Avoid These Seven Seller Financing Pitfalls at All Costs!!!

Avoid These Seven Seller Financing Pitfalls at All Costs!!!

Expect a big pay off on your unpaid principle balance?  even though. Unrealistic expectations from the lender will occur when the paper was poorly written. Would you rather have $97,000 to sell your $100,000 note for only $80,000 or less? The difference in usually comes down to the following. Here’s the biggest mistakes note sellers make and how to avoid flushing money down the drain.

•                         Mistake #1- Disregard of the Dodd-Frank CFPB Guidelines 

The Dodd-Frank legislation was passed on January 10, 2014. It imposes some very stringent guidelines on private lending. Not following those guidelines will leave the original lender and the subsequent note buyer with huge liabilities. This includes balloons, interest rates

ü  The Seller Financing Solution?

Engage the services of a Loan Originator to create a compliant file which will be the very same documentation required by a traditional lender. Equal to Fannie Mae 1003 Loan Application which will include the 8 items to make a compliant file:

• Income and Assets  
• Employment Status  
• Debt  to Income Ratio 
• Credit history*** 
• Monthly Mortgage/Rent 
• Monthly Mortgage Related Obligations 
• Monthly Debt Payments  
• Other Monthly Debt Obligations

The buyer can and will pay the required fee which could be as high as $1500.

                        *** The payer’s credit report lets you know how timely they have paid bills in the past. This is a good indicator of how they will pay on a seller-financed note. It also has a huge impact on how much an investor is willing to offer, should the seller ever decide to sell the note payments. Sadly, many sellers never check credit when offering owner financing. Have the buyer fill out a simple one page application that grants permission to pull their credit upfront or ask the buyer to pull their own credit and provide the report. Whenever possible, avoid accepting owner financing from any buyer who is not current with timely payments in the prior 24 months. Blemishes or job situations happen, on going negligence is systemic. 

                          Good Documentation = Good Loan = Higher Profit

• Mistake #2 – Charging a Low Interest Rate

Money today is worth more than money tomorrow. A simple look at escalating food and gas costs will show a dollar today won’t buy as much next year or the year after! This concept, known as the time value of money, plays a large role in investor note pricing.

All factors being equal, an investor will pay more for a higher interest rate note. We’ve seen sellers charge 5% or less on notes. Imagine the discount when an investor wants a 10% yield!

ü  The Seller Financing Solution?

Charge at least two to four percent above the standard bank loan rate  for a similar loan transaction. Be sure to take into consideration the credit, property type, and down payment, which may justify further increases in the interest rate.

• Mistake #3 – Low or No Down Payment

The down payment determines how much equity the buyer has in the transaction. The greater the equity, the less likely a buyer will default. There is a reason banks require mortgage insurance whenever a buyer puts down less than 20%! In desperation, some sellers will even accept a zero down payment. Unfortunately, these buyers have even less at stake than a renter. A renter at least has a security deposit along with the first and last months rent!

ü  The Seller Financing Solution?

Require a down payment of at least 15% to 20% at closing. Consider creating 2 notes a 60% first and a 20% second to get a reasonable loan to value.

• Mistake #4 – Not using a Loan Servicing Company

Sellers tried to save money and collect the payments them self vs outsourcing thus saving on e time set up fee of up to $200 and $18 to $15 /monthly which can be paid by the buyer. This lack of payment validation by a 3^rd party servicer will give cause for discounting the note value.

ü  The Seller Financing Solution?

Engage the services of a loan servicing company when the note is originated and have the buyer pay the set up fees and the monthly servicing fees.

Mistake #5 – Requiring a Mortgage Balloon Payment

Ballooning 2^nd mtg, with no payments expecting a full payout  tries to be a nice guy, with no money down from the buyer, thus creating a 2^nd, balloon only to make it easy on the buyer, but creates poorly written paper

• Mistake #6 – No Tax and Insurance Escrows

Not requiring the escrowing for tax and insurance proration and  leaving  it up to the buyer to pay as when and if………

ü  The Seller Financing Solution?

Require that the borrowers payments include escrowing for taxes and insurance included with payable to the servicer with each monthly payment just as it would be done in a traditional transaction.

• Mistake #7 – Lender as an Additional Insured

Not added as an additional insured  usually an oversight, but can leave a lender up a creek without a paddle.

ü  The Seller Financing Solution?

Include / require that the lender be listed an additional insured in the closing documents just as it would be done in a traditional transaction.

A variation of any of above mistakes will result in heavy discounting of the existing note, maybe as high as 50%.

ü  The Seller Financing Solution?

Sell a(Partial) stream of payments and you as the lender keep the risk. Hold the back end of the note, sell the front 60 payments to free up cash and continue that process.

Other items come into play when valuing a seller financed note ranging from property type, to seasoning terms,  to 1^st or second position notes.