TriMark Capital Funding, Inc.

From the late 1990’s up until early 2007, low interest rates abounded in real estate, so there was not a lot of interest in, or need for, owner financing, also called seller carry-back financing. Basically anyone who could possibly qualify for a 5%-6% home mortgage loan or an adjustable rate mortgage (ARM) or home equity loan went out and got one. Banks and credit unions scrambled to find more customers by relaxing their lending criteria (to the point of being ridiculous) and offering competitive interest rates and a variety of loan products, many of which included negative amortization and an adjustable rate that would automatically reset at some point in the future.

The result was predictable. Practically anyone that wanted a home mortgage or home equity loan could find a bank or financial institution somewhere that would give them one.

That was still somewhat the case right up until a few months ago when the sub-prime real estate and mortgage markets collapsed. Today, it is extremely difficult for sub prime borrowers to get financing to buy homes, and the sub-prime meltdown has had serious, lasting repercussions on the prime real estate and mortgage markets as well.

The ARM’s have started automatically resetting their interest rates, many people could no longer afford their new mortgage payments, defaults and foreclosures skyrocketed and everything changed, almost overnight. Gone are the days of the stated income mortgage loan (so-called “liar loans”). Common sense is making a remarkable comeback and lending institutions are once again making lending decisions based upon sound financial principles such as income verification, cash equity and down payments, and of all things - people’s actual ability to afford and repay their loans. Equity is important, interest rates are climbing, foreclosures are skyrocketing at an unprecedented rate, over 40,000 mortgage brokers have lost their jobs just between January and September of this year, and we still haven’t seen the worst of it yet. To protect themselves, banks and other mortgage lenders have tightened their lending requirements considerably and many have terminated their sub-prime lending programs altogether.

But here’s the rub: Millions of people are STILL going to need to sell their homes in the coming years and millions of people are STILL going to need to buy homes. Given the combination of tightened lending qualifications, a flood of new and recently foreclosed homes on the market and a brutal buyer’s market that is going to get much worse before it gets better, sellers have no choice but to compete for buyers. And what’s the easiest, most common sense way to stand out in the crowd and attract qualified buyers?

Simple. Just make it easier for someone to buy YOUR property than your neighbor’s property.

How? By offering seller financing.

The reasons for offering owner financing vary, but include:

• Seller wants to generate a pool of motivated, qualified buyers quickly
• Seller wants to defer taxes on gains
• Avoid excessive bank closing costs and fees
• Seller wants to close quickly
• Creating more flexible terms and payment schedules
• Working with weak buyer credit
• Sales between family members, or divorce agreements

Owner financing notes can vary, but always includes an agreed upon term, interest rate, payment amount, and payment date on which the buyer of the property must pay the seller. The conditions are formally written into a note, called a promissory note or installment note. Usually, the seller would have preferred to have received all of the cash upfront. Even if that wasn’t the case at the beginning, circumstances may have changed or new investment opportunities have appeared that cause the seller to need cash quickly.

There are investors, both institutions and private, who will buy these notes. They will generally discount the note (pay the seller an amount below the note’s current balance) to offset their risk and meet certain yield requirements. The amount of discount varies across notes, but the two biggest factors in determining the discount (besides the type of property) are the amount of equity in the property (cash down payment plus principal payments received) and the credit of the buyer. The more equity and the better the buyer credit, the more that the note is worth.

For creating a real estate note, here are some tips we give to our clients so they can minimize the discount they’ll have to take and maximize the amount of money they would receive if they later need to sell it and how to protect themselves if they don’t:

• Require a good down payment in cash - Get a minimum of 10% cash down payment (more is preferable) for a house and 20-30% for commercial properties, land and mobile homes with land. These numbers cannot always be reached, but try to get as much money up front as you can without financially crippling the buyer. Also, if you accept a 2nd mortgage in lieu of a cash down payment, you will not be able to sell the 1st for many years.
• Insist on a 1st lien position - Don’t carry back a note in any lien position other than a clear 1st position
• Sell to a buyer with decent credit - A FICO mid-score (credit score) of at least 650 is preferable, though 625 is usually adequate. You’ll often still be able to sell the note even if the buyer’s credit is below 600, but be prepared to take a much larger discount. Get a tri-merged credit report for your buyer and their spouse.
• Interest rate of at least 9.5% - More is better and keep in mind that if you accept a lower interest rate, you’ll also have to accept a higher discount when it comes time to sell your note.
• Keep the term of the note as short as possible - A 5-7 year balloon is usually best. This provides enough time for the buyer to re-establish their credit if necessary, establish a strong, consistent payment history and still gives you an exit strategy so you’re not carrying the note for 30 years. A shorter term will also help to minimize the discount if you decide to sell the note.

Other items that we consider to be positive when deciding whether to buy a note and how much to pay include:

• Property is owner-occupied (for houses and mobile homes)
• Access to power, water, and roads (for land)
• The property and surrounding area being in good condition
• Regarding commercial notes: multi-unit apartments or general purpose office buildings are easier to place than specialty businesses like restaurants, gas stations and auto repair facilities. A note on a property that was previously a gas station or anything that could have adverse environmental consequences will be much harder (or impossible) to sell due to the potential environmental contamination liability.

You’ll also want to be sure that the sales price is not above the market value or the current appraised value and that the title to the property is clear by getting title insurance.

You can visit our Real Estate Note Buyer page for more information on selling a real estate note, mortgage note or business note.

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