Doing Owner Financing Correctly

12 Replies

I am a mortgage note investor and end up with a fair number of non-performing notes.  A percentage of these will turn in to REOs.  I typically sell my REOs off-market for cash to investors or on-market in the conventional manner, depending primarily on property condition.

I would like to begin offering some owner financing on the off-market investor sales to help the investor get in easier with less cash up front. I am thinking of doing a non-recourse loan with a longish amortization and a balloon a year two out. This type of thing seems to me to be very similar to a standard PML/HML funding of a fix and flip deal, the difference being that I am also the seller. I thought this group could help me understand the proper process to follow.

If I were originating a consumer loan, I would use an RMLO.  My understanding is that this is not necessary with a commercial non-recourse loan.  So my question is, what are the steps required to get the deal done once I have a buyer lined up and vetted?  My best guess at the moment is that I would execute a PSA with the buyer and then use a title company to create the note and security instrument, issue title policies, and record the deed and security instrument.  What am I missing?

You do not need an RMLO if you are selling a property to an investor.  The only time you need an RMLO is if the buyer is going to live in the property.

@Neil Aggarwal  

Thanks for the response Neil.  I've got that part.  The question I have is what I need to do to get a commercial loan like this done.

You better check with your attorney, a good finance attorney, if you take the property through foreclosure your borrower can expect you to obtain the best price possible in an attempt to obtain any excess equity above what is owed to you. Doing an installment sale isn't a sale that attempts to obtain excess equities.

Need to expose your foreclosed properties to the market, not sell from backroom deals.

Selling to an investor for cash is fine, an equity loan is a horse of a different color, residential or commercial.

Now, if you take a deed in lieu of foreclosure, you then own the property as you accepted the property as payment, the lien is extinguished and the borrower abandons any claims of excess equities.

The reason lenders have sale requirements is to keep a lender from going into the real estate business, there becomes an incentive to foreclose and go into RE sales, you are a regulated lender, not a private investor.  

If you are in a title state, look into courts of equity which can still apply as to fairness for your indemnification of a cash loan.

About the only difference in residential and a simple commercial note is the heading saying "Commercial Loan" or "Commercial Note". Usury laws usually won't apply. Any personal property, if any, is secured by a UCC filing. Commercial sales should break out the land value and value for improvements. Stick with a HUD-1, it works for a small commercial settlement. You must have a complete accounting of settlements for commercial, you don't have to use a HUD-1, but it is simpler on small properties.

You don't have Dodd-Frank issues in commercial but you can have basically the same areas of concerns with predatory lending/dealing, ability to pay, short fused balloons, management or experience is more of an issue for a borrower, level of sophistication is higher.

As a broker, do you do loan servicing? Check with your state finance dept and see if you can service under you license, you may need a servicing license.....this isn't your home you're selling/financing, you're in the business. Some states require a license for commercial loans, your RMLO might meet that and it may not.

Another aspect, loan classifications in your state may not be totally defined by a borrower's intended use, the property type can make a difference. A residential property sold alone may not meet their opinion of commercial. 

I held the property for sale, listed. If it doesn't sell in 30 days an investor can make an offer, you can accept the offer, your money investor can finance that investor or you can, you're not a bank. That new loan carries the next project and clears off the old loan, you can loan more than the defaulted loan payoff. When that loan is paid off it becomes cash available for operation. On these I never sought any deficiency judgment. I could also get a wavier of equity claimed in return for a release from the judgment.

Time to wholesale is before a foreclosure, I don't want title from a lien interest, allow the borrower to sell and you can do so without recourse.

But, non-recourse loans have been a kick around here for several years, especially with one syndicator type, most housing investors here really don't cross the threshold for non-recourse in commercial and if you have investors as your source of funds, you're toying with their legal abilities to collect. I might let someone off the hook, but I'd never make it non-recourse from the beginning with someone else's money as a broker. I don't know what your risk management level is.

While it may be obvious that you can get a house back that was improved, what if your borrower drops dead and you then get into the construction business too, bankruptcy, incapacitation is even worse! And, you get another REO having to go that route all over again. Good luck :)

@Mike Hartzog   Assuming this is a 1-4 unit dwelling, CFPB has a lot of guidance and regulations on the properties.  A safe way to handle this, is to attempt a loan work out first and try to get it re-performing.  You probably tried this already with sending notice of default, work out letters, etc.  Next thing to try is @Bill G. method of deed in lieu.  The very last resort is foreclosure.  What the regulatory agencies are looking for is the "intent" to work the issues out with the mortgagor.  We can document that the mortgagee tried to resolve the issues with mortgagor, then we can't be accused of predatory lending.  Good luck.

@Mike Hartzog  These are the same type of deals I have been researching lately, but where I would be the buyer/investor. I am looking trying to structure the deal where the owner is essentially the lender. Low money down, a couple of years and balloon at the end. That gives me the opportunity to rehab and flip or do a rate/term refi if I want to buy and hold (which is my goal).

Great topic, I am looking forward to more input from fellow BPers!

*followed

Originally posted by @Jonathan Key:

 These are the same type of deals I have been researching lately, but where I would be the buyer/investor. I am looking trying to structure the deal where the owner is essentially the lender. Low money down, a couple of years and balloon at the end. That gives me the opportunity to rehab and flip or do a rate/term refi if I want to buy and hold (which is my goal).

Great topic, I am looking forward to more input from fellow BPers!

*followed

An owner in title can not encumber his own property with a lien, so you might take up your plan/question in another thread. Mike hasn't been back yet, I'd bet he understands the points I was making above.

Steve, predatory practices are not necessarily avoid by showing you tried to work out an existing loan, the attempt may not even apply to other factors.

A lender should do their due diligence before suggesting a deed in lieu, I'm sure Mike would.

In suggesting that a deed would be accepted. a lender needs to take care as to simply stating the facts of a deed acceptance and the factual benefits for a borrower.

That letter should have another letter enclosed, from the borrower to the lender, requesting that the lender accept a deed in lieu, this shows that the borrower was not unduly influenced from the initial letter and that they are requesting an option to resolve the matter they may not have been aware of. The borrower signs the request and you move forward to deed execution and settlement. A lender that accepts a DIL has no recourse for any deficiency amount.

The borrower needs to be told to obtain advice from his tax advisor, as they may have tax consequences. The lender will be treating the note as paid in full. (that means if you got a discounted note, you just had a profit to pay taxes on).

If, as a lender you want to own the collateral, take a DIL and avoid title and sale issues.

Good luck :) 

@Bill Gulley  Thanks for the clarification and advise. I will do exactly that as soon as I do my due diligence research on the topic as well as reach out to Mike.

Thanks for your input on this guys.

@Steve K.   - I agree with you on the workout suggestions.  I do all of this for my NPNs now, and manage to work out a fair number of them.  The scenario here is disposition of the REOs once all of that has failed and I have taken title via DIL or FCL.

@Jonathan Key   - You clearly get what I am trying to do here. 

@Bill Gulley - I'm not totally getting the issue you mention with a deed from foreclosure vs. DIL. There is a redemption period in some states consider, but beyond that, the REO is ours to sell. You seem to be suggesting that there is a problem putting a lien on an property you own as part of a purchase and sale transaction. I would like to hear more about that. Owner financing has been around for some time now. The problem I am having right now is that I have never done it before so don't completely understand the differences between owner financing and originating a loan on some other purchase and sale transaction in a purely lending capacity.

Mike, there is a difference between an equity funded loan and a cash loan, equity loans are installment contracts, even if the title is past, the title is subject to paying as agreed, if the note is not paid, as you can see in the UCC, the transaction is not completed at title to financed assets reverts back to the seller, the title reverts back with the seller's original title interests owning the property.

There are lien states and title states as to collateral that may be conveyed, a lien only conveys a lien interest not ownership rights, securing collateral is not ownership and the collateral must be sold with proceeds first applied to the cost of sale, then costs incurred such as safekeeping of the collateral, then to the obligation  and any excess is owed to the owner-borrower, this has nothing to do with redemption rights to meet the obligation within a time frame.

Title states convey title to collateral, taking back collateral puts that lender in title and they may dispose of the property, the owner may be out any equity, but then comes "courts of equity" as to what might be fair as far as indemnifying the lender and then what would be a windfall profit to a lender, being a lender is not buying the RE and being in the RE business. Make a 100K loan on a 1,000,000 property, that lender is not going to get 900,000 as an extreme example.

All states have the concept of courts of equity, fairness and it may be a matter of another suit aside from foreclosure, or a borrower can take a non-judicial process to a judicial process by suit.

Bottom line, seller financing, ownership reverts back from a default and cash loans create a lien interest or title interest intended to allow a lender to recover their advances, to be made whole, not to become a predatory dealer in that collateral. We don't have pawn brokers in real estate!

The point above, is your ability to convey ownership rights while having only a collateral interest in the property circumvent the borrower's interests and rights to excess equities beyond what is owed to you. This can fall under a wrongful foreclosure process as well as other predatory acts.

With a collateral interest, take a deed in lieu of foreclosure as described above. The deed is given as full payment of the obligation and the owner conveys all rights and title to the collateral, now you own it, you can move in, rent it, sell it or just let it sit there and rot if you want to.

Hope this is clearer than mud :)

Sorry, seller financing, you convey ownership rights, title with a general or special warranty deed, after that conveyance you file the deed of trust or mortgage next, you aren't filing a lien on a property you own. This is still an installment sale.

Other installment sales do not convey title, such as the old contract for deed, or a financed option with a lease, some trust conveyances are made after full payment has been made.

What is was referring to was the implied comment as to holding title as an owner and having a lien interest in that property, that doesn't fly.

Not really an exception, but an example, I sell you a 1/2 undivided interest in a property, I may still have an undivided interest but I may secure your interest with a security agreement, my lien is not to the interest I hold but rather that held by you.  :)

Originally posted by @Bill G.:

The point above, is your ability to convey ownership rights while having only a collateral interest in the property circumvent the borrower's interests and rights to excess equities beyond what is owed to you. This can fall under a wrongful foreclosure process as well as other predatory acts.

With a collateral interest, take a deed in lieu of foreclosure as described above. The deed is given as full payment of the obligation and the owner conveys all rights and title to the collateral, now you own it, you can move in, rent it, sell it or just let it sit there and rot if you want to.

Hope this is clearer than mud :)

Bill - I think the point you are missing here is that I am talking about REOs, i.e., properties I have title to already, not notes.

Originally posted by @Mike Hartzog :
Originally posted by @Bill G.:

The point above, is your ability to convey ownership rights while having only a collateral interest in the property circumvent the borrower's interests and rights to excess equities beyond what is owed to you. This can fall under a wrongful foreclosure process as well as other predatory acts.

With a collateral interest, take a deed in lieu of foreclosure as described above. The deed is given as full payment of the obligation and the owner conveys all rights and title to the collateral, now you own it, you can move in, rent it, sell it or just let it sit there and rot if you want to.

Hope this is clearer than mud :)

Bill - I think the point you are missing here is that I am talking about REOs, i.e., properties I have title to already, not notes.

No Mike, read again, the interest taken as a lender as collateral, need to understand what interest a lender has, you don't own it as you think you do as an owner, you are a creditor until you pass title as a lien holder. then look at title states and the issue there  BP NOT RESPONDING AGAIN! Sorry Later. :( 

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