Although the housing market is improving in many areas as values increase, obtaining a loan is still a challenge for a large number of people. Generally, banks continue to require high credit scores and decent down payments before giving loans to consumers looking to buy houses. For homeowners looking to make their house attractive to a larger group of potential homebuyers, offering owner financing can be a real advantage.
Owner financing is, in essence, having the property seller act as the "bank" and agree to carry the financing for the property sale. This is accomplished through a normal and legal transaction in which a real estate note (also called a mortgage note) is created along with the standard documents that accompany other real estate sales. Once the transaction is completed and the buyer has begun making payments, the original owner has the choice of either holding on to the note or selling it to a mortgage note buyer.
About Owner Financing
Owner financing and creating mortgage notes can be used for residential, commercial buildings, mobile homes, and even land, though it is most often used with houses. It has the advantage for the property seller of providing additional profits over a long period of time while providing flexibility to both parties in the note setup. Owner financing is best used when the original owner owes little or nothing on the property, as it does not work well if there is a large underlying loan.
Ideally, the real estate note has the following elements:
- Sales price is consistent with the true value of the property
- The property is in a good shape and in a good part of town
- Buyer puts in a minimum of a 10% down payment (more for commercial and land)
- Credit score of buyer is at least 625
- The note and documents are correctly prepared by an attorney or title company
- Terms of the note have a good interest rate, no balloon (large and final) payment for at least five years, a lender's title policy, etc.
If the note holder does decide to sell the note to a note buyer, there will still be a discount but it would be less on a strong note than a weak note. The discount is how much less than the current balance that a mortgage note buyer would pay to buy the note.
Of course, the reality is that most notes do not have all of the characteristics shown above. In that case, you should consider just selling part of the note. For example, if the note has a 30-year term, the note buyer might offer to just buy the next five or ten years worth of payments instead of the entire note. This means that you would receive less money upfront but more money over the long term. In most cases, the original note holder would have the option of selling additional payments to the note buyer. This way of buying and selling a note is called a partial purchase or just simply a partial.
If you have sold a property using owner financing and have note, then there are three options for you:
1. Keep the mortgage note and continue to collect the monthly payments. You would need to ensure the property taxes and insurance are current, as well as track the principal and interest payments from the buyer.
2. Sell the full note a mortgage note buyer. Depending upon the strength of the note, the amount that you are paid may be a little or a lot less than the current balance on what is owed.
3. Sell just some of the payments using a partial. Over the years, most note holders have gone this route because of the flexibility that they get and the total income received.
Sell Your Note
Once you have decided to go with one of the last options above, you will want to make sure that you are working with a reputable and knowledgeable note buyer. You should ask lots of questions about their experience and licensing, as well as:
- Google the person and company to learn more about them and whether others have commented on them
- Check websites related to scams to be certain that your chosen partner is not listed there.
- If you are working with a broker on a property in California or certain other states, be certain that the person is a licensed real estate broker and is current. If they don't have a license, then you should move on, as that person is probably operating illegally.
While owner financing is not a fit for all property transactions, it is useful to know about it so that you can use it in the right situations. This type of financing does not get much press but has been successfully used since ancient times and can be a great tool for you.
Alan Noblitt is the owner of Seascape Capital Inc., which buys and brokers real estate notes and business notes. He may be reached at 1-800-634-4697, or visit the website at seascapecapital.com/mortgage-notes/