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> REAL ESTATE 101 > USING
& CREATING NOTES
Using
Notes to Buy Property & Creating A Note You Can
Sell
October 29, 2007
Many
times when selling or buying a property you can use
note buying-selling as one tool in your arsenal. Sometimes
rather than getting a loan you can get the seller to
create a promissory note but rather then the seller
holding the note he/she can sell it immediately after
closing to get all the funds he/she needs. Another way
to use this technique is to sell property using seller
financing and then sell off the note you created to
a note buyer at a discount. Regardless of either way
you do it, you will need to create a note you can sell
fairly easily.
The
following is an outline of the things and elements that
should be considered when creating and structuring a
note which the note holder/payee wishes to sell at or
shortly after closing. One element that is not addressed
in the following outline itself is “seasoning”,
or aging...while there’s no doubt that a note
that has a few years successful seasoning, is a more
valuable note, of course this element is completely
absent in a “simultaneous” sale, where the
note is purchased as the property sale is closed.
Credit
of the Property Buyer(s)
The better it is, the more valuable the carryback note
is going to be to prospective note buyer. Don’t
know what the property buyer’s credit is ? Then
don’t bet the barn on a great note sale. Because
the note buyer will want to know the buyer’s credit.
And if selling to husband and wife, or more than one
buyer, demand credit and financial statement from both.
These days it’s common for the wife to earn more
than the husband and you want to know all about both.
And if noteholder is not equipped to obtain credit report,
ask your bank or local credit agency. They’ll
help you get it. Just remember you’ve got to have
written consent from prospective buyer to get it.
Sales
Price of the Property
Should be at or LESS than provable/establishable
value of the property. More than actual value of the
property ? Then expect your note to sell for LESS than
you want. Why ? Because the experienced note buyer wants
the property buyer to have some equity in the property-so
the property buyer isn’t likely to default.
Provable
Value of the Property
Don’t know ? And the property buyer hasn’t
demanded an appraisal of any kind ? Great, if all cash-but
if you’re taking back a note, and wanting to sell
that note simultaneously, just know that the note buyer
is going to want to know the property value. And many
problems are created if your note sale is AFTER the
property sale, and the property is now inaccessible
to an appraiser.
Down Payment
Zero down deals are done all the time, but
not popular with note buyers. They want to know that
the buyer has immediate equity in the property, something
to protect-so the less the down payment you’re
taking, the less the cash you’re going to be selling
your note for.
Terms
of the carry-back note
A.
Interest Rate: Higher the better, but not so high as
to gamble with usury law violations. Many states have
usury laws that govern personal, consumer loans (e.g.
WA has 12% “do not exceed” rate); however
not all states have usury laws. So check before you
structure your deal. Don’t know what a good interest
rate is for your deal ? Ask a mortgage person. Or residential
agent. They live with this on a daily basis and they’ll
give you some good advice.The lower it is, the poorer
deal for the note buyer and he’ll just make up
by charging you more of a discount when he buys it.
B. Length of Note: Again ask what normal,
going term is currently. Probably typical length is
5 years currently, or maybe 10 to 25 but with 3 to 5
balloon. Important to the note buyer, because he doesn’t
want to wait forever to get repaid. But not too short...I’ve
seen notes with 6-12 months go begging for a buyer because
the note buyers feared the property buyer couldn’t
pay it off in that time period.
C. Balloon: Again, the note buyer
wants to have this on his books for no more than 3-5
years, so even if the new note has a 20-25 year amortization
period, to keep the monthly payments within reason,
the note should have a 5 or so year balloon for full
payoff in that time.
D. Loan-To-Value Ratio: Total loan-to-value,
of both 1st and new 2d, must be considered, and typically
not to exceed 75% of provable value, for the buyer of
the new 2d to be seriously interested. Also, many 2d
buyers want ratio of the 1st to the 2d to be no more
than 4:1. Translation: they don’t want a little
2d that’s behind a huge 1st, which might have
a much bigger RATIO than 4:1. (e.g. $100,000 1st and
$10,000 2d would be 10:1; but $30,000 1st and $10,000
2d would be 3:1). Do some shopping and learn what note
buyers would accept, before you structure your property
sale. Of all the elements listed here, this is probably
the one most ignored by note buyers. It they like everything
else, they might not care at all about the LTV.
E. Will the Lender on the 1st Permit
the 2d You’re Willing to Carry?: Frequently the
lender on a new institutional loan inserts a clause
to the effect that it is permitting NO carryback loan
by seller, and you’d better hammer this out up-front
if you’re expecting to carry a 2d and expecting
to sell it.
F. Security for your 2d: Normally
should be a recordable Deed of Trust, or mortgage in
non-D/T states, drafted to comply with laws of property
situs (where it’s at !) to secure payment of the
2d. And to be recordable in Deed Records it should normally
be signed, and acknowledged by notary. Further it should
normally have provisions to the effect that any default
on buyer’s part in payment of his 1st note is
also a default in the carryback 2d. And, although frequently
omitted, it should contain explicit, written permission
for its holder to verify current status of the 1st.
G. Buyer’s Identity: If selling
to husband and wife, make sure they ARE husband and
wife and have both execute note and Deed of Trust individually.
Don’t permit one to sign for both. Not permissible
or binding on spouse in every state and you don’t
even know for sure they’re still married. And
if you’re selling to corp. or LLC, make sure you’re
also getting the buyers on the note and deed of trust
INDIVIDUALLY. I see too many notes where ONLY the corp/LLC
is on there, and the people signing, sign ONLY as corporate
officers-this doesn’t bind them individually and
your note isn’t going to sell to note buyer
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