Partials – The Secret Weapon to Underwater Mortgages

Almost 1 in 5 owe more than homes are worth, screams the headline from Time Magazine. Across the nation declining property values are creating negative equity with some hard hit areas like Las Vegas reporting a 1 in 2 chance of being underwater with a mortgage in excess of property value.

Mortgage lenders are reeling from increased delinquencies and mounting losses as borrowers opt to just walk away.  While the seller-financed industry is not immune, it does have a secret weapon for dealing with negative equity – the partial purchase.

When an existing note is presented to an investor for purchase the Loan-to-Value (LTV) has already been established.  This LTV is based on the owner financed note amount in comparison to the sales price.  If the value has gone down since the property sold then the LTV can actually increase and even exceed the value, creating negative equity.

While note investors can’t control the existing LTV they can control the amount invested or the Investment-to-Value (ITV).  This exposure rate is based on the current property value and will generally decrease as the risk increases.  A lower ITV based on declining values can create a high discount to the seller.  The partial purchase is on the rise as investors demand lower exposure while still presenting an appealing offer to the seller.

The best way to highlight the benefit of a partial purchase is to show one in action.

• Joe Seller sold a property in 2007 for $200,000.  Mary Buyer had put down $20,000 creating 10% equity and 90% LTV. Joe Seller had agreed to owner finance the balance of $180,000 at 8% interest payable in 240 payments of $1,505.59.
• Two years have passed with timely payments and Mary Buyer has paid the principal balance down to $172,075.08 with 216 payments remaining.
• Unfortunately property values have declined in the area and the current value is now only $170,000.  This is more than the current balance creating a new LTV over 101%.  All of the equity has been erased and the buyer now owes more than the property is worth.
• The seller is in need of cash to pay bills, finance his daughter’s college tuition, and help make ends meet.  An investor reviews the transaction with the payer credit and only wants to invest 50% of the current property value resulting in a purchase price of $85,000. 

What? An offer of only $85,000 for a balance of $172,075! Understandably Joe Seller does not want this kind of discount. The solution is a partial purchase.

• The investor desires a yield of 11% on the $85,000 investment and is open to a partial purchase. The investor will need to purchase the next 80 monthly installments of $1505.59 to achieve an 11% yield.
• The seller receives the $85,000 at closing and retains rights under the partial purchase agreement to the 136 payments remaining after the investor receives the next 80 payments.  If the payer continues to pay on time the remaining principal balance will still be $134,355.17 when the note is reassigned to the seller from the investor.
•  The seller has cash today and a nice future income.  The seller might also sell additional payments when the partial pays off or the property value improves.

A partial purchase will not be a solution for every transaction. Keep in mind that a partial does not stop a buyer from missing payments and becoming delinquent.  It provides for a lower exposure for the investor in the event they have to foreclose and resale the property.

If the payer has very poor credit or recently lost their job, a note investor may decline to purchase the note altogether, even on a partial basis.  While a 50% ITV might sound like a good way to make money foreclosing and reselling, most note investors are looking for cash flow.  The time and expense to foreclose and possibly rehab a property far away might outweigh the yield benefit.  Transactions that are currently in default or have a high likelihood of default are better candidates for local real estate investors or workout specialists.

When the remaining underwriting issues are positive a partial purchase based on the current fair market value can be an oxygen line to a transaction that is underwater.  It is important for sellers, note brokers, and investors to have the partial purchase strategy to survive the current economic and real estate crisis.

To read the full details on the US negative equity status visit the source article written by Barbara Kiviat for TIME Magazine and published by Time, Inc. on March 4, 2009, entitled “Nearly 1 in 5 Owe More Than Homes are Worth!”

For more tips and documents on using partials to sell or purchase mortgage notes visit the bookstore for Personal Profit Series: Notes – Your Complete Money Making System to Buying, Referring, Creating and Holding Real Estate Notes!