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Seller Financing Explained

General Info:  In light of current economic instability and today’s downward trending housing market, more buyers & sellers are turning to Seller Financing as an option.  We often receive calls from sellers stating that they are thinking of selling their home on a contract, otherwise known as Owner financing or Owner Carry Back.  They tend to ask what their best option is in structuring a contract for sale  to a note buyer..  Below is some general information about seller financing and items we look for when bidding on notes.
The past few years of easy financing have pushed the idea of “carrying paper”out of the forefront of many sellers’ minds.  Seller-financing has been around for years, and remains a very popular strategy for financing the sale of real estate in some parts of the country,.  In fact, it is reported that over $94 billion  dollars in private real estate notes are created each year.  In the current economic climate many more buyers and sellers will turn to seller financing to get a deal done.

If you don’t need all the proceeds from the sale right away, then seller-financing a home can be a very secure investment.  When a person invests  in the stock market, they  have no guarantee of a reasonably stable underlying value.  In contrast, seller-financing gives the seller a steady rate of return based on the interest rate of the loan.  Furthermore, sellers who seller-finance can (and should) charge a higher interest rate than the going “bank rates” because seller financing often makes the deal more appealing to the buyer. This is especially true if the buyers do not qualify for a traditional bank loan.  The biggest risk to the seller is that their buyer will fail to make timely payments (known as “defaulting on the loan”).  In such a case the seller can foreclose on the property and resell  it to recoup their money. 

Many property owners are comfortable using their properties collateral for a guaranteed monthly cash flow, because they are very familiar with the property after having owned it themselves.  The sellers should retain the right to inspect the property at regular intervals after the sale, and actually do it!

Selling your note?
A well structured contract helps make it’s subsequent sale more attractive to institutional or private notebuyers.  There are many factors that can be adjusted to come up with creative solutions that meet the needs of all parties concerned.  Seller-financing is one of the most flexible and adaptable options available in the sale of real estate.  Well constructed notes can be sold at a minimum discount.
A note secured by a deed of trust or mortgage can be bought, partially assigned, and sold fairly easily.  The sale of the note is similar to sale of real estate.  Many of the same principles apply. 
The amount of discount required to sell any given Trust Deed, Mortgage, or Note is related to the amount of risk it represents.  We determine the relative risk of any cash flow by evaluating the following factors:

1.  Buyer’s equity in the property.  (We prefer the LTV not to be over 60-65%).
2. Credit history of the buyer.  (We encourage the seller get a recent copy of the buyer’s credit report).
3. Payment history.
4. Loan Seasoning.  (We like to see at least six months of timely payments before we bid on a note).
5. Note interest rate.  (The seller should be able to charge more than a bank would charge).
6. Terms or length of the loan. (A long term loan or contract will be bid at a large discount if sold.  We encourage the seller to require a balloon payment in 5-7 years)

There are several factors influencing the value of a note or contract; we have touched on the main concepts.  A note or contract is not overly complicated in most cases, but it does require some forethought in it’s creation and maintenance in execution.
For instance, the payment history needs to be carefully documented if the note holder (seller) ever wants to sell all or part of the note or contract. The buyer of the note or contract will want to see a copy of the payment history; they will not just take the note holder’s word that the note is performing.  We always recommend that the note is placed and serviced by a third party escrow company.  We also recommend  the sale be closed at a licensed title company.
A note or contract that pays predictably is more valuable than a note that has delinquency problems.
Here are a few simple components that should be included in every contract or note:

1. Origination date - the date the note was made. This date should be the same as the date on the Deed of Trust or Mortgage.
2. State the date the interest begins - usually a note is created in advance of the close of the sale, so this date needs to be clearly documented.
3. The date the payments are due - the date the first payment is usually one month after the date that interest begins, however, the payments can be set up many ways such as: monthly, quarterly, semi-annual, and annual.
4. The date of any balloon payment due - not all notes will call for a balloon payment, but as we suggested above many sellers/note holders will ask for a 5 year balloon to preserve the value of the investment.
5. The principal amount of the contract (face value) – this is the total loan amount.  Ideally this number represents less than 60% of the sales price or market value, meaning the seller got at least a 40% down payment.  The more down payments the seller receives, the better security they will have.  Always try to get as much as possible.
6. The name(s) of the borrower(s) - the people buying the property and responsible for paying on the contract
7. The name of the person(s)/entity receiving payments on the note, also known as the beneficiary - if you sell your property and carry back the note/contract you, in essence, become the bank.
8. Location where the payments are to be made - the borrower needs to know where to send the payments.  In most cases, we recommend using an escrow servicing agent, they are a dis-interested 3rd party who receives and distributes payments and also maintains a Tax and/or Insurance reserve account if called for in the contract terms.
9. Interest rate - usually stated as an annual rate, even though payments are received on a monthly, quarterly, or even semi-annual basis.  The rate or “yield” on the contract must be spelled out clearly for both buyer and seller. 
10. Payment amount - the amount of the payments should be clearly defined, for example; two-thousand five hundred and seventy-eight dollars and thirty-eight cents. ($2,578.38)
11. Property insurance must be required, and the seller should be listed on the policy as the mortgagee.

The above elements don’t encompass every potential aspect of the transaction, but are a great starting point.  If you think you will want to sell all or a part of any note or contract, then it is essential that you structure the transaction in a way that preserves the value of your contract in the secondary market.  When you are going to act as the bank on the sale of your own property you need to think like a loan officer at a bank, and put all the paperwork together properly so that you are well secured.  We always suggest having an attorney look over your paperwork before you close the deal.

We would be happy to bid on any note or contract you hold.  Please remember that although we have listed important parts of the notes, and what we are looking for, each note and/or contract is different and all factors will be taken into consideration to determine the amount we are able to pay you for your note or contract.  Please contact us if you are looking to “cash out” your real estate note or contract.

Creative Finance
Toll Free: 1-800-999-4809 or 406-721-1444 Fax: 406-721-1459
info@creative-finance.com