Selling with Seller Financing

Mortgage notes are typically discounted to offset our closing and operating expenses and to obtain an attractive yield for our investors. However, when you are selling a property with seller financing and creating a new note, there are definitely a few things to keep in mind that will help you get the most money when you later want to sell the note to Texas Note Buyer or a note broker:

Get an Application. The turbulence in the mortgage market over the last several years has caused traditional mortgage lenders to tighten their credit standards. Similarly, the secondary market for owner financed mortgage notes has become more conservative. Your prospective buyers will never again be as willing to provide you with a loan application as they will be during your initial negotiations, so when the discussion turns to owner financing, ask for a copy of their drivers licenses, loan application, and check their credit.

The standard FNMA 1003 Loan Application may seem excessive to you and the buyers for an owner finance transaction, but when you really read through it you’ll discover it provides valuable insight into the stability of your buyer. The application will ask for all the personal details you may be uncomfortable asking them about yourself, such as social security numbers, income and housing history, whether or not they’ve filed bankruptcy or had a foreclosure, etc. The loan application will also ask them if they are a U.S. Citizens, which is important information for a note buyer. Call us before selling your property to a non-resident alien to find out what additional items will be required to sell the note.

Get a Credit Report on Your Buyers. The buyers themselves can obtain a report directly from the three largest credit bureaus, Equifax, Experian, and TransUnion, or your Realtor may offer to assist with this also. A lot of the "free credit report" websites will provide an easy to read report with everything a consumer would want to know, except for the credit scores. They usually charge money to give you a report with scores, but the scores are what you must know before selling them a house with seller financing. 

We consider scores over 650+ to be the most desirable and 600-650 to be "average." If your buyer has scores under 600, it will certainly have a negative impact on what we can offer for your note, and may even prevent us from being able to make an offer at all (lots of equity or seasoning often compensates for poor credit).

Sometimes we see credit reports where the buyers don’t have any credit scores at all because the credit bureau had an insufficient history from which to assess a score. A “no score” report can result from no credit history, or it can be the result of no recent credit history. Not having a credit history isn’t a bad thing, in fact more people these days are (wisely) choosing not to use credit. If there are any tradelines listed (they are probably more than a couple of years old) make sure they are not all collection and charge-offs accounts.  A “no score” report because of no credit history is a good thing as far as we’re concerned, but a “no score” report due to no recent activity and a delinquent past is less attractive to a note buyer and will generally require a longer pay history with you before we can buy the note.

“..if you wouldn’t want to have to collect a payment from your buyers each month, we probably won’t want to either.”

Credit scores don't always tell the full story, however, and you’ll need to actually read what’s on the report.  Here’s what you don’t want to see on your buyer’s credit report:  foreclosure, bankruptcy, judgment liens, tax liens, recent (last 12 months) late payments on car loans, or a historical pattern of delinquency.  Bottom line: if you wouldn’t want to have to collect a payment from your buyers each month, we probably won’t want to either. Fortunately, there are other factors we consider that can offset a low credit score, the most important being Equity.

Get the Biggest Down Payment Possible. The amount your buyer puts down has a huge impact on what your note is worth.  Banks and other traditional mortgage lenders use a ratio referred to as "LTV" (loan to value), which is the mortgage loan amount divided by the sales price. We look at this ratio, too, since a bigger down payment is often an indicator of greater financial stability and future performance, but the number that really matters to us is "ITV" (investment to value), which is the amount we are paying for the note divided by the lower of the sales price or appraised value of the property.

The more equity your buyer has in the property, the less likely he is to default. The more down payment you receive, the less you have to finance, and the less your note has to be discounted to get a note buyer down to an acceptable ITV. We typically see down payments ranging from 10-20%, and more is always better.

Charge a Premium Interest Rate. Higher is better, to a point, and make it a fixed rate, not adjustable. If I sell a property and carry the financing, the “Bank of Me” charges 10%. If your buyer tells you rates are in the 3-4% range, suggest they contact their bank or mortgage broker to get that rate and that you’ll pay their closing costs for an all cash deal. You’d be better off pitching in towards their closing costs than selling the note later at a discount, but if they were willing and able to get traditional financing, they probably would have done that already and not be talking to you about owner financing. Of course you can negotiate the rate with them, but keep in mind that as your interest rate goes down, the more your note will have to be discounted to produce a yield suitable for us to buy the note.

There is one rule in your negotiating, however, and that is Do Not Inflate Your Sales Price Above Market Value.

An astute negotiator will realize that sometimes it is better to give into a buyer’s desire for a lower interest rate in exchange for something more valuable right now: cash. Lower your interest rate in exchange for more down payment. Lower your sales price for more down payment. There is one rule in your negotiating, however, and that is Do Not Inflate Your Sales Price Above Market Value. Doubling your sales price to give the buyer 0% interest will create a note that few (if any) note buyers will want to buy. Don’t do it!

Get Monthly Payments and a Shorter Term or a Balloon. Stick with monthly payments and leave annual or quarterly payments for farm and ranch properties. As for an amortization term, shorter is better, so go for 120 or 180 months instead of the industry standard 360 months. If your buyer needs  a 360 month amortization to keep payments low, consider including a 60, 84, or 120 month balloon payment to encourage your buyer to maintain their good credit and refinance before the balloon payment becomes due. A balloon payment in 60 months can improve the value when you sell a note, but a balloon payment due in under 36 months makes our investors a little nervous given the popularity of walking away from one’s home and mortgage and a tight lending market.

Third Party Verification of the Down Payment. That huge down payment you negotiated with your buyer may be good for your bank balance, but will not establish your buyer has equity if you fail to document it properly. We recommend closing your sale at a title company where they will do a HUD-1 Settlement Statement showing your buyer’s down payment. It is important that your buyer’s down payment goes to the title company so that you have third party documentation of the funds.  Do not accept cash from your buyer outside of closing! If you do not want to use a title company or attorney to handle the funds and closing, have the buyer give you a check and deposit the funds in your bank account. In this way you will have your bank deposit records, a copy of the buyer’s check, and the buyer’s canceled check to provide the third party documentation a note buyer will need.

Get Title Insurance. It’s much easier to fix a title problem before the sale than years later when you want to sell the note. An Owner’s Title Policy will assure your buyer that he will actually own the property he’s buying from you, and a Mortgagee Title Policy will assure you, the seller, that your documents were prepared properly and that they establish a legal, marketable, and insurable, security interest in the property that you can later sell to a note buyer. The title company issuing the title insurance will also want to close the transaction to make sure that part is done properly as well, which helps you by giving you the third party verification you need for the down payment.

Maintain Verifiable Pay History Records. An accurate and verifiable payment history is essential when selling your note. Too often we see a good note only to find out that the seller has accepted cash or that he has cashed the buyer’s checks or money orders and does not have a verifiable pay history. A receipt book or handwritten ledger are not acceptable because they cannot be independently verified. Have the buyer send you a check or money order each month and deposit it into your bank account. Do not cash it and do not take cash out the deposit! You want to have the exact amount of the payment show up as a deposit each month into your account.

Property taxes cannot be delinquent when we purchase a note, and we usually do not allow the seller to pay them for the buyers from our note purchase proceeds at closing.

Make Sure Property Taxes are Being Paid. Right up front, be sure your buyers know that you expect them to mail you a copy of the paid tax receipt each year before they become delinquent. Alternatively, call the county and city tax departments or check their website each year to verify that taxes are being paid. Property taxes cannot be delinquent when we purchase a note, and we usually do not allow the seller to pay them for the buyers from our note purchase proceeds at closing. Don’t let your buyers get behind with the taxes, but if they do, make sure they get setup with a monthly payment plan ASAP and verify that these payments are being made to the tax office. Failure to pay property taxes before they become delinquent puts your buyer in default and is grounds for foreclosure under standard deeds of trusts, mortgages, and contracts for deeds.

Make Sure Your Buyer Has Hazard Insurance. Your buyer should provide you with a copy of their Hazard Insurance Binder prior to closing with an effective date no later than the day you are scheduled to close. The insurance company issues a policy once they receive payment. You can have the title company collect the insurance premium and disburse it to the insurance agent at closing, or you may allow your buyer to make payments on the policy to the insurance company. Either way, the important part is to make sure the Binder lists your buyer as “insured”, lists the property address, has a coverage amount for the dwelling that is no less than your loan balance, and lists you as the “mortgagee” or “loss payee” with your correct mailing address.

While this is not an exhaustive list of “do’s and don’ts”, these are the most important things you need to get right when selling with owner financing. We are always willing to help with your owner financing questions, so please feel free to call and ask for help if you need it.

What We Do

Are you collecting payments?  Why wait years to collect small monthly payments when you can sell mortgage notes you currently hold for the cash you need today?

We are note buyers in Texas, seeking Owner Financed Real Estate Notes, Promissory Notes, Deeds of Trusts, Mortgages, Contracts for Deeds, and Land Contracts for our own portfolio, as well as for other private investors, hedge funds, pension plans, and institutional investors.

We pay cash for notes secured by both residential and commercial real estate, notes created from the sale of a business, and most any other type of payment stream.

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