Owner-Financing Secrets for Investors: What makes a Good Note?
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.
You said: "no one will buy your paper if it’s less than 5% down. "
Are you saying that there needs to be 5% equity (because it now appraises for more due to appreciation, rehab, etc) or that even if they're trying to sell the note 10 years later, they STILL need to show that there was a 5% down payment paid at close?
This is perfect! However, I was told that a discount of 5% is not uncommon. Was I given bad info? I have great asperations for being a seller financer. My background in the car biz, financing to credit challenged individuals and keeping the note inhouse has bred the idea of moving the numbers to bigger fish and longer time. Selling of this accounts receivable has afforded the opportunity. So, knowing what to expect on the other end is paramount! Thank you.
There are a lot of note brokers out there that are not true investors or buyers of large pools. 5% is a little light to figure on in my limited experience in that arena, but 7%-10% is definitely doable. I would also disagree with the 5% down information. I have a note where they put down a lot less than that, however the note has aged for 2 years with no 30 days on it and I get at least 5 emails a day trying to buy my note. My thoughts are... they're paying, why do i want to sell? In 3 more years they'll refi and I'll get it all. There is good info in that article, although maybe a light hustle, since the discount is so large... maybe that is their experience. I will tell you that like used cars, no deal is the same. They all have different variables, and as such, a blanket statement such as a 15% discount being standard, isn't quite accurate.
Good Luck,
Shawn(OH)
You must be new? There is no info on you in your profile. Whats you story?
Lets say I were to rehab a property, find a potential buyer, and originate a loan within 1 month or 2.
Are you saying that I won't be able to find an investor who will purchase the note from me because of lack of seasoning?
-------Previous Post of Mine------------------------
I am a newbie doing homework in hopes to start rehabbing properties.
In specific I am looking into originating a loan for selling a rehabbed property
Steps
- get authorizationi and run the credit report of prospective buyers
-pick the buyer with the highest credit score and submit their info to a mortgage investor (the investor may require a quote request form to be filled out)
- originate the mortgage and sell to the investor
Has anyone had experience selling their rehabs using a method similar to this? From your experience is it faster than listing with an agent? (mortgage investor is more flexible). Also would this method be too complicated for my first rehab?
Thanks,
wayne
Think about it from the buyers point of view. They do not know if the person paying on the note is going to even pay on it. If you let it go for 6 months and they pay on time everytime, then if gives the note a little credibility.
I understand the reasoning.
My question is are there any investors who have had success using this method with respect to rehabbing.
3 - 6 months is a long time to be holding a property and wiating to collect on your equity
Absolutely. I work with investors who do not need ANY seasoning, and they also work with rehabbers who want to use temporary owner financing (simultaneous close) to sell their property quickly.
I am not sure if you were talking about buying property via owner financing, as I imagine most rehab deals sellers want cash, and not to hold a note, but I am sure it differs in different parts of the country.
Thanks, Dave
This is a good tool to have available and you did a nice job explaining the mechanics of it. However, I just want to point out that you glossed over something in your example that made your deal sound better than it is. Quick readers of the article beware.
Using the numbers from your example I end up with $12,287 in my pocket, not $29,787.
How is that?
75K purchase w/ 60K mortgage means I shelled out 15K up front. Assuming I spend 2500 on closing costs for the loan, I'm 17.5K out of pocket. I get 5K for the downpayment so now I'm 12.5K OOP. Selling the note puts 24,787 into my pocket, so my net profit is 12,287. Not bad, of course, and a very nice profit for no work and no carrying costs (assuming no rehab and a quick FSBO sale).
Dont you also have to pay capital gains on the realized profiit from the sale at 105K ? that would take a chunk out of your 12,287 as well.