Real Deal #149 – Seller Financing, Second Liens, and the 80-10-10.

Welcome to Real Deals!  It’s always easier to learn from real life so here we share information from actual owner financed transactions.

When the bank loan and the buyer’s down payment don’t add up to the sales price, a seller might consider owner financing the difference.  Here’s how a classic 80-10-10 worked with owner financing on a four unit residential property in Baltimore, MD.

The seller was a worn out landlord and the buyer was an experienced real estate investor.  The units created cash flow through monthly rental income in excess of monthly expenses.

The buyer and seller agreed upon a sales price of $132,0000 with a down payment of 10%, or $13,200 at closing. The bank agreed to lend up to an 80% loan to value resulting in a 1st position note of $105,600.  This left a remaining 10% or $13,200 that still needed to be paid or financed.

This type of challenge is often solved with the seller agreeing to owner finance the small remaining balance.  This is a classic 80-10-10 deal where the lender receives a first lien of 80%, the buyer puts down 10%, and the seller owner finances the remaining 10% in the form of a second lien.

The seller agreed to owner finance $13,200 in the form of a second lien at 10.75% interest with monthly payments of $123.23.  The amortization was based on 30 years with a balloon payment all due and payable in 10 years.

The transaction closed and the first and second liens were documented on the closing statement so all parties, including the lender, were aware of the arrangement. The seller received 5 monthly payments and decided he would prefer cash now rather than monthly payments over time.

Finding an investor to purchase payments on a second lien can be a challenge.  An investor knows that the bank will get paid first and should the buyer fall behind on payment the bank can foreclose.  This leaves the second lien holder having to decide between walking away or investing more money to pay and protect against the first lien.  If there is very little equity to protect (in this case less than 10%) a second lien holder will often just walk away and move onto the next deal.

Due to the risk and volatility, second liens are usually just held by the seller rather than sold to an investor.  However, there are times a private investor will consider purchasing second liens at a steep discount, generally less than 50 cents on the dollar.

This seller was able to locate and sell their note payments to a self-directed Individual Retirement Account or IRA.  The seller received $5,753 for the note, which was about 44% of the remaining balance.  This provided an anticipated yield of 28% to the investor.  The note investor or IRA ended up with a final yield of over 60% when the buyer was able to pay off the second lien early, after just two years.

Real deals are based on actual transactions completed within the past ten years. Market conditions change frequently resulting in pricing and underwriting changes by note investors.  Work with qualified professionals when creating new notes to obtain accurate and up-to-date pricing and investment parameters.