What Kind of Note Terms Are Note Buyers Looking For?

Question

We are considering offering seller financing on some of our rehabs, as the market cools. How could we structure a note that is attractive to sell quickly and for the least amount of discount and little seasoning? What kind of terms, rates, down payment, underwriting, servicing, etc.? Thanks.

Andrew Smith · Answer

We generally pass on loans not serviced by a licensed servicer. The loan documents should be drawn up and reviewed by a licensed attorney. These are big roadblocks for us if either one is not in place. As far as terms go, most note buyers purchase at a discount to Unpaid Principal Balance (UPB) and expect double digit returns on their investment. No pay history means more risk so buyers generally expect higher returns (and purchase at a deeper discount to UPB). calltheunderwriter.com can also help with origination. Any decent performing note calculator can help you see what investors might pay you based on the terms of the note.

A bigger down payment always means less risk for the lender...

Sara Wallace · Answer

@Abby Shemesh

You are a WEALTH of information. THIS is the type of lender/loan officer people need: one privy to their products as well as market averages, pro’s & cons.

Bravo! from an investor Realtor that specializes in bank foreclosures. I rarely see usable, direct knowledge relayed so well. 😁

Abby Shemesh · Answer

@Matt B. - We are running into this question a lot nowadays. There are many variations to this answer depending on different factors such as geo-locations and the economics of said locations.

So, I will discuss in general terms to simplify. Fix and flip, short-term loans are attractive to some but not preferred by most note investors from our experience due to their short fuse and heavy costs/energy of moving capital around frequently.

Most mortgage buyers have a strategy which is more akin to buy and hold as opposed to moving in and out of investment positions like a trader.

That being said, the structure should look something like this:

a) 50% to 65% LTV (using conservative ARV - don't go crazy here)

b) Set an amortizing loan term and structure if you can so the borrower is chipping away at the principal (interest only is less attractive but doable) - shorter the amortization, the better the price (typically). Fix and flips loan terms range between 6 months and 36 months depending on the strategy and the market conditions.

c) @Andrew Smithrew Smith is correct in stating that note buyers are looking for double digit returns and loans are sold at a discount. The closer you can get double digit rates, the less of a discount your will experience when bringing these assets to market. Long and short, rates should range between 10% (very low end assuming the borrower has a ton of skin in the game) and 13%+ (assuming usury laws in your jurisdiction)

d) Season the payments for at least 1-6 months before selling to establish some sort of predictability with the payments chain. Predictability is the name of the game and most of these Fix and Flip deals are non-recourse (Corp borrowers w/ no SSN #). If you do have recourse / PG that would allow the note buyer to check the borrower's credit to establish predicability that way as well. Recourse is a much better scenario for pricing metrics from our experience.

e) Set up a loan servicing company to collect payments like FCI (corp borrowers) or Madison Management (who reports to credit which helps individual borrowers maintain and increase their score for their exit financing). This will go a long way if you do not mind the extra steps.

f) Compliance may come into play if the loan you are originating is or becomes a consumer loan and not an investor loan. Consumer in the sense that the borrower will occupy the subject property as their primary dwelling. If this is the case, you want to have a Mortgage Loan Originator (MLO) underwrite the transaction using your in-house criteria in order to take the liability out of your hands. CallTheUnderwriter.com is a good place to start for compliance on consumer loans.

I hope this is helpful. All the best.

Abby Shemesh · Answer

@Matt B. - Sorry for the confusion. If these are consumer mortgage loans that changes some things but not all mentioned above.

1. Stick to shorter amortizations. No interest only structures whatsoever! 30 years is a long time for a return on investment. The mathematics on a 30 year amortization will translate into lower offers. I would recommend sticking with 15 years full-amort or less. If you have to go for a longer amortization, inch up instead of just shooting to 30 years. If the borrower cannot afford 15 year amortization, try 16, 17, 18, 19, 20 etc. If you have to go to a 30 year amortization be prepared fro a steeper discount.

2. Make sure the rates you charge are 2-4% higher than what banks are charging. If you borrower wants a bank rate, with all due respect, they need to go to a bank then. You are not Wells Fargo or BofA nor do you (or I) receive subsidized capital from the FED or the folks closest to the money printer.

3. Make sure you get a decent down payment. 15% should be bare minimum! If you are collecting less than 15% down, be prepared to not be able to sell the whole note at once. You will only be able to sell it in bite-size portions (called a Partial Purchase). If you wish to sell the whole loan in one shot, you should be collecting down payments in the 20% to 30% range. If that is not feasible, then you may need to season the payments for many, many months or even years before you can sell the whole note on a full purchase.

4. Make sure you create recourse loans for the best pricing. Collect personal guarantees from the borrowers. Not doing this can result in tens of thousands of dollars less on your offer.

5. As mentioned in my previous post - Set up a Credit-Reporting, loan servicing company to collect payments like August REI (Texas only) or Madison Management. This is paramount for helping individual borrowers maintain and increase their score for their exit financing. This will go a long way if you do not mind the extra steps.

6. MOST IMPORTANT - As mentioned above in my previous post - Compliance may come into play if the loan you are originating a consumer loan. Consumer in the sense that the borrower will occupy the subject property as their primary dwelling. If this is the case, you want to have a Mortgage Loan Originator (MLO) underwrite the transaction using your in-house criteria in order to take the liability out of your hands. CallTheUnderwriter.com is a good place to start for compliance on consumer loans. There are others but they will require that you service with them and they do not report to credit. That is you call though of course.

Hope this clears up my last post.

Matt B. · Answer

@Abby Shemesh

Thanks for the incite. Just to clarify, we are not looking to originate a fix/flip type note to an investor. We are looking to sell our completed rehab projects end buyers that will occupy the property.

We do plan on having them underwritten and serviced.

John Underwood · Answer

So as you can see people buy notes to make a good return. They are looking for a deep discount and double digit returns.

Maybe a better position for you is to keep these and make this profit yourself?

You might find a smaller bank that would give you a portfolio loan after you show the returns you are getting or a private money person to back you.

Get to know your local smaller banks and join the local RE club where people like to loan money out of their self directed IRA.

If you could keep your notes and offer 3/4 of the interest to a private money person it would be a win for you both.

Get a decent downpayment from any owner financing deal so you have the money for a foreclosure if things go south.

I know people that sell with owner financing using a land contract. They keep the deed in their name till paid in full. If someone stops paying and leaves,  they sell it again and again. When it does pay off they clean up the title if needed.

You can also sell of a portion of a note or so many payments on the front end. Many options.

Rick Pozos · Answer

Maybe consider keeping a 2nd on the house that you sell. That would put the first that you are going to sell at a lower loan to value percentage, thus making the first more secure. You are already using an RMLO and a servicing company which is a must.

So if you sell a 200k house, the buyer puts down 20k. 180 is left. Split that into a 1st of 140k and a 2nd of 40k that you keep. You will get a little profit up front and more of your profit with spread out over 25 or 30 years at 8% or 9% interest.

This not only lets the buyer know that you are committed to the seller paying his mortgage, the buyer of the note also is secured at 70% loan to value. They are pretty secure that even if there is a little bit of a downturn, they are not going underwater with the amount owed to them. Do you think a secure and low LTV mortgage is worth a little more than a 6% mortgage that is at 95% LTV?? Also, you need to find the right buyers for your notes. Most people on BP are going to want 12% yield on their notes. Find people who have CDs, CASH or IRA money that is just sitting there. They will probably pay 100% of your loan balance.

OR how about the first lien being lower interest rate than the 2nd. Sell off the lower interest rate 1st to the CD or IRA people and keep the higher 2nd!!

Abby Shemesh · Answer

@Sara Wallace Boyd - Thank you very much for the #Love and feedback.

Very much appreciated!

We have been operating in the secondary mortgage market industry since 2006 and the primary mortgage market since 1999.

Lots of experiences to share.

Looking forward to more conversations and new opportunities. Cheers.

What Kind of Note Terms Are Note Buyers Looking For?

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