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How To Craft A Good Owner Financed Note


Pen and pad to write a letter.

How can real estate investors and sellers maximize opportunities by creating better owner financed notes?

Offering owner financing has become very attractive to homeowners and real estate investors. While there are several ways to do this, seller held mortgages have been one of the most popular. They can help sellers minimize taxes, create passive income streams, and get more out of each asset.

Creating a seller financing mortgage note actually creates a new asset. However, the terms and features of the note will greatly impact how valuable that asset is. A poorly structured note may be virtually worthless to anyone else, whereas a good mortgage note may be highly attractive to other investors. This can be very important if you ever get in a pinch, or need more cash in a lump sum. It also makes sense that following what others consider to be a valuable and safe loan note to some extent may also make a better performing note for you to hold.

So what factors impact a mortgage loan note’s value?

LTV

Loan to value makes a significant difference. Clearly an underwater note is going to be far less desirable than a property that has some equity. Of course, many of these seller notes are created to finance those with low or no down payments. This may not be too much of an issue if you don’t plan to sell for a few years and expect values to increase, but don’t factor it in.

Lien Position

Will this note be a first, second, or third mortgage? First and seconds are both in high demand today. While seconds normally carry higher yields, firsts are seen as less risky.

Down Payment

In addition to LTV, you will need to know if the buyer intends to put down any money. If they made partial payments over several years under a rent to own or option agreement, be sure to document the payments. The more information here, the better.

Location

Location makes a massive difference. Many mortgage lenders already restrict their lending to certain geographic areas. Some black list rural areas, or where mortgage fraud is common. Keep in mind that the secondary market for owner financed loans is far smaller than that for institutionally originated home loans. The better your location, the more valuable and salable it will be.

Property Type

Are you financing a single-family home, condo, farm, vacant lots, or multifamily property? What is it made out of? Is this a mobile or manufactured home? Is it concrete block or wood? This can all make a difference. Some lenders and note buyers won’t like condos. Few may buy loans on mobile homes. Think about what properties are the best built, least risky investments, and easiest to resell in a default. These will make the most attractive notes.

Credit Score

Note buyers will want to see a credit profile on the borrower. What they will buy may change over time. For example; high LTV loans and rock bottom credit scores might be fine in a boom, but in really tough times note buyers may insist on higher credit scores and other features. Making a few call to note buyers in advance might help clarify what scores they are looking for.

Loan Amount / Loan Balance

This is another factor in which it helps investors and sellers to put themselves in a lender or mortgage note buyer’s shoes. Multi-million dollar loans are something which even banks take to capital markets and pool multiple investors’ funds in. Small balance loans can be more work and expense than they are worth. $100,000 up to conventional loan limits will likely receive the most attention from end buyers.

Interest Rate

Unless selling to a note buying company or note broker that will just flip your note, they are buying for yield. Conventional mortgage interest rates have been incredibly low. They have been setting up investors for terrible yields. In comparison; 5 percent or 6 percent interest on a private loan can be far more attractive, but investors should also look forward. Could it pay to make a more aggressive loan (higher LTV and lower credit score) with a higher rate? In 5 years from now, other rates may be in the double digits.

Number of Payments

How long will the mortgage note be for? How many installment payments will be left when you go to sell?

Seasoning

Seasoning plays a significant role into the value of a note. Have borrowers proven to pay timely for 3 months, 12 months, or longer. Some note buyers will have minimum seasoning periods. The longer you can hold, the more valuable the note will be from a seasoning perspective.

Amortizing or Balloon Mortgages

Is there a pending balloon payment? Will the payments pay off the loan by the maturity date? A balloon might be a good thing in a rapidly rising market. It may not be for long term hold investors, and environments when borrowers will find it difficult to refinance.

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