Note Professor Newsletter

How To Structure a Note To Sell at Closing - The Paper Continued

While it is true, if you put this data into the formula for determining the present value of a note, you would get a premium price, the fact of the matter is that the terms are such that the payors can not perform. This type of note is a foreclosure in embryo. (If you do not understand how to determine the price of a note, you need to go to "How To Discount a Series of Payments with a Balloon.")

When structuring the PAPER, set the time from 20 to 30 years, with an interest rate of around 10% to 12% in today's market. (In Texas, do not exceed 12%, as some note buyers will balk at that high of a rate. Always check to see what your state's usury laws are.) If your buyers are startled at the high interest, remind them they are not having to pay PMI, which will be approx 1% to 2.5% of the loan. If you add this fee on to a 6% conventional note, the payment will not be much different than your 11% note. PMI can add from $83 to $200 monthly on a $100,000 loan. I talked with a couple last month that told me that their payments would be higher getting their house refinanced at 6.5%, with PMI, than the 10.5% they are paying now.

Make sure the loan payment is around 30% of the monthly income. The higher ratio of income to house payment is, the less warm and fuzzy a note buyer feels. By this I mean if the payor's monthly income is $1000 monthly, the mortgage payment should be in the $300 range. How do you know what the buyer's monthly income is; because you got a form 1003 from the beginning, remember?

Next comes the down payment. I am going to go into this again when we discuss the PROPERTY, but I cannot emphasize enough to get as much down as possible. If you remember nothing else, remember this..THE MORE DOWN PAYMENT YOU GET, THE MORE MONEY IN YOUR POCKET. The reverse is also true…The less money you get as a down payment, the less money in your pocket. Remember, the buyers are not having to pay points, they are not having to pay loan origination fees, and they are not having to pay what I call "because I can" fees. This means more money for the down payment. If the buyers do not have at least 5%, insist they come up with more…even if they have to go to relatives for help. Better yet, if it is a young couple, and Mom and Dad have good credit, in exchange for lending the young couple some money for the down payment, put ole Mom and Dad on the title for a small percentage, and get them on the note as well. This, along with the added down payment, will make your note extremely more valuable.

Why does extra down payment mean more money in your pocket? Because note buyers go by what is called ITV (investment to value), rather than loan to value. Here is a brief explanation that might bring things to light. Say note buyer will wants 80% ITV ratio on a owner occupied single family home. Let's further assume we have a house appraised at $100,000 where the sellers took nothing down, carried a note for $100,000 and the buyers had perfect credit. At an 80% ITV ratio, this note could be purchased for $80,000. This is a $20,000 discount, and the seller would receive $80,000

Now let's assume this same house and buyer, there was a 10% or $10,000 down payment, where the seller carried back a $90,000 note. A note buyer would pay the same $80,000, but this is only a $10,000 discount. The seller would then receive $80,000 from the note buyer, and $10,000 from buyer, for a total of $90,000. This is an increase of $10,000.

Here is one other point that is very important when taking back owner financing, whether you intend to keep the paper, or sell it. If you sell more than 5 properties a year using owner financing, the government considers you to be a lender. You must conform to government regulations. DO NOT PANIC. This merely means that certain documents must be completed at closing to satisfy TILA (Truth In Lending Act) and RESPA (Real Estate Settlement Practices Act). These include among other things the HUD-1 and TILA documents that merely states the amount of the loan, the interest rate, terms, and amount of interest paid over the term. It is no biggie. Title companies do them routinely.

Do not fall into the trap of having "kitchen table" closings, where there are no HUD or TILA statements, and expect a note buyer to rush to give you top dollar, when you have not complied with the law. AVOID THIS TRAP.

To summarize, make sure the terms are realistic. THE MORE DOWN, THE MORE IN YOUR POCKECT, and make sure you comply with government regulations.

Contact me, and I will be happy to help you set things up to make an offer.

Next month, I will "wrap" things up with "THE PROPERTY". I will be discussing equity, and different ways to structure a note to give the note buyer the equity he needs.

As usual, contact a CPA and attorney before dealing in notes. And contact me if you have any questions or comments.