Ten Steps to a Quality Seller Financing that results in a marketable Note

Photo by Stuart Miles on www.FreeDigitalPhotos.net.
Photo by Stuart Miles on www.FreeDigitalPhotos.net.

So just how does a seller financing transaction work when a real estate investors is the buyer and the borrower?

For example let’s say I have a cash flowing rental house for sale at $50,000, that rents for $750 a month.  I have an investor buyer who is going to put 30% down on the home or $15,000 and finance the remaining $35,000 at 8% for 10 years or 120 months giving me a principle and interest payment of $424.65.

What kind of paperwork do I need for the sale contract and what do I need to do to actually close this transaction.

On the sale contract there are many ways to write it up.  My personal real estate contract has the basic sale information, closing date and inspection information.  It also has a spot for me to write in the terms of my seller financing transaction.  If you are writing this up using the KCRAR forms, you would want to include a Seller Finance Addendum to define what the seller fiance terms will be.

As the seller and the lender, I would want to complete my own due diligence on the borrower, so that I am comfortable lending the borrower the money and that I have a note that I could potentially sell down the road if needed.

What should I look at and make sure I have completed if I want to sell the note down the road.

1.  In the world of Dodd Frank, I would want to have some sort of document or statement written up that the borrower will sign and notarize where the buyer borrower verifies that they will not be living in the property and that the loan is a non-owner occupied loan.  One person I have spoken with goes to the extent of asking them to have a third party, preferrably an attorney also read it, explain it to them and also sign off on it.  Other lenders I know will only lend to a corporate entity.

2.  Next we want to verify that the sale price is as close to the real actual value of the home.  That we are not over inflating price because we are seller financing and we can.  Sure a seller financed home should be worth more than a house sold for all cash or even with a bank loan, but not a whole lot more.  I would suggest getting an appraisal or possibly a Broker Price Opinion from a disinterested Third Party Realtor that you can put in your file should you need to sell this note down the road.

3. Next you want a valid loan application from the borrower so you know who the borrower is, what their address and phone number are, and their social security number.  You want to know income an all that other stuff, but the contact and social security number give you something to work with, not only in completing your up front due diligence, but also should you sell or the loan go bad, you know how to find the borrower.

4.  Credit Report, you personally may or may not want this.  However down the road, should you sell the loan, this is an item that loan buyers are going to want, so you need it up front too.

5.  Decide if you want the borrower to personally guarantee the loan, meaning should they default you can not only foreclose and take the house, but also sue them personally for any deficiencies.  Or you may want to offer a non-recourse loan that only gives you the right to foreclose, but not go after the borrower personally should they default.

6.  Review everything to make sure it looks like a sound loan.  Does the borrower seem like a good credit risk and does the income generated cover the costs and should the deal go south, do you have enough equity to foreclose and sell and not loose out.

7.  The next step is creating the Note which the borrowers promise to pay and the Mortgage or Deed of Trust that governs the way the loan will be collected and foreclosed on if things should go south.  Where do you get these documents? Well with the internet that’s fairly easy, you just Google and get docs.  Your title company may have something you can use as well.  Or you may want to have an attorney review what you find or draft them for you.  Just keep in mind that technically your title company and your Realtor if one is involved should not be writing up these documents as that is practicing law with out a license and could get them into major hot water.

8.  Picking a Trustee.  In Missouri and other Trust Deed States, you need to name a Trustee on your Deed of Trust, this is the person who will be responsible for foreclosing should the loan go bad.  It’s not a real big deal as the Trustee can always be replaced by a foreclosing attorney down the road.

9.  After all is agreed upon, everything should go to the title company who make sure everything is signed, recorded and funds disbursed as needed.   They will also provide your buyer with a Title Policy and you should spend the extra $200 (or have someone spend it) to get a lender’s title policy.

After it is all said and done, I highly recommend turning  the collection of the payments over to a servicing company that will collect the payments, pay any debts that need to be paid out of the payment . . . escrows for taxes and insurance for example.  They will also be responsible for sending the right documents to the government and to the borrower and to you, so everyone pays their taxes correctly.

And make sure to keep in a very safe place – your original note and mortgage or deed of trust in paper form as they will be needed down the road should you ever want to sell the loan or foreclose on the loan.  Also keep in a safe place your appraisal or BPO that you had completed, the borrowers Loan Application, and Borrowers Credit Report.  With these things showing a good borrower and a good 3 to 6 month payment history, you should be able to then sell that loan for a premium price down the road should the need arise.

So lets go back to my example of selling the house for $50,000 with a $35,000 loan in place for 10 years at 8% interest.  Let’s say I purchased that house for $15,000 and put $5,000 into the repair and then made the sale.  I would make $15,000 upon sale and have a marketable $35,000 note that I could very easily sell in 6 months for $29,000 . . . meaning I made $9,000 profit on my $20,000 investment plus the payments I received over that 6 months. Or I could keep it and net a whole lot more.

Want to learn more about the Note Business, be sure to join us in January on the 13th at the monthly meeting and on the 24th for a full day workshop with 30+ Year Note Veteran Eddie Speed from NoteSchool . . . plus several of his local mentor students.