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Owner-Financing Secrets for Investors: What makes a Good Note?
| | Thursday, March 04, 2004 @ 08:00 AM EST
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Contributed by: Charles Breeding
Charles Breeding Properties
Read more archived articles about Paper and Mortgage Investing
Most real estate investors (and realtors) miss one important fact about the marketplace: only 35% of the buying public can qualify for a mortgage through a traditional lending institution. If that’s the case, without attempting owner-financing, you are automatically limiting yourself to 35% of the buyers when you want to sell. By simply advertising “seller-financing” or the equivalent “owner financing,” sellers will often triple their traffic of qualified buyers.
Robert Kiyosaki in his book, Rich Dad, Poor Dad speaks about an alternative financing strategy that he employs which some real estate investors don’t fully take advantage. In this article, we will explore what is owner-financing
is and how can it work for me? What makes for a good, salable note and what are my options with a promissory note? And if I sell my note, what can I expect?
What is seller-financing?
In seller- or owner-financing, you act as the bank. You set the terms, typically 30 years. You set, in negotiations with your buyer, the interest rate and you assume the risk. You decide the down payment, often 10% of the purchase price -- a minimum of 5% is a must or you won’t be able to sell the paper in the future. Incidentally, no one will buy your paper if it’s less than 5% down.
What interest rate should I ask for? I suggest that you negotiate somewhere around 8-12%, typically averaging 10%. Investors ask, “If home-buyers have a 5 – 10% down payment and you’re asking 10% interest rate, why wouldn’t a they go to a bank?” I reply, “Go to the bank.” Many buyers, for numerous reasons – bankruptcy in past, loss of job, debt-to-income ratios – can’t qualify for a mortgage. Thus, you set the terms in negotiation with your buyer.
Read Me First!
Here’s a very important point: if you as the holder of the promissory note don’t have at least 15% equity, or spread between what you owe on the house and what the value is of your note, this won’t work for you. For example, if you owe $80,000 and you hold a promissory note of $100,000, you can easily sell the note. Investors sometimes call me with a $100,000 note and they owe $90,000 – they are out of luck unless they want to bring money to the closing table.
Obviously, a buyer of your note is willing to front you cash NOW for payments that won’t come for 15, 20 or 25 years from now. The natural “time value of money” law creates a typical discount of about 15%.
If I sell, what can I expect?
If you decide to sell your note to a buyer, it generally must have 3-6 months worth of “seasoning” or payment history, and NO late payments in the history. Here’s what to expect:
Ø The higher the down payment, the lower the discount.
Ø The longer the terms, the better.
Ø The higher the interest rate, the lower the discount.
Ø Credit rating of the payor is a factor; 550 or better is preferred, but we represent buyers who will purchase a note of a buyer at below 500.
An Example
Let’s say we have the following deal:
§ $100K appraised value that you buy for $75K (assume $60K mortgage)
§ You sell it for $105K with a 5% down payment
§ Financed amount: $99,750. At 10% interest over 360 months, they pay you $875/month.
§ Your $75K mortgage at 7.5% = $524/mo. for a positive cash flow of $351/mo which over 30 years = $126,360.
Great cash flow, right? I often ask investors, “Why sell it, then?” Often, the reason is to go on to their next investment, taking the cash and running. There’s a myriad of reasons which are all valid. The point is, however, you have the option of selling the note if you choose. Using the same example:
§ A note buyer quotes you $84,787 which means you pocket the $5K down payment plus $24,787 – the difference between your $60K mortgage balance and the note buyer’s cash to you. Yes, you make your money when you buy the property!
Options = Good Decisions
It is EASY to make GOOD decisions when you have no bad options. A broker like myself can provide you over 40 note buyers through a single contact, which means we’ll shop it to get you the least discount and best price on your note. The quotes are free and often within 6 hours. Buyers will sometimes pay part or all of closing costs.
Realize the partial note buys are very popular with investors where the note buyer purchases the next 60 payments, after which the payments revert back to you from your buyer. It’s an easy way to generate “bridge” cash for special circumstances.
What about second mortgage paper? Tough. The market has really dried up of ready buyers of second mortgages without very steep discounts taken by the note holder.
The more options that real estate investors have at their disposal, the more flexible their strategy allows them to acquire and move properties.
Note: Charlie Breeding is a Certified Cash Flow Consultant and is the President of Creative Cash Flow Solutions. He has spoken to two of the four NC REIA chapters on this topic in the last year. To learn more, click here
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