The US Mortgage Market
2009 was a monumental year for the United States mortgage market. The writing had been on the wall, but it seemed overnight the world came to the realization that housing prices in the US would not increase indefinitely. Since 2009 tens of billions of dollars have been lost in mortgage investments, company after company has been forced out of business and the effects are still being felt.
Without notice mortgage originators have stopped creating sub-prime loans and this large group of buyers/borrowers is now left with nowhere to secure financing. Today, there is a staggering number of potential real estate buyers who can only look to the property seller for the financing they need. While this seemingly simple step of financing the buyer may seem like a good idea, we recommend you learn some fundamental elements of the business before becoming a mortgage lender.
- The demand for owner financing has increased significantly since 2009 and will continue to climb as more borrowers find they don't qualify for conventional financing.
- Offering owner financing to potential buyers is a more powerful marketing tool now than ever before.
- For the reasons addressed above, the ability to sell sub-prime owner financed loans has been greatly reduced or eliminated altogether.
- Offering owner financing will help you sell your property, but doing business with the wrong borrower(s) could potentially lead to larger problems for you than the unsold property was causing.
Owner Financed Mortgages
Knowing how to successfully use owner financing is extremely important. Learning these guidelines will limit whom you offer owner financing to, help you sell your note if you desire to do so and hopefully, reduce the chance of facing a foreclosure situation down the road.
- Always require a potential buyer to provide you with a recent tri-merge credit report on them. Financing a borrower without this information is not prudent, regardless of how well you may know the borrower(s).
- Always require a potential buyer to make as large a down payment as possible. This is the buyer's financial commitment to the property and from the lender's perspective, the larger the better. A good guideline to follow would be 20% of the purchase price.
- Do not make the mistake of owner financing a buyer who has a poor credit history and cannot make a substantial down payment. This has always been a bad combination for lenders and it is especially true today.
If you follow these guidelines you will have the option of selling the new mortgage loan you created within a few months of the closing. That way, if you really desired cash from the sale you can still have it. Failing to follow these guidelines may result in you creating a note that is not marketable or one that will have to be deeply discounted in order to sell.
Owner financing is a sensible way to sell property and extremely common all over the United States. (It has been estimated that approximately 10% to 15% of property sold is now sold with seller financing.) Offering to finance the purchaser of your property can help you sell it quickly, may provide tax benefits and will give you a nice source of monthly income.
Owner Financing Advantages for the Seller
- The number of potential buyers will increase significantly.
- The sale price should not have to be reduced below market value.
- The sale will close more quickly than with bank financing.
- Any potential income tax liability from the sale may be able to be deferred.
- In most cases, the note you create can be sold and converted into cash at any time.
Owner Financing Advantages for the Buyer
- The buyer will not have to meet rigid bank qualifying standards.
- The buyer may be able to purchase a property the banks would not qualify him for.
- The buyer will pay lower closing costs.
- The buyer may be able to make a smaller down payment than the banks would require.
- The buyer may have the option of creating flexible payment terms.
- The buyer won’t have to pay origination points or mortgage insurance.
- The buyer may not have to establish a prepaid escrow account for taxes and insurance.
Creating A Quality Mortgage Note or Deed of Trust
Of course, creating a high quality note and mortgage or deed of trust is of primary importance. We strongly suggest employing the services of a competent attorney to represent your interests in the sale and creation of the note and mortgage or deed of trust. If you decide to finance the purchaser, you should negotiate the best possible terms and make sure your attorney drafts the documents. Here are some important tips and advice:
The sale price should be nothing less than the properties fair market value. There is no reason to discount the price if you are financing the purchaser. Don’t allow the sale price to be negotiated below market value – and then have the buyer ask you for owner financing.
The down payment is the purchaser’s initial investment in the property. The larger the down payment, the more motivated the purchaser will be to protect his investment. Consider carefully: Would it be wise to sell your property to a buyer who is unwilling or unable to financially commit himself to the property you are selling.
The interest rate you charge should be a function of the down payment, credit worthiness of the buyer and number of scheduled payments. The rate should be higher than the interest rates being charged by banks. Remember, the banks only advertise their best rates, and the buyer probably doesn’t qualify for them. Don’t be afraid to require at least 2% higher than local banks are charging.
Banks are professional lenders. They don’t lend money without reviewing a credit report on the borrower and you shouldn’t either. Just like any creditor, you have the right to information that shows the buyer has an adequate source of income to pay the note obligation and has a good credit history. If selling to a person with less than good credit insist on a larger down payment.
The amortization of a note refers to how many payments are scheduled. For most private note holders it doesn’t make sense to create a note with a 30-year payback. Creating a term up to 15 years is more practical. Scheduling a balloon payment will allow you to shorten the term of the note without increasing the monthly payment required of the buyer.
Banks require monthly escrow payments for good reasons. It would be wise for you to require the buyer to make monthly escrow payments for taxes and insurance as well. While requiring more work, it will help prevent the undesirable situation where the tax and insurance payments are not being made.
As the lender in seller financing, you should require the purchaser / borrower to provide you with a lender’s policy of title insurance. Every bank requires this. If you ever decide to sell your note you will need this policy of title insurance. Requiring the buyer to purchase the policy will save you the expense down the road.
Closing the Sale
It is very important that you have a competent attorney or title company represent your interests in the creation of documents and at the closing. As the seller, the financing documents protect your interests. Your attorney should prepare these documents. After the closing, be sure your new mortgage, deed of trust, contract for deed or land contract is recorded immediately to protect your interests.