing should not change unless the property value comes in low or subsequent documentation does not support the information provided on the worksheet. A firm quote should indicate, “credit reviewed with pricing” and “subject to standard due diligence and underwriting review of documentation.”

Get It In Writing

Quotes are generally returned within 24-48 hours or the next business day. The quote should come back from the investor in writing via fax or e-mail and is normally good for 30 days.

If the quote has not been formally accepted within 30 days, it might be subject to change in the event the investor’s pricing model or cost of funds have altered. Some investors will  require a new credit pull after a certain period of time (generally 60 days), which could also cause a pricing adjustment if credit has worsened resulting in a lower credit score.

By gathering accurate information and basic documentation upfront, note brokers and sellers can receive a firm offer.

For more helpful tips on selling notes for top dollar pricing be sure to read 21 Insider Secrets You Must Know Before Selling a Mortgage Note and consult the 2010 Directory of Owner Financed Note Buyers!

When a Mortgage Note is sold an Assignment of Mortgage is recorded at the county level. Additionally the note itself is endorsed over to the investor. The type of language used on the endorsement plays an important role in whether the investor has any recourse against the seller or prior note holder for repayment of the note.

A standard note endorsement would read:

“Pay to the order of (Insert Investor’s name), without recourse.”

When the endorsement specifies “without recourse”, an investor can only seek recourse against the payer or property for nonpayment of the note.

However if the endorsement reads “with recourse”, the investor has the option of also seeking recourse against the seller if the buyer quits making payments.

If the note does not specify either with or without recourse, then it is assumed that the endorsement is made with recourse.

The Purchase Agreement also plays a role on what type of recourse an investor might have against a note seller. This agreement often contains certain representations and warranties that the seller makes in order for the investor to purchase the note.

Most sellers would prefer to sell a note without any recourse or obligation to buy back the note from the investor should the buyer or payer fail to make payments. It is important to understand the documents that will be executed when selling a note to avoid any surprises.

Whether a seller, investor, or note broker, there are many opportunities to make money with owner financed or seller carry back notes.  There is a lucrative secondary market for seller financed notes also known as the paper business. Here are a few of the most common ways people make money in the note business.

Maximize Selling Profits

A seller often takes back financing for a buyer to appeal to a larger group of buyers and maximize the sale price. A property seller may also elect to take back a portion of the sale price for long term interest income.  Why should the banks make all the money?

Did you realize that a bank earns back almost 2.5 times the loan amount on an average $100,000 loan at 7.5% that runs for a full term of 30 years? The payment would be $699.21 based on a 360 month amortization which means the buyer will pay back over $251,715.60 after 30 years on the $100,000 loan.  All due to the power of interest! 

Referral Fees

A note broker or note consultant earns a referral fee by acting as a financial middleman between a note seller and a note investor.  A note broker markets to note holders offering to help them liquidate their note payments for cash today.  The note broker then connects the note seller with a note investor, earning a fee at closing.  This fee can range from hundreds to several thousands of dollars depending on the size of the note and their relationship with the investor.    

Interest Income

Investors purchase notes for the interest income.  First an investor can earn the interest rate or face rate charged on the note.  An investor can further increase their return by buying the note at a discount.  For example if a note has a balance of $25,000 at 8% interest the investor can offer less than $25,000 to purchase the note for a return of 10% or more.  The greater the discount the more the return is increased!

Rather than holding for long term interest income, an investor might also purchase a note at a discount and then resell at a later date for a profit.  This is often accomplished by combining several notes together in a group or portfolio selling at a higher price to a larger bulk investor.

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