So you have decided to sell your home with seller financing, how do you structure the note to ensure your investment is safe and secure? What can you do on day 1 that will help you during the duration of the loan? If I decide to sell, what can I do now to get the highest offers in the future? |
Introduction
The lure of Note investing is the monthly “mailbox money” received with minimal effort over a very long period. When setting up a Note, the set-up phase is critical to ensure your long term success and to maintain your investment value. Take the steps now to ensure your Notes future financial success.
Setting Up Your Note
When creating notes, it is important to understand how a Note is valued and then develop steps to maximize the value. Read through these key areas to understand the important areas to focus on during creation of your Note.
#1 – Borrowers
Picking your borrower is key to the success of your Note. This relationship will last for the next 10, 15 or 20 years. So do not skimp on this step. Take the time to understand who the borrower is, understand their background, their education and their employment history. Two keys steps to complete are a credit check and a debt to income ratio. Both steps will help you to understand the borrower and their ability to pay. Some new lenders are nervous about being too invasive or prying too much. You must remember that you are entering into a long-term business relationship with the borrower, so understanding who you are working with is key! (read more about selecting Borrowers)
#2 – Collateral
The property is secured to your Note. Ensuring this property is in good condition and is well maintained during the life of the Note is critical to ensure your investment value. Make sure to add terms to the mortgage that requires the borrower to maintain property upkeep and add options for you, the lender, to ensure upkeep if needed and the ability to charge back to borrower.
When pricing the property, work with a professional to get accurate value for the property. There are two tools that can be used – property appraisal or a broker price opinion (BPO). The property appraisal is a certified valuation, more accurate, more detailed and more costly. When you get a loan with big bank, these are required. A broker price opinion is a faster, cheaper and less detailed estimate conducted by real estate agents. Do not use advice from a friend or what you think the value should be!
#3 – Buyers Equity
When closing the deal, the down payment is normally the last item mentioned. After working through all the other details, you sometimes almost treat this as an afterthought. Getting a down payment is key to showing the commitment the borrower has to the business relationship but also a great indicator of their desire to stay. Getting from 0 to 5% down is not setting you up for future success. The target down payment is 20%. This is what most banks require, and you should as well. Get the down payment at closing and do not defer or finance the amount. This down payment is often called the “cushion”. The cushion allows you to walk away from closing with some cash in the pocket while giving you something to hold if the deal goes south quickly.
#4 – Terms
Ensuring the future success of your Note often revolves around this step. Set the terms incorrectly and your investment can fail. In creating terms, we strongly recommend using professionals, such as an attorney, title company or RMLO. Try to find professionals that have done Note deals in the past. Picking help based on friendship will not help your rate of success.
When creating the actual terms, remember you are becoming the bank, and you will be in this relationship for the long term. Trying to be a friend at the beginning will hurt you in the future! Pay attention to the market. Find out current mortgage rates and set your rates at a premium. You are not a mega bank so do not underprice your Note. (read more about setting up Terms)
#5 – Pay History
On day 1, decide how you will manage your Note going forward. Put the process together in advance so you can sit back and enjoy your mailbox money. We highly recommend using a 3rd party servicer to handle your borrower interaction after closing. These are licensed professionals that know what should be done during the lifetime of the loan.
If you choose to self-manage, you will need to collect payments, update amortization, provide tax reporting and potentially escrow management. Each step is very important to maintaining the value of your Note. We do recommend that you maintain borrower payments and escrow in separate bank accounts from your personal bank accounts. Make sure to deposit payments timely and adhere to late payment penalties. We do not recommend collecting payments in cash but if you do make sure to maintain a receipt book and deposit to a bank when received. There are some online tools that will help you maintain the amortization which is the basis of all annual tax reporting.
#6 – Paperwork
Properly managing a Note means you need to develop a process to store and maintain all the paperwork produced both at closing and during the lifetime of the loan. Either buy a fireproof safe or get a safe deposit box to store the paperwork. The most important piece of paper to maintain is the actual promissory note. The Note should be considered legal tender and receive the same treatment that you have for cash. If you sell the Note, the original document will be required and will be transferred at closing. (read more about securing Paperwork)
Summary
The initial set up of your Note will determine your rate of success with your investment. Understanding and adhering to the basics will ensure your Note’s value will be maintained during the life of the loan and if you do decide to sell, it will ensure you get the highest offer for your Note!
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Connect with Peak Notes Why not set up a meeting with a Peak Notes specialist to discuss setting up your new Note and the best steps to maintain and increase the value of your investment! Meetings are brief, cost nothing and can give you more insight into how you can maximize your investment potential! If your property is located in Florida, please click on this link and set up a meeting with John (Meeting with John). If your property is located outside of Florida, please click on this link and set up a meeting with Karen (Meeting with Karen). |
DISCLAIMER-Peak Notes is not an accounting or legal firm and the recommendations above are best practices and observations from our years working with notes. Always consult a licensed professional for both accounting and legal issues.