Hi everyone and welcome to part three in this series on note structuring. In part two of this series we discussed, using some common sense guidelines how to qualify your potential borrowers. Now that we have qualified the borrower, we will discuss establishing loan terms that are beneficial for all parties involved.

All too frequently I see notes that have been created it what appears to be desperation, for example zero down payment, very low interest rate or even no interest rate to a borrower with sub 500 or worse credit.  I understand that as banks have tightened lending policies, good borrowers may seem scarce. But believe me, they are out there and if you offer to carry the financing on your home sale they will come out of the woodwork.

So at this point we have confirmed we have a good credit borrower, with a substantial down payment that intends to live in the home. Now let's get down to establishing favorable terms. The terms being the interest rate that will be charged to provide the financing as well as the specific the length of time the financing will be given. Years ago, a thirty year term was the norm when buying a home. In recent years, many sellers following the lead of some banks have been requiring balloon payments in five, three or even as short as one year. As a general rule I would recommend establishing a note term somewhere in the middle of these two extremes.

While there is certainly nothing wrong with creating a thirty year, fully amortized loan for your borrower you will find when you go to sell that loan that because of the long tern nature of the deal the payments out beyond the 10-15 year mark are discounted quite heavily, for the simple reason, they are so many years out into the future. On the other hand, interest only loans and other short term loans that require only one-five years of payments before they mature will typically require the borrower to refinance to make the balloon payment obligation at the end of the loan. More often than not, note investors are a skeptical bunch and will look at very short term deal and buy the monthly payments but will tend to stay away from the balloon, assuming the borrower will not be able to secure the financing to cash them out.  Or, if they are willing to buy into the balloon payment they will look at it as if they will have to extend the loan themselves just to keep the payments rolling in.

As with many things in life, moderation is often best. This also applies to the length of loan terms. A moderate loan term that amortizes the loan, meaning the borrower is regularly and consistently paying down the principal balance is best. Many of the loans I have created on properties I've sold have been done like this, a thirty year amortization with a balloon in ten-fifteen years. With this type of structure there are multiple benefits for you, the borrower and the eventual note buyer. First and foremost, the borrower gets a monthly payment they can afford. Additionally the monthly payments they make are paying down the loan principal and allowing them to build an escalating equity position. Which will in turn, allow them time to have built a substantial equity position in the property and making the likelihood, of them being approved for a refinance loan much greater.

For the note buyer there are some distinct advantages to this type of structure. First they can be fairly confident that the good credit borrower will make a substantial number of monthly payments before a balloon payment comes due. Allowing them time to recoup a greater amount of the funds invested into the note purchase and without the drawback of thinking their money will be out there for twenty or even thirty years. Plus the note buyer's confidence in the borrower's ability to refinance out will be much stronger. And of course, giving the note buyer confidence in the borrower's ability to cash them out when the time comes will result in a higher purchase price for the note seller. The bottom line it will put more money in your pocket at the closing of the note sale.

Now, let's wrap up this discussion with the other big factor that will affect the note purchase price, the interest rate on the note. All too often we talk with note holders that have created loans with interest rates that are well below market rates. I had one gentleman just yesterday, tell me the reason he accepted a 4.5% rate on his note was because he saw that was the rate the local bank was advertising. Another gentleman told me his borrower negotiated him down to a 5% rate, stating "I could get a much lower rate at my bank".   Let me say this in response. Do not fall into this trap! Tell the prospective borrower, "if you want bank rates then go to the bank and cash me out." Chances are they won't take you up on it, knowing they will likely have to pay several thousand dollars in points to get that kind of rate in addition to the fact that their income, job history, source of funds, liabilities, etc...will be scrutinized meticulously. Stick to your guns, the headache and uncertainty associated with traditional bank financing is more often that not a great motivator, allowing you to dictate a more favorable and salable interest rate.

Although I see interest rates that run the gamut, most owner financed transactions average in a range between 7%-10%. I have always written notes on the properties I've sold between 9%-10%. Simply put that is the minimum interest rate I am willing to accept to carry the financing for the borrower. Of course, you will have to let your individual situation be your guide when determining what rate to carry the note. Taking into consideration, the credit of your borrower, the amount of down payment they have and the length of time you will possibly carry the note and your need to sell the property.

Lastly, let's talk briefly about seasoning. In the note business seasoning refers to the length of time the borrower has paid on the note. Most note sellers want to sell their note as quickly as possible after it has been created. The minimum amount of seasoning American Contract Buyers LLC will currently accept is one month. Meaning the property must be closed and you must have received at least one monthly payment prior to us buying the note. With that said one month of seasoning is not optimal and will not result in the best possible or premium pricing. Why is that you ask? Track record, while you may have done everything right when creating the note, the borrower has yet to demonstrate a proven track record of timely payments. If you have the ability to collect the payments for a year or more you will benefit not only from the monthly income but also from a much better note buyout price.

I had hoped to cover proper documentation, record keeping, loan servicing and a few other important areas such as the importance of a title policy. However, we'll have to cover that in a future posting.

Until next time, have a great week.

Damen

          I get at least six to eight calls a week offering to sell me a lease option.  First of all I buy real estate secured notes not pie in the sky hoped for deals.  That may sound harsh but a lease option is NOT a real estate secured note, mortgage or contract.

          Lease Options may look like a solution for everyone at the time but more often than not they turn into huge disasters.  They sound simple enough but in fact a lease option is much more complex than a straight purchase.  In addition to the sales price other factors must be negotiated including but not limited to: rent credits, repairs, taxes, option consideration, closing costs, future depreciation/appreciation, terms, option extensions, appraised value, just to name a few potential flies in the ointment.

          Sellers and even real estate agents have almost no understanding of the mechanics of writing an effective lease option.  I can't imagine any third party, such as myself, wanting to step into the potential nightmare that most lease options are guaranteed to cause. 

          Real estate agents often will as a last ditch effort recommend a lease option, if all other typical sale methods have failed.  The agent knows that he will be able to pocket something with a lease option transaction versus NO money if he ends up with an expired listing. 

          Buyers that are interested in Lease Options are interested in such transactions because they can't get a loan due to no money and/or bad credit.  Not exactly the type of buyer prospect that a seller should be looking for and certainly not the type of buyer that an investor is looking for.  What happens in a year, or two the buyers still can't get financing and they still have lousy credit and no savings.  In such cases these buyers will then press the seller to lower the price, carry financing or extend the option.  None of these things make sense to me to even consider becoming involved in.

          Lastly, MOST sellers who proceed with Lease Option agreements know that their property is overpriced.  Furthermore such sellers know that such transactions will rarely close. As a matter of fact most count on it and relish the idea of taking the property back keeping the lease option money and moving on to the next "buyer". The only real benefit to the lease option is to the seller/landlord in that it is a good way for the landlord to find tenants who will take better than average care of a property and will usually pay the rent on time in the hopes that their circumstances will get better and that the house might become their property.

          So, in the end what do we have?  Well unfortunately for most concerned we have a deal that falls through.  The buyer is unqualified and the property is overpriced, a recipe for heartbreak. 

          I suggest that if you have a chance to buy a house on lease option that you walk the other way.  The truth of the matter is that lease options rarely make sense to investors, sellers or buyers.

Until next time

Darlene

Hello and welcome to part two in this series on note structuring. In part one, we discussed the value of establishing property value or sales price of the property. In this segment we will be concentrating on qualifying potential borrowers, keep in mind we are primarily focusing on residential type properties. In this industry, residential properties will obviously include single family homes but will also include manufactured homes with land, as well as smaller multi-unit properties under five unit's duplexes, triplexes and four-plexes.

Within the residential property types we have two distinct classifications (owner occupied and non-owner occupied). When you begin marketing your property and start meeting with potential borrowers it is imperative that you distinguish those that will be true owner occupants from those that maybe real estate investors looking to pick up a new rental on an owner contract. Why would that matter, you ask? Historically speaking those folks who are buying a home to live in are better for you as a note holder/note seller for several reasons. First of all, potential note buyers will look at the owner occupied borrower in a much more favorable light and consider the loan less risky and will be willing to invest more into an owner occupied note than a note secured by a rental property. Why is that? Simple, as demonstrated in the latest housing decline many real estate investors simply walked away from their upside down rental units. While the same is also possible for owner occupants, it is less likely a borrower will walk or default on a home they live in than on that they do not. Secondly, owner occupants typically take better care of a property they live in, as opposed to one that is simply a rental. The bottom line look for potential borrowers that plan on living in the home, it will mean more dollars in your pocket.

Now that we have established a sales price and understand we are looking for owner occupant buyers, let's get down to the nitty-gritty of credit, more specifically the potential borrowers credit. All too often in this business I meet with sellers that have, what on the surface appears to be a very good note, turned into a very difficult to sell or a non saleable note all because they sold to a borrower with terrible credit. Why is credit important? Well, a credit report is one of the only ways a potential lender (you) has of determining how this potential borrower pays their debts or obligations. Ask your self this. Would you rather sell your home to some one that has a good history track record of paying their bills on time?  Or, would you prefer to sell to someone that never pays their bills on time; has multiple collection companies chasing them and perhaps even has federal tax liens that could possibly even encumber your property.

So what is good credit, you ask? Credit scores range from about 300-900.  Other than no score borrowers the lowest score I have ever seen was in the 340 range. At the other end of the spectrum, the highest score I've seen lately was in the upper 890 range.

As far as a breakdown of scores goes, you will generally get your best pricing for notes where the borrower has "A -Credit" a fico score of 720 or better. Borrowers in this range are considered to have excellent credit, typically have a well established payment history on four or more trade lines and are considered low risk. Next, we have the "B-Credit" or good credit borrower with a fico score of between 719-680. This borrower typically has good payment history on multiple accounts with only minor blemish, such as an explainable late payment. Then we have the "C-Credit" or below average borrower with fico scores from 679-600. While scores in this range are still considered OK and are fairly common, they are generally considered higher risk. This borrower has typically had a few hiccups. Usually in the form of late payments, shorter established history on fewer accounts or other derogatories. Finally, we have the "D-Poor Credit" borrower with fico scores of 599 and below, this is where OK credit turns to downright ugly. Credit in this range will most certainly contain numerous derogatory accounts, multiple late payments, charge offs, repossessions, bankruptcies etc...  If your potential borrower has credit in this range, I would recommend waiting for the next interested party to come along. The fact is if you accept the sub 600 borrower, you will likely not be able to sell the note without taking a severe discount or you may not be able to sell it at all.  

The next step in qualifying your prospective borrower is to determine the amount of cash they have to put down on the home purchase.  If you intend to sell your note shortly after origination (within the first 1-3 months) and you expect to get premium pricing; I would suggest getting at least a 20% down payment or more.  Now hold on your saying, why if someone has 20% down and great credit would they not just go get a loan from a bank? Well, if they can great. All the better for you, but the fact is right now the banks are being quite tight with the purse strings and simply aren't lending like they once were. Also, they may have to pay thousands in points and origination fees just to get the loan. Most borrowers would rather use those funds to pay down the principal balance of the loan, rather than to line the pockets of their mortgage broker.

But what if my borrower only has 10% to put down, but meets the other requirements (owner occupant and good credit)? If you have a good credit borrower with only 10% down, you could look at doing a bit of creative financing by creating what is known as an 80/10/10. By that I mean get 10% down, carry a 10% second lien and an 80% first lien. With all other things being equal, this type of structuring may be your next best option to getting a 20% down payment and will still garnish favorable pricing in the secondary market.

So, to summarize in order to create an owner carry, residential note which will net you the best pricing at the note sale you want an owner occupant buyer with good credit and enough "skin in the game".

Keep in mind these are best case scenario's for newly created notes. While we have certainly purchased and sold notes that had less than stellar credit borrowers, low down payments, and low borrower equity. If you have the option and knowledge to create a more marketable instrument, it is in your best interest to do so out of the gate.   

In my next posting we will discuss some of the other factors that will play into the pricing model such as the note rate, term of the loan, verifiable payment history, proper documentation etc...

Until next time

Damen

Well let's get started with the basics. In my previous post I said we would discuss the basics of loan structuring, protecting your interest as a property seller and creating a valuable instrument for resale.

Several times a day I am approached by property sellers looking for advice on how to structure a saleable note. First let me say there is no great mystery to creating a well structured loan that mutually beneficial for all parties involved, the property seller, the potential buyer and last but not least the note buyer.

Certainly the first thing you will need to decide when making the decision to carry a note or loan for a potential borrower is do you intend to keep the loan for your own income or will you at some point want to sell the loan in the secondary market to a note buyer. If you intend to keep the loan forever and know for a fact that you will never want to sell the note on the secondary market or are one of those folks who don't mind taking the property back if the borrower defaults, good for you. However, since most of the folks I work with do eventually plan to sell their note I will begin there.

Prior to getting to qualifying a buyer/borrower let's talk about the property itself. For the purpose of this posting I will be focusing on residential properties and will leave commercial and land type transaction for a later discussions.

If you have not already done so, explore your market area. In other words, know what is for sale in the area your property is located, compare similar properties. What are like properties selling for in your area?  Speak with several local realtors and get their opinions on the current market value of the home you intend to sell. Or, better yet take it one step further and get an appraisal or order a BPO on the property you intend to sell. I would personally recommend a BPO. A BPO is a Broker Price Opinion and is basically a summarized opinion of value performed by a local real estate broker, who is familiar with the local real estate market. It will include several local listing and several recent sales of comparable properties. They can be ordered online for typically under $125.00 and are more than likely the same type of property valuation the secondary market note buyer will order to establish property value.

Why you ask would we want to get an opinion of value from a realtor rather than from an appraiser? Well the answer is simple. If the borrower defaults and the note buyer is forced to take the property back, who do you suppose they will call to resell the property for them? You guessed it, more than likely a local realtor and really who knows the market in that area better than the realtors who are listing and selling properties in the area everyday. Here are links to a few reliable vendors you may wish to contact regarding a BPO on your property http://www.bposonline.com and http://www.evaluateusa.com.

Establishing an asking price is a crucial factor in marketing your property and is one aspect that is unfortunately often overlooked or done hastily with little or no research. There can be several drawbacks to a hastily established asking price. Obviously, if the price is too low you could potentially be leaving thousand of dollars on the table. If too high the property may not sell in a reasonable time or even worse you may inadvertently be creating a loan that is upside down out of the gate and severely discounted in the secondary market. Neither of which is appealing to a reasonable property seller.

In my next posting we will discuss the rewards of qualifying your potential buyers.

Until next time,

Damen

            I hope everyone enjoyed the recent Holidays. Over the New Year weekend, I was lucky enough to get together with several old friends and associates. We did a lot of catching up and talked about the many changes 2009 brought to each of our lives, some good, some bad and some downright tragic. One dear old friend had it especially rough. Not only had her and her husband lost a great deal of their retirement savings when the markets tanked, they also closed their construction company down after several very poor years. However, this is not a tale of woe; no, far from it. As many Americans have done or are doing they have rebounded, picked themselves up, dusted themselves off and found new opportunities in their lives.

Have you lost your job?  Did your business nose dive with the economic bust?  Did they erase your name off the office door or demote you to street parking?  Don't be ashamed if any of these things have happened to you.  The same, or worse has happened to millions of other people in the United States and abroad.  What is truly important is how you react to these significant changes. 

            In 1998, or there about, Dr. Spencer Johnson wrote a simple allegorical tale about two "littlepeople" and two mice.  The book sold like hot cakes and topped the best seller lists for over a year. 

            The four characters are very different.  First, we have the two mice; Sniffy, a perceptive little guy, who is quick to perceive changes to the environment; and Scurry who runs about dealing with the changes.  When the great stash of cheese disappears one day the two mice use basic instinct and move ahead.  They do not question where the cheese has gone they just put one paw in front of the other, and lo and behold, discover an even greater horde of cheese.  So, using instinct and trial and error they continue life without too much analysis or disruption. 

On the other hand the two "littlepeople" who had also been living off the cheese in the great maze are dismayed when the cheese disappears one day. In fact the "littlepeople" Hem and Haw are angry, dismayed and hungry.  The cheese has always been here Hem rationalizes, which in his mind means the cheese will come back so he will wait for its return.  No need to change his routine.  No need to forge into the unknown.  Despite encouragement from his friend Hem is steadfast and will not move from his comfort zone and seek out more cheese.  He will stay put. 

Haw, on the other hand, ventures forth into the maze.  Haw is rewarded with occasional crumbs of new cheese along the way and soon he begins to visualize a big and better cache of cheese just beyond the next corner.  Within a short time Haw is invigorated by the challenge of the search and begins to enjoy himself.  Haw accepts the premise that change is good and that the only inhibitor to having bigger and better is the limitation of his old and limited value system.   

Haw writes messages on the wall of the great maze at varying times.  At the end of the story he has reached several life altering conclusions which he summarized by several specific laws, which I have conceptualized below.

                   The Cheese Laws

1.           Accept the law of change.  The cheese will move.

2.           Expect change.  Be ready for it.

3.           Watch for signs of change.  Know when it will occur.

4.           Adapt.  Change quickly, so you can enjoy fresh cheese.

5.           Change your attitude.  Pack up and follow the cheese.

6.           Enjoy.  Savor the new.

7.           Repeat the process.  Be ready to move on. 

I know that it is frequently hard, but stomping your feet or sobbing will not bring the cheese back or get you a new corporate parking space. So, get started.  There are no good excuses for inaction.  Remember, you are in charge of your life no one else.

Have a wonderful and properous 2010

Darlene