Mortgage Notes – Dealing with other loans

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If you still owe money on a property and want to sell it using owner financing (creating a mortgage note), would you later be able to sell that note?  The short answer is – yes, usually.

Let’s say that you own a house worth $100,000 that you’re currently renting out, and you owe $40,000 to your local bank.  If you sell the house for $100,000 and receive a $10,000 down payment, you will be carrying a $90,000 note.  This is all quite normal.  Yes, there is a small risk that the bank finds out about the sale and triggers the due-on-sale clause, but that is a remote possibility.

If a mortgage buyer offers to buy your real estate note, they will always be offering you at least $40,000 even if they are just buying some of the payments.  With very few exceptions, mortgage note buyers want to be in 1^st position (senior lien), so will want to pay off that underlying loan.  The same applies if there are overdue property taxes or other liens against the property.

So, if you only wanted to pay off that loan and be done with it, a good note buyer will offer you $40,000 to buy PART of the note (meaning a certain number of payments – for a review of partials, see my blog from a few weeks ago here).  More likely, you want to pay off the underlying loan but also get some cash now.  In that case, the mortgage note buyer may offer you $55,000 to buy a larger share of the note.  The first $40,000 goes to the bank and the other $15,000 goes in your pocket.  Plus, you will receive additional monthly payments in the future.

Of course, this only works if the total value of the underlying loans and liens is significantly less than the note balance.  Using the earlier example in which the note balance was about $90,000, you could not sell the note if the underlying bank loan was $85,000 or if the property is underwater.  A wise note buyer always buys notes at a discount, and a purchase price of $85,000 or more is unrealistic in these economic times.

The bottom line is that the underlying loans – be they bank loans, hard money, or some other lien type – are not necessarily a showstopper if you are considering selling the note in the future.  Selling part of the note is a tool which you will want to keep in the back of your mind in case you decide to utilize it on down the road.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.