Six characteristics of a good ticket
The six critical factors to consider when purchasing or creating a real estate-backed note include the buyer/borrower, collateral, down payment, terms of the note itself, maturity, and associated paperwork. We will review these one at a time.
The most important of these is the person who buys the property and gets a loan from the seller. Most seller-financed loans are created for people with a credit score of 600 or higher, although most banks have a minimum of 620. As with banks, the better your score, the better. the interest rate you can get.
If you’re creating a note, you can protect yourself from an applicant with bad credit by getting a larger down payment and charging a higher interest rate. These are things a note buyer will look for when considering a loan purchase.
The second thing to analyze is the property that is offered as collateral. A nice 3-bedroom house in a nice suburb would be worth more than a single on 35 acres, 20 miles from the nearest grocery store. A well built apartment building would be worth more than 50 acres of land.
When purchasing a note you must affirm that the property is correctly appraised. If you get that number wrong, the whole thing starts on shaky ground. While you may want to check a home’s value on Zillow, Trulia, or eppraisal.com, your most accurate number will come from a BPO (broker’s pricing opinion) created by a local realtor who actually went to view the property. . Compositions sold and comp listings will be more accurate than anything produced by a software package like Zillow.
The third factor to consider is the down payment. Consider two people who each have a house worth $50,000. One puts in $800 and the other $5,000 (10%). The ticket with the big down payment will be worth more than the other if everything else is equal. If a buyer has enough “skin in the game,” he’ll be more likely to make paying his mortgage a top priority, since he has more to lose if he defaults.
The fourth thing to look at is the terms of the loan. What is the interest rate? Currently, a rate between 8 and 10% is quite common in the seller financed world. Much above that will make it difficult to pay. A note with a rate of 5 or 6% may pay too little to be attractive to an investor who will be forced to heavily discount its offer to get the required return.
The payback period can also affect the perceived value of a note. Generally, a short amortization period is more attractive because an investor will get his money back faster.
If a note has a provision to collect security deposits for taxes and insurance, that should generate a better price when sold than one that does not. In the latter case, the lender is counting on the buyer to set aside funds to take care of these payments, but that’s asking for a lot of self-discipline from someone who has shown through their credit score that they may not have much.
If the buyer is unable to make the insurance payments, you, as an investor, may need to attach forced insurance, an expensive option to keep yourself covered.
Property taxes will be collected eventually and usually have a lien position prior to the first mortgage. Non-payment over a period of years can lead to the loss of the property in a tax sale.
The last thing to look at on the note itself is the full payment. An investor making an offer to purchase a loan will want to feel confident that the buyer can afford the payments and still have enough left over for all of their remaining living expenses. Also, if local rental rates are higher than your mortgage payment, that’s another incentive for the buyer to meet their obligation to pay on time.
The fifth factor is called seasoning. That is simply the amount of time the borrower has been making payments. A note buyer will offer more for a three-year-old note than one on which the new owner has only made three payments. A good track record gives the investor the confidence that payments will continue to be made on time and can even offset the negative effect of a low credit score.
Sixth and last, all the ancillary paperwork contributes to the total value of a note. Here is a list of documents to request from the seller of the note: title deed, tax certificate, mortgage or deed of trust, the lange (showing loan transfers), mortgage transfers, credit report, payment history and original application, including the borrower’s social security number. If you’re creating a seller-financed note, having all of these documents will keep the value of your note as high as possible.
So whether you’re buying a ticket or creating one, the same six puzzle pieces will be responsible for the size of the discount offered when a ticket is sold.