Residential Real Estate Agent · Denver, CO · Member since 2010 · 73 posts · 36 votes
Hello All!
I don't know if this is a Market-Place question but I had a fellow investor express his concerns about selling his homes on Land Contract so I'd like to pose the question here, using our terms: Does our model have enough Reward vs Risk against Walkaways?
Most of our homes on LC can be paid off about 10yrs or less. I can provide an example LC if requested but our basic requirements are:
-10% Minimum Downpayment
-9.9% Interest Rate
-Avg $650/Month Payment:
Principle+Interest Payments Only (Buyer's are responsible for Prop. Taxes+Insurance (We audit regularly to make sure home is insured)
-Proof of Income+Ability to cover entire PITI and still survive!
-Poor Credit is fine (so far) as downpayment has helped minimize risk of forfeiture.
-Homes are Priced at comparative Retail Sold Prices (within last 12 months)
-No Balloon's/ No Pre-Payment Penalties/ Fixed Interest Rate
I hope I can get some feedback or if other Noteholders here have run into buyers abandoning a home even though they put down a sizeable downpayment please feel free to share.
1. A note buyer should have an ITV south of 65%. As a note buyer, you normally want to purchase your notes where the worst case scenario is the payor making all their payments. Best case scenario is that they DO walk away.
2. As the original note holder (after you've sold the property), normally your profit margin allows you to be able to take such a hit. So, for instance, if you're selling a property for $50K on a LC, you're hopefully no more than $35 to $38K into it...a down payment and a small payment history should allow for the deal to still be profitable should you encounter a walkaway.
1. A note buyer should have an ITV south of 65%. As a note buyer, you normally want to purchase your notes where the worst case scenario is the payor making all their payments. Best case scenario is that they DO walk away.
2. As the original note holder (after you've sold the property), normally your profit margin allows you to be able to take such a hit. So, for instance, if you're selling a property for $50K on a LC, you're hopefully no more than $35 to $38K into it...a down payment and a small payment history should allow for the deal to still be profitable should you encounter a walkaway.
Bryan: Thanks. Good to be back. Just been swamped with my day job as well as my night job.
Patrick: Yes, ITV is the investment to value ratio.
Another thought, since you are the original note holder, here are a few tricks to minimize the chance of walkways:
1. Send the payors a complete payment schedule, one that they can check off with each payment. Seeing the actual payoff schedule might motivate them to stay the course.
2. At the end of the year, send them a Christmas card and kindly remind them that there is no penalty for pre-payment.
3. (Save this one only for the right payor). As the note holder, you have every right to modify their loan, if need be. If you plan on keeping the note, a combination of extending the term and lowering the interest rate can be used to get to the payment that the payor can afford.
And, because you are the note holder, modification doesn't require a 3rd party, or a chain of command at the bank. You ARE the bank!
We already do send the payoff letter and will definately be sending Holiday/ Thank you Cards with a $50 Visa/Giftcard but the kind pre-payment reminder is a great touch!
As far as any necessary loan modification we are prepaired (again, for the right payor!) to modify the loan if need be.
Your attention to this post is greatly appreciated, Loc!
In the land contract, there is little risk to the seller when the buyer walks away. The buyer loses their down payment and any interests to the property and the seller retains control of the property through foreclosure. You will have to maintain payments to your original lender if there is an underlying loan, but hopefully the buyer's down payment and any positive cash flow from their payments can cover a few months until you find a new buyer.
When offering seller financing, the note should be structured in a way so that it is sell-able to a note investor in the event that you would like to receive a lump sum of cash prior to the buyer is able to obtain new financing. As the note holder, you could enjoy the cash flow but at the same time take on the liability if the buyer walks away or miss other investment opportunities when your cash and credit are tied up.
As you know in your area, the big risk is not simply the walk-a-ways. Those are easy.
It is the ones who want to stay but don't want to pay. Those will cost you.
Even worse, the above often turn into ones who want to take what they an when they are finally forced out. I have seen many a Metro Detroit home stripped by the homeowner. Appliances, copper, wires, cabinets, everything.
The more they have put down and will lose, the more they feel entitled to damage the property on their way out.
Sounds like you are treating your people right, but they do crazy things.
ITV, down payment, and the locale are the biggest considerations from my point of view.
If you have a large down payment and set it aside you can stomach eating payments (assuming there is an underlying loan) or degraded yield if there is no loan. It obviously has the psychological effect of getting the buyer to have skin in the game too.
ITV provides sufficient security interest if they quit paying so that you will be assured you can foreclose and sell on a new note if the market price drops for the property in the years after you wrote the loan.
To me the biggest consideration is the locale. Tenant friendly states make it hard to foreclose. People can always play games with declaring bankruptcy, which can cost you dearly. This is especially true if you are stomaching mortgage payments for an underlying loan. In these cases having a large down payment is key.
If the note is structured properly the walk-away risk is minimized. You always run the risk of some nutjob damaging the property, declaring bankruptcy and tying things up for a while, etc. Everything has risk, but if you underwrite things properly a portfolio should spread these risks out and keep you out of a lot of trouble.
Another quality thread here on BP folks! When it comes to being a note holder the most important factor is security. Security is created from the buyer(s)/payer(s) investment ("skin in the game") in the form of down payment and seasoning, credit and your equity position/ITV as the note holder. Security also comes in the form of of favorable terms and strong, enforceable and legally compliant loan, sale and note documentation. Your ITV is dependent on an honest appraisal of the property and the deal you can negotiate with the note holder. To me that is what makes the business exciting!!!