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H & P Capital Investments LLC
Issue 25
July 2007
Note Myth: Get More Money for Your House Using Owner Financing
by Tom Henderson

Now that the sub prime market is vanishing, 'gurus' are giving you misleading information that owner financing solves all your problems. For example, in today's mail, I got two advertisements for seminars touting that you can get a higher price for your property using owner financing. THIS IS A MYTH.

I was reading with amazement how these "gurus" were telling you that if you had a house worth $150,000 that is not selling, you could use owner financing to get your price, and sell this property immediately. All because the buyers do not have to go through a bank to qualify.

While it is true you can command a "higher selling price" using owner financing, this does not translate into more money, especially if seconds are brought into the picture. These gurus do a great sleight of hand by equating a "higher price" with more money. THEY ARE NOT THE SAME.

Can we agree that buyers with 5% or more down, with decent credit, can take out a conventional loan, with no need for owner financing. What "more buyers" really means is more sub prime borrowers. Sub prime borrowers do not make note buyers feel warm and fuzzy.

For example, take a scenario of a $150,000 house where you got a $3,000 down payment and took back a first lien note (the same concept applies to a wrap) for $147,000 @ 9%.for 360 months. You now have a hoard of buyers wanting the property. It appears that you got "full price" for your house, but did you get more money? How much cash would you really receive if you sold the note.

Now let's convert this note to cash. The note buyer is looking at little equity, at best, and at worst, little equity with a low credit score. Being conservative, let's say a note buyer would pay 85% of the unpaid balance of this note, which is $124,950 plus the $3,000 down. This is a grand total of $127,950( not counting closing costs). You could have discounted the house to $135,000 and received "more money", but at a lower price. Are you beginning to grasp and see that although you got a "higher price", this higher price did not translate into more money. Why? Because the note was discounted due to low equity and/or low credit score. Thus a "higher price" is not the same as getting more money,is it? Now magnify this concept where the gurus are telling you to take back a second, which has no value to a note buyer, not to mention the risk of loosing all your second lien note's value should the first go into default. Are you really receiving a "higher price?"

Does this mean there are no good reasons to owner finance? Heavens no! Does this mean you should never take back a second? Heavens no! There are good reasons to owner finance and to take back seconds, but "getting a higher price" is not one of them. Why, because a "higher price" is not the same as getting more money.

Next month: I will discuss when smart investors use owner financing.

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Watch That Interest Rate
How Not to Get Pencil Whipped: by Tom Henderson
woman pencil

Let's review the three factors that determine the value of a note. I call these factors THE THREE P'S. 1. the People 2. the Property 3. the Paper. In this issue I am going to discuss one element of the Paper that causes your note to become less valuable. I am talking about low interest rate.

A good example was a note I received recently from a lady where the equity in the property was more than enough to give a note buyer a warm and fuzzy feeling. The note had 55 months of seasoning. The credit score of the payors was in the high 600s. The problem was the interest rate was only 5%. In today's market, assume most note buyers want at least a 9% yield. Let's see what happens to the value of the note when we put the data into time value of money calculations.

Here is what the original note looked like: (Original terms were 240 months for $115,000)

N = 240
I/Yr = 5.00
PV = 115,000
Pmt = -758.95
FV = 0

After 55 months she brought the note to me. Here is what the note looked like:

N = 185 (240 minus 55 payments made)
I/Yr = 5.00
PV = 97,746.17 (PV after 55 payments)
Pmt = -758.95
FV = 0

Now, let's assume a note buyer wants a 9% yield. What is this note worth?

N = 185
I/Yr = 9
PV = 75,794.24
Pmt = -758.95
FV = 0

OUCH!!!! $75,794 for a note balance of almost $97,746.17. This is of the unpaid balance. Why? Because of the difference in the interest rate spread. Let's do a little more calculator practice. If she had charged 9% instead of 5% when the note was created,here is what her note would have looked like.

N = 240
I/Yr = 9
PV = 115,000
Pmt = -1,034.68
FV = 0

After 55 months, the 9% note would look like this

N = 185
I/Yr = 9
PV = 103,331.23
Pmt = -1034.68
FV = 0

Because of the seasoning, equity, and good credit of the payors, this note would have commanded a price of at least 92% of the balance which is $95,064. Why? Because the note buyer would discount the note for only the normal risks and accounting costs, not for interest rate spreads.

Why did she charge such low interest? Because they were "friends" and 5% was what the banks were charging. This was a costly error. DON'T YOU MAKE THIS MISTAKE.We ended up buying a partial of this note, which solved her problems, but she still would have preferred to sell all of her note.

The moral to this story: If you are going to owner finance, charge more than the "market" interest. This will eliminate interest rate risks, and make your note more valuable if you need to sell.

The Note Professor Notebook goes in depth into these kinds of calculations.

If you need help in structuring a note to sell or buy,contact me. It can save you a lot of money.

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Tom's Speaking Schedule
NoteWorthy Convention

Tom will speaking on "How to Make Large Yields with Small Money" October the 4th through October 7th 2007. NoteWorthy Convention. Las Vegas, Nevada

Note Professor Notebook on sale at the NoteWorthy Bookstore.

Tom Henderson
H&P Capital Investments LLC

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