When an owner financed properties are being bought, a number of documents must be prepared. Among them is the purchase agreement, also known as a sales contract. Another document is the promissory notes, which includes the principal amount, the payment schedule, the maturity date, etc.
One of the most common questions I get from note buyers is why they’re receiving less than the current value of the note. Afterall, they reason, the note seller receives all of the principal plus any accrued but unpaid (or future) accumulated (or future) monthly payments. They will also want to know the average discounts received by sellers.
When considering whether to discount a loan, there are several important factors that we take into account.Credit of the payerWhat type of real estate is it? (Residential, Commercial, Mobile Home, Land)Where the property is located (neighborhood/urban versus rural).Amount of down paymentEquity in the house (the difference between the house’s current market price and the total of all outstanding mortgages).Condition of the propertyInterest rate on the noteTimeliness of payments
Why A Discount?
When a loan provider like Seascape Capital buys an asset, they take on a great deal of financial responsibility. They must make sure that the property being purchased is worth what they think it should be worth. They also have to make sure that everything goes smoothly during the process. For example, they may have to buy the property before it can be sold. That means that they would have to put down cash to own the home. Once the sale is complete, they will receive back any amount left on the mortgage balance.
If a borrower pays back a loan at an annual percentage yield (APY) of 5 percent, then they must pay back $5 for every $1 borrowed. However, if the borrower pays back the loan at an APY of 3 percent, then they must repay $3 for every $1 borrowed, but they’re only paying out $2 instead of $5.
We never purchase notes hoping or intending to foreclose, but if all other options have failed, we may be forced into foreclosure. It takes a lot of time and effort, and the note purchaser receives no income during the entire transaction.
All of the above factors add up to more risks. The lower interest rate is intended to offset some risks. Notes with negative elements such as bad payer credit or low equity will receive a lower interest rate than notes without those negatives.
When asked about an average price reduction, there isn’t one. However, when looking at discounts, some notes may be priced below 50%, others between 60%-70%, and others above 90%. Stronger notes may even go up to 100%, but these are rare occurrences.
Let’s say you have a $100k first lien mortgage loan that is being amortised over 15 years at an annual rate of 4%. You’ve made six monthly payments of $739 each. The unpaid principal is now $97,541 and here are two different situations:Scenario # 1Scenario #2Sales price$150,000$105,000Down payment$50,000$5000Original note amount$100,000$100,000Credit score of payer700600
Clearly, the scenario presented in #1 is less dangerous than #2 because there were larger down payments and better credit scores. For the homebuyer, this means that the homeowner is less likely to default on the loan, and that there is ample value in the house if a default occurs. In case #1, the homebuyer may choose to receive a 6% interest charge on the remainder of the loan, thus requiring a total purchase price of $86,732.16. In contrast, in case #2, the homebuyer might opt for an 8% interest charge, thus demanding a total purchase price of just $75,936.00.
There are several reasons why you might want to sell a mortgage note despite needing to take a loss. Here are some of them:Pursuing other investment opportunities besides the one that you’re currently working on.Simplifying the finances of an heir of an estateNot worrying about property taxes, insurance, and maintenanceDon’t worry so much about whether payments will be made every single day.
If you’re thinking about buying a house, then sell a note instead. You might not get as much money, but at least you won’t have to worry about paying for repairs or maintenance.