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