Specializing in Mortgage Backed Notes
By Admin
Ready to Sell Your House?
Hoping to stand out from the crowd, sellers often advertise “Owner Will Finance!”
Accepting payments over time provides buyers an alternative to bank financing. Of course sellers do not want to trade a house for a buyer that will not pay.
Before you agree to “Be the Bank” read these 7 Tips For Safe Seller Financing!
By Admin
When a property is not selling, most real estate agents are quick to suggest a reduction in the sales price. It is common to see the tag line “Price Reduced” added to For Sale signs, listings and ads.
In today’s real estate market, obtaining a mortgage can be a large stumbling block to home ownership. According to the Mortgage Bankers Association, 30+% fewer borrowers are able to qualify for a loan today than one year ago. Underwriting has tightened significantly and only those with a stellar credit rating and a significant down payment are able to obtain bank financing. By offering owner financing, a seller can reduce marketing time and maximize price while providing the buyer an economical alternative to bank loans.
The buyer makes a down payment and the seller accepts payments over time from the buyer. In essence the seller becomes the bank and is able to collect interest on the balance financed at the agreed upon rate.
Rather than collect payments for 20 to 30 years, most sellers will prefer a balloon payment provision that requires the buyer to refinance and payoff the seller in 7-10 years. The seller also has the option of selling all or part of the payments to a note investor for cash now.
Back in the 1980’s the use of owner financing increased when interest rates were in the teens and borrowers had trouble qualifying based on the high monthly payments. Seller financing is now offering a similar solution to the financing challenges caused by strict underwriting requirements.
Offering owner financing can be a very effective way to reduce marketing times, provided a property is priced at fair market value using comparable sales. Simply add the words “Owner Will Finance” to the advertising and watch the inquiries increase.
By Admin
When a seller allows a buyer to make payments over time for the purchase of property, it is known as owner financing or seller financing.
This private financing by the seller can take the place of a bank loan or be in addition to a conventional mortgage.
The payment amount, interest rate, and other terms are agreed upon between the buyer and seller. The amount financed by the seller will depend upon the amount the buyer places as a down payment and whether there are any bank loans.
Here is an example of how seller financing works…
- A property owner advertises his or her house for sale, either on her own or through an agent.
- A buyer makes an offer, and they agree upon a sales price of $175,000 with a 10 percent down payment of $17,500.
- Rather than requiring the buyer to obtain a bank loan, the seller carries back the balance of $157,500 in the form of a note and mortgage. It could also be a note and deed of trust or a real estate contract, depending on the customary documents for that state.
- The note spells out the terms of repayment. In this case they agree upon 8.5 percent interest at $1,211.04 per month based on a 360-month amortization. The seller does not really want to wait a full 30 years for payments, so the note requires payment in full, known as a balloon payment, within seven years.
- A title company or real estate attorney is used for the closing to be sure all parties are protected and the documents are in compliance with and state laws.
Because the buyer is making payments to the seller rather than an institutional lender, the legal arrangement is called a private mortgage, seller carry-back, installment sale, or owner financing.
The seller has the same mortgage rights as a bank, so if the buyer does not make payments, the seller can foreclose and take the property back.
When the seller prefers cash today rather than payments over time, the rights to future payments can be sold or assigned to a note investor on the secondary market.
By Admin
The interest rate a seller agrees to accept when providing owner financing to the buyer has a large impact on the note value. Unfortunately, many sellers overlook this important decision.
Each year it seems the cost to buy the basics just keeps going up. It is not your imagination; it is called inflation!
As an example, in July 2008 the inflation rate was 5.6 percent higher than in July 2007 (based on the Consumer Price Index reported by the U.S. Department of Labor on August 14, 2008). Worse yet, some basic items like energy increased 29.3% over that same time frame.
So what does inflation have to do with seller-financed notes? Well a seller would need to at least charge an interest rate equivalent to the inflation rate just to break even!
Rather than just breaking even, a seller desires a return on their investment. By accepting an IOU or payments from the buyer that money is tied up. Plus, once the property is sold the new owner will be the one to directly benefit from any increase in property value.
The seller is now acting as the bank and should expect a return at least equivalent to the interest rate a bank is charging for a similar loan. The seller does not have the protection of private mortgage insurance that many banks require adding another level of risk that should be rewarded by an increased rate.
Since the buyer is saving the costs a traditional bank might charge for a loan (points, underwriting fees, origination fees, etc.) it is reasonable to expect them to pay an interest rate above what a bank would charge. On average, it is recommended that a seller financed note carry an interest rate of 2-4% higher than bank rates to compensate for these matters.
If a note holder ever desires to sell their future note payments for a lump sum of cash, they will quickly realize how important the note interest rate is to investors.
While investors look to a variety of factors to determine their pricing, all things being equal, a higher interest rate results in a higher purchase price from a note investor.
For example, a seller holds a note with a balance of $100,000 with monthly payments of $1,110.21. If the note rate is 6% and the investor wants a 9% yield then the offer would be $87,641. Now if the note rate were 4% the offer would decrease to $81,623, but if the note rate were 8% the offer would increase to $95,274.
For simplicity of comparison, these examples assume the monthly payment amount remains the same and there are acceptable credit, equity, and documentation. But you get the idea, the higher the interest rate the more valuable the note.
The time to give serious consideration to the note interest rate is at the time of creation. There are no take-backs or do-overs. The rate you agree to accept at closing stays the interest rate for the life of the note. The only way to change it later is to get the buyer to agree and execute a formal note modification. It is highly unlikely a buyer or note payer is going to agree to have their interest rate increased at a later date (unless there is some advantage to them).
Be sure to give the amount of interest charged on a seller financed note serious thought. It will affect the value of your note not only today, but also far into the future.
By Admin
Many sellers accept owner financing without any idea of how much the buyer can actually afford to pay.
The last thing a seller wants is to stress over receiving monthly payments or worse, getting the property back through foreclosure.
The amount a buyer can afford to spend on a house depends on their income, overall debt, cash they can put down, credit rating, and the mortgage terms.
There are three different calculations that are traditionally used by mortgage companies to determine how much house a buyer can afford. These are known as the Income Rule, the Debt Rule, and the Cash Rule. While owner financing does not require the strict use of these rules, it makes sense to utilize the standard as a guideline. (Better safe than really sorry, right?)
If you ask a real estate agent or lender for an estimate of how much house a buyer can afford, they will typically use a version of the Income rule. The Income Rule says that the monthly housing expense, which is the sum of the mortgage payment, property taxes, and homeowner insurance premium, cannot exceed a certain percentage of income.
This is often referred to as the front-end ratio and ranges from 27 percent to 30 percent for most lenders.
If the maximum percentage is 28 percent, for example, and the monthly income is $4,000, the monthly housing expense can not exceed $1,120 (4,000 x .28 = 1,120). If taxes and insurance on the home are $200 per month, the maximum monthly mortgage payment is $920. At 7 percent interest for a 30-year loan, that payment will support a loan of $138,282. Assuming a 5 percent down payment, the maximum price of the home this buyer can afford would then be $145,561.
The Debt Rule says that the total debt expense, which is the sum of the total mortgage payment plus monthly payments on existing debt like cars, credit cards, etc., cannot exceed a certain percentage of income.
This is often referred to as the back-end ratio and ranges from 36 percent to 43 percent.
If this maximum is 36 percent, for example, and the monthly income is $4,000, the monthly payment can not exceed $1,440 ($4,000 x .36 = 1,440). If taxes and insurance are $200 a month, and existing debt service is $240, the maximum mortgage payment the buyer can afford is $1,000. At 7 percent interest and a 30-year loan, this payment will support a loan of $150,308. Assuming a 5 percent down payment, the maximum price of the home would then be $158,218. (You will notice that is significantly higher than what we calculated using the Income rule.)
The Cash Rule says that the buyer must have cash sufficient to meet the down payment requirement plus other settlement costs.
If the buyer has $12,000 and the sum of the down payment requirement and other settlement costs are 10 percent of the sale price, then the maximum sale price using the cash rule is $120,000 (12,000 divided by .10 = 120,000).
Since this is the lowest of the three maximums in this example, it would be the affordability estimate that is safest to use for this scenario.
How much house a buyer can afford is easy to overestimate if you ignore one of the three rules. Don not make the same mistake as many of the mortgage lenders that ignored these standards in past years.
Granting loans to buyers that could not afford the payment played a large role in the sub prime toxic mortgage mess that took place in the early 2000’s. Remember, there is no federal bailout program for sellers accepting owner financing.
Do your homework and be sure the buyer can afford the house payment before accepting payments over time.
