Consider this. You find a $30,000 ugly distressed home that just won't move in this real estate market. Believe it or not, chances are you can snatch up this property for $5,000 cash. Then, you need to turn it right around and market it as an owner financed deal. Charge a $1,000 down payment with an 11% interest rate for the duration of a ten-year loan.
What exactly does this mean for you? It means that after you receive that down payment and the payments on the note (just under $400 a month), you’ll recover your $5,000 investment in right around a year. This leaves the final nine years to collect payments on a piece of property you only paid $5,000 for. You win and your buyer wins, because they only had to come up with a $1,000 down payment and monthly payments of $400. This is less than many people pay for rent… and the property is completely paid off in ten years!
So yes, the main objective is to hold onto that note for the full ten years. However, there are times that it just isn’t practical and you need to sell that note.
Selling A Discounted Mortgage Note
When you're first starting your business, you’ll probably want to SELL or FLIP a few of your notes in order to generate more cash for future investments. Or to reduce your own debt load. This is a great way to eliminate your own personal debt.
How To Setup Deal
If you do decide to sell your note, you should try to structure it in such a way that you will be able to successfully sell it. Many institutional buyers are unwilling to buy a note if the borrower is a credit risk or if there is insufficient equity in the property. Make sure your buyer has relatively good credit before selling the home to them. If their credit score comes back at a 520, it’s unlikely you’ll be able to sell that note. However, a buyer with a credit score of 640 or higher makes them a much lower risk – either for you, or for the institution you may sell the note to.
When dealing with the equity portion, you can structure two notes on the property so you can sell one note and keep the other. The first one could be for about 75% of the selling price and the second for the balance. In other words, you can create a first mortgage for $20,000 and a second mortgage for $9,000. You would keep the second mortgage and sell the first one as it would be about 66% of the sales price of the property. This, the note will be easier to sell to an institutional buyer.
Another option is to create just one note with the knowledge that the financial institution you’re working with will only give you a portion of the face value. Think about it: if you sell a $29,000 note at 30%, you would still make a little over $11,000 profit after the sale.
Dealing with Professional Note Buyers
When looking for a financial institution to sell your note to, make sure you’re selling to a cash buyer or a note buyer and not just a broker. Keep in mind that many institutions will want the note to be “seasoned”, meaning that the borrower needs to have made anywhere between 3 to 12 month payments on time. They will likely also want an appraisal on the property and to ensure the borrower isn’t a credit risk.
In addition to institutions, you may want to look for personal investors to purchase your notes. These people may be a hard money lender, a private money lender or simply another real estate investor buyer who wants to get a good return on his or her investment. People like landlords make great note holders because they like the cash flow.
Working with Investors
To look for a private investor, you might want to attend some local real estate investors association meetings. Here, you can network and find out who the some local investors are. Even if you don’t get a good response, you can try a different approach. If you know who uses private money, you can go to the courthouse and find out who their investor is.
However, when working with a private investor, you really only want to deal with experienced investors. Imagine this: an investor buys a note from you, but the buyer defaults on the loan. You certainly don’t want that investor calling you to buy the note back!