Mortgage Notes and How to Structure Them
As noted in my article last month, collecting payments on a mortgage note is not the same as collecting monthly interest on a savings account. Whether you’re a mortgage buyer or a property owner, the processes and paperwork before, during, and after the sale need to be done by certain standards to maintain the legality and enforceability of your contract.
Want more articles like this?
Create an account today to get BiggerPocket's best blog articles delivered to your inboxSign up for free
The most important part of the sales transaction is to get as large of a down payment as you can, with a minimum of 10% for residential and higher amounts for other property types. There are three reasons for this. First, and most importantly, is that you’ll want to have an equity buffer in case the payer defaults and does not leave the property in good condition. You will need the money to make repairs and to foreclose before you resell the property. Second, the payer should have his own money committed to the house so that he suffers financially if he walks away. Third, if you ever sell the note, you’ll get a higher price for it if there is a strong equity position.
Before you commit to selling a property or buying a real estate note, get a current credit report on the payer(s). Go beyond just looking at the credit score, and check the details of any past defaults and late payments. If the payer has excellent credit, it indicates a higher chance of them being responsible payers for you.
Unless you are a professional with expertise and experience in real estate notes, work with an attorney or title company in setting up the documents. These will include such items as the promissory note, deed of trust or mortgage, closing statement, etc. The mortgage note should reflect items like the interest rate (get at least market rate), term of the note (best if at least five years unless the note is quite small), the payment amount, and the due date and grace period for payments. When the transaction has completed and both parties have signed the appropriate documents, the title company will record the deed, which makes it a matter of public record that you have a financial interest in the property.
During the term of the note, consider having an outside party service your note. In case there are issues with late payments, unpaid taxes or the like, they should be able to help you in resolving those issues.
And finally, if the payer defaults on the note, enlist the help of a competent attorney right away. In the wake of the housing bust, states have become stricter about the process that lenders and real estate note holders must follow. If you deviate from their laws, you will often delay getting the property back and may even be penalized financially.