The Texas Note Company, ten things to think about when creating a note.  If you are considering offering owner financing on the sale of real estate then you need to read this.

1. Down Payment -

When you sell property using owner financing the down payment sets the tone for the whole transaction and the value of your note.  A common mistake among sellers is to accept a small down payment.  It is amazing the price you can get for your property with little or no down payment.  Just don't be amazed when you sell your note the deep discounted offer you will receive.

 

Here is why it is important.  For starters when you sell your property you want to get something out of it right away, like a good down payment so you can go onto you next project.  Secondly, and more importantly, you want a 15% - 20% down payment because it puts skin in the game for the buyer.  Meaning if times get rough for the buyer he is less likely to walk away with a larger down payment.  Statistics prove that the larger the down payment the less likely  of default. 

 

Now lets say that you did receive a 20% down payment on a $200,000 home, $40,000, and the buyer did default.  You not only get to keep the $40,000 but you will get the property back, hopefully in good condition and not after a long foreclosure process.  The $40,000 protects the seller in this case of default, because if that happens there is a period of time where no payments will be made and legal cost could be added in.  You don't want to be out of pocket for non-payment and legal costs.

 

Note investors look at the equity a note has in the property.  A 20% down payment immediately provides the equity note investors are looking for and will pay top dollar for your note.  You have to remember that note investors are looking for the cash flow.  They are not looking for a note that has a high risk of default and a large down payment reduces that risk significantly.  Note investor don't want to worry about defaults.

 

My advice is to request a 20% down payment and take nothing less than 10%.   That way you have solid equity in the note and it provides you with cash immediately as well as gives you options at a later time.

 

2. Buyer's Credit Worthiness

When you sell your home you need to have some idea of the buyers credit worthiness.  You need to do two things before you finalize the transaction.  First get the social security numbers of the payors and keep them with the documentation.  Second you need to know what their credit scores are of the buyers.  Have the payor go online and pull their own report at www.truecredit.com, it cost about $30.

 

You will want to have the buyer's social security numbers as a part of the paperwork because if you decide to sell your note this will be one of the first items that the investor will request so they can check the credit.  Having all the documentation and information you need in one spot can make the sale of your note go a lot smoother.

 

You as the property seller and bank in this transaction will want to know what the buyers credit score is so you can evaluate for yourself the credit worthiness of the buyer.  You want to make sure that they will be able to make the loan payments each month. 

 

Note investors offering top dollar for real estate notes will only do so for those note with payors that have credit scores above 620.  Remember you as the note holder want to leave yourself with options should you decide to do something different later on down the line.  In today's current economy you will find many buyers that have a score below 600.  You can still make the transaction work but just make sure you stipulate that the buyer gets in a credit repair program which all parties will benefit.

 

There is a saying:  " I can help those with money and no credit.  I can help those with no money and good credit.  I can't help those with no money and no credit."  It is so true, you can always compensate in the transaction for poor credit, a bigger down payment.  If you proceed anyway with the transaction make sure for the larger down payment, get them into a credit repair program and hold the note for at least 8 months for seasoning then sell your note.

 

If you are going to help those with no money an no credit, It is highly recommended that you put the note in a Land Title Trust.

 

The Texas Note Company offers note sellers a program where a credit repair specialist works with the payors to build their credit so you can sell your note for top dollar.

 

3. Documentation Practices

This is where I see a lot of frustration and note sales take a turn for the worse.  The ORIGINAL promissory note is the GOLD in the transaction, The Texas T.  Losing that document can be a very costly mistake and akin to burning cash money.  I have been to a few closings where the note seller does not have the ORIGINAL promissory note and kills the deal altogether.  The signatures should be in blue, but if they are in black you can wet your finger and then rub on the signatures.  If they smear you have the original document, if they don't then you have a copy.

 

Now aside from losing the promissory note you can save yourself a lot of pain and anguish if you practice sound record keeping practices.  Keep the original promissory note and all the documents from closing in a safe findable place.  Don't just shove them in a drawer and forget about them.  These are the documents that will be needed to sell your note

• Deed of Trust
• Promissory Note
• Settlement Statement / HUD 1
• Buyer Credit Report
• Warranty Deed
• Property insurance (hazard)
• Title Insurance

 

If you have all these documents at hand this will expedite your transaction significantly, if not then it can drag on for several weeks.

 

4. Accounting of the Note

When it is time to sell your note you have to be able to prove that you have a performing asset.  It could be the ideal note, as far as structure is concerned, but if the payments aren't flowing  and on time the return on the note doesn't make a hill of beans.

 

Note Investors are purchasing the cash flow payments, the most important thing they want to know is the likelihood of those future payments to continue as agreed to in the ORIGINAL promissory note.  Sound accounting practices will make this process easy for you to prove.  If you are going to do the accounting yourself my suggestion is to open a separate bank account only for that note.  The account can act as a clearing account for all you note transactions before you transfer the money  to your personal account.  This will document your payments, give you image copies of the deposited checks and you will have the bank statement at your fingertips.  This way you will be able to prove you have a performing asset.

 

If you are one of those that would rather not deal with the accounting of the note have a Loan Servicing Company, like The Texas Note Company, service your note.

 

5. Interest Rate

Like the down payment sets the tone for the real estate transaction, the interest rate sets the tone for the value of the note.  Note investors are looking for a 9 - 12% yield, that being said don't write a note that has a 5% interest rate amortized over 30 years.  The only way a note investor will even consider that is by offering a deep discount.  Secondly if you are ok with a 5% yield on you money/property go ahead and offer a 5% interest rate.

 

There is no reason to offer a buyer the type of rate they could get at a bank, and if they couldn't qualify for a bank loan why would you take that type of risk and offer them the same rate.  Banks have deeper pockets.  You have to keep yourself in mind when you set the interest rate.  5% is to the benefit of the buyer, not you.

 

My suggestion is to offer an interest rate of 10%, that will add strong value to your note and be attractive to investors.  If you are bartering with the buyer do not go below 8% and expect to keep the value in your note should you decide to sell.

 

6. Term of the Note

Setting a term of 10 to 20 years is usually best when you think about how long to carry the note.  This is where you can be sensitive to the buyer and what he can afford each month.    Just don't create a note with a low interest rate amortized for 30 years.  You want top establish a term where it is attractive to an investor and offers incentive for the buyer to refinance using traditional methods.  Investor usually like shorter term notes so they don't have extend their money for 30 years.  A term between 10 an 20 years is usually right in line with what an investor will pay top dollar for.  There is nothing wrong with creating a note that is for 12, 13, or 16 years in term.  If you can create a 10 year note with straight amortization then that would be what I would recommend. You need to make sure that it is affordable to the payor.

 

7. Balloon Notes

Balloons is a good option but you need to be careful how you use it.  Don't create a note amortized over 30 years with a three year balloon just because it sounds good and think you will get all your money in three years.  When using a balloon like that you need to make sure you have a clear exit strategy for that to work.  Some sort of event should occur in three years for that to work.  Besides a 5% interest rate like I said before is not attractive over thirty years even with a balloon.

 

There are some investors that like balloons and some not so much.  I have two thoughts, first for those investors that like balloons.   Amortize the note over 30 years with an interest rate of 10% and the balloon due in 7 years.  That will still provide opportunity for an exit strategy for the payor to refinance if  the payor is able to qualify using traditional methods.   Should you need to cash out of that position before then there are investors that will purchase that paper.

 

Secondly, for those investors that don't like the balloons so much but like the cash flow.   Again amortize the note over 30 years with a 10% interest rate and have the balloon due in 17 years.  In this scenario I will be able to provide you with a partial offer.  We will make you an offer for the 17 years of payments and you keep the balloon when it comes due after that time period.  The other possibility is those investors who like balloons may make you a full offer as well.

 

8. Clauses to include on the Promissory Note

Recently I had a note hold contact The Texas Note Company to sell their note.  Upon review of the note, it was a 0 % interest rate over 10 years and the contract just discussed the terms of the note with no Due-on-Sale clause or Late Payment clause or for that matter it really didn't identify the lien.  Here the seller was only thinking of the buyer and not themselves. 

 

Just a little note here before we proceed, real estate professionals, title companies, attorneys  and accountants don't always know how to put a good solid note together and make sure all the numbers check out.  That is why it is important to contact a note professional that has a lot of experience crafting notes.  It could have a significant financial impact to you the note holder.  Contact The Texas Note Company, PLEASE!

 

The due-on-sale is a provision in a mortgage note document which gives the lender the right to demand payment of the remaining balance of the loan when the property is sold. It is a contractual right, not a law. This means that if title to the property is transferred, the lender(bank) may (or may not), at its option, decide to "call the loan due.  The due-on-sale speaks for itself, the last thing that you want is for the buyer to turn around and resale the property to someone that you have not had the chance to evaluate and determine for yourself if they are credit worthy to make the monthly payments. 

 

The other item you want to make sure that is included on the promissory note is the Late Payment Fee clause.   Without this clause you will not be compensated for a payor who is regularly late.  You want to be able to protect yourself from financial loss from a chronic late payor.

 

For those of you that offered owner financing on the sale of your property and want to defer capital gains you will want to have a prepayment penalty clause on the note and the deed.  You will want to verify that the law permits the clause based on the type of property your are selling and where it is.

 

9. Title Insurance

One of the most common "short cuts" I see, where owner financing is offered, is the buyer and seller fail pay for a title insurance policy.  Often the title is checked, an abstract, but that does not guarantee that the tile is clear.   The buyer should demand that the title insurance to make sure that all taxes, HOA dues and any other potential liens accounted for and cleared.  If you don't then you the buyer will be responsible for them. 

 

No investor will purchase a note if there is not a title policy to go along with the note, and even if there is one they will usually require that an abstract be performed from the date the property last sold.  My recommendation is to include a title policy with the sale of the property.

 

 

10. Real Estate Professional Services

When you offer owner financing for the sale of property, there are real estate professionals that can assist you with process and add a lot of value for their service.  A title agent, real estate attorney or accountant can facilitate the transaction to make sure that every item is accounted for and processed correctly.  I have had the best luck with Title Agencies.  They facilitate the transaction and make sure that each parties interest are accounted for and done properly.

  

 Robert E Young  graduated from Southwestern University in 1989 with a Bachelor Degree in Business Administration. He worked for several years at Citibank and Dell Computer. Robert now pursues his passion for helping people through traditional and innovative real estate transactions. Robert lives in Austin, Texas and has two beautiful daughters whom he loves spending time with. In the spring he can often be found in the dugout coaching his daughters kickball team the Porcupines. To learn more about Robert and The Texas Note Company go to TexasNoteCo.com