Posted almost 5 years ago

Selling a Mortgage Note? Here are 6 Easy Tips to Determining Value

Normal 1417742320 Sell Note For Top Dollar

If you or one of your clients are planning on selling a mortgage note and you want to understand how an investor will determine the price of said asset, then listen up...

There are many variables that must be considered in determining a price for a mortgage note for sale on the secondary market. But, before we get into that, lets see if the note is even salable at all.

Determining if a Mortgage Note is Salable

1) DOWN PAYMENT - First and foremost is down payment. The down payment (or cash from the property buyer to property seller at the time of sale) will determine if the loan can even be sold at all. The simple fact is, the more money a property seller (aka note seller) will collect as a down payment, the more money the note will sell for when it comes to liquidation of this asset - plain and simple. If the property buyer (aka the borrower) only has a 5% down payment (or lower), this will not likely be a high offer to the note seller (if any at all). In order to see the higher offers from investors, ideally there should be AT LEAST 10% down to receive a minimum, full offer buy-out. Keep in mind that 10% down is average at best. The big offers occur when the down payment is between 20% and 30% (non-borrowed capital) from the property buyer.

2) CREDIT OF BORROWER/PROPERTY BUYER - I will keep this short and sweet. The higher the credit of the property buyer/borrower, the more money the mortgage note will sell for when taken to market. Most seller financed note transactions are completed due to the fact that the property buyer/borrower may have less than stellar credit, and that is fine. As a note purchaser myself, I understand that not every borrower will have a 720 FICO score or higher. As long as their credit is 580 or higher, the note has a chance of selling. The higher the score, the higher the note-offer.

3) RECOURSE vs NON-RECOURSE - If you are selling your property (commercial or residential) to a corporate entity, family trust, non-for-profit, etc., it would be highly recommended that you make sure your get a written personal guarantee by an individual of said entity (the president of the company, the executor of the family trust, etc.). A mortgage note with no recourse (aka - no personal guarantee/no guarantor) can mean the difference of tens of thousands of dollars LESS in your pocket when you sell a note. This does not mean that we cannot buy a non-recourse note, although the majority of investors will simply pay much, much less (due to the extreme risk involved in the case of default by the borrower). Also, make sure that the guarantor (or the person signing the personal guarantee) has somewhat of a decent credit score, otherwise that task in getting the personal guarantee will be for nothing.

Determining the Value of a Mortgage Note for Purchase

From my experience, I found that there are three major mechanisms of determining a mortgage note's value when it is being taken to market. Two of the three items are considered by reviewing the terms of the note, and the last mechanism is determined by the investor cost of capital (COC). 

***Please keep in mind that pricing out mortgage notes are not a one-size-fits-all approach, and there are usually many more variables involved when reviewing these types of assets, which should be done on a case-by-case basis.*** 

4) INVESTOR YIELD REQUIREMENT – This is a mechanism that is determined by the investor’s cost of capital and risk appetite. This function wildly varies between different note investors. The cost of capital for most private mortgage note investor (from my experience) ranges from 6% to 8%. If you are selling your mortgage loan to a bank, their cost of capital will be lower, but they will make you jump through MANY more hoops to fund the deal. This means that the actual yield requirement is around 10%, as high as 15% total. For the more greedier note investor, it could go as high as 20% plus. This is why you should always get multiple offers from note investors when pricing your note.

5) INTEREST RATE - I have seen a lot of seller-financed loans for sale with very low interest rates. This makes for a low note offer and here is why: If the investor has to pay 8% for their money to buy notes, and the interest rate of the note being reviewed is only 5%, that means that the investor’s cost of capital is 3% higher then the face value rate of 5%. Lets say the investor wants to make an 11% gross yield (or gross profit before his/her cost of captial) on this note example, that means that the investor would need to actually go for a 14% yield in pricing. I arrived at this due to the 11% for the investor’s pocket and 3% to make of the difference in the cost of capital. Why, did I bother to even give this example? The reason is simple. If you are seller financing a property and carrying the paper (aka creating a mortgage note), then you need to charge a higher interest rate then the traditional commercial banks. If your buyer/borrower wants the same 3.75% rate they see/hear on TV or radio ads, with all due respect they need to go to a bank to get the money that cheap. Private note sellers are NOT banks, nor do they have the same risk-tolerance as large (big-box) banks like Wells Fargo and Bank of America. In a perfect world, the interest rate charge on a first position, seller-financed note should range between 7.5% as high as 12% (depending on the usury laws of the state in which the property is located). Having a interest rate attached to a mortgage note that exceeds the maximum usury law amount in the state in which the subject property is located makes said mortgage note absolutely worthless to a note investor for purchase.

6) AMORTIZATION / PAYBACK PERIOD - This is the final item that determines how your mortgage note will be valued. The simple explanation is that the longer the payback period, the less your note will sell for when taken to market – plain and simple. Most note investors like to be out of an investment within the first 5-15 years (generally speaking). If you have a 30 year payback period, that is a heck of a long time for an investor to wait for a return on investment. It is always recommended that your amortized a note you are planning on creating no more than 15 years if you are planning on selling it. I use to be able to say that you could easily put a 7 year balloon on that note, but with the new Dodd-Frank regulation, effective January 01, 2014 (Title XIV Section 1401(2) (E) Mortgage Loan Origination Standards), that is no longer possible unless you are a licensed loan originator in you state in which the property sold. The shorter the payback period, the more money your note will sell for when it comes to liquidation.

So what will you expect to receive for a mortgage note offer when you are ready to sell?

AVERAGE NOTE PRICING – The average 1st position, performing, seller-financed mortgage note will usually sell between $0.70 and $0.85, depending on the loan characteristics.

A+ NOTE PRICING – The above average, seller-financed, 1st position note will sell between $0.86 and $0.97 depending on the characteristics. In all honestly, this A+ pricing requires at least a 700+ FICO score, stellar payment history, 20%+ down and a payback period of 12 years or less.

If you have any questions or comments on this post, please feel free to contact me at any time.

Comments (6)

  1. Are those prices based on the value of the mature note or current payoff ?

    1. Robert Hilliard - that would be current, unpaid principal balance. Notes are purchased based on percentage of the current balance, not future value with interest. 

      The person holding the note collects interest. If a note holder sells the note to a new note holder, the new holder will then be entitled to the future interest in exchange for the lump sum cash buy-out. 

      I hope this answers your question. 

  2. Sorry, that was 2017 Honda CRV.  Brand new and good down payment on it prior to purchase.  

  3. I am interested in paying off my 1917 Honda CRV by Citi Diamond Preferred with 0 interest for 8 months.  However, if you cannot offer me the same interest as I have with them, 4 1/2% then this would not be worth my time.  Can you match this?

    I need to save money the best I can.  The bank offers the same.  I must have good credit.  So, I'd like to see what you guys can do.

    Ann Reed

  4. Well, fair, but #5 isn't the correct approach, interest is a reflection of risk, not an arbitrary number slapped on a note, there are also usury laws, so you probably have limitations on seller financed rates in residential loans.

    The note rate is rather irrelevant, as the yield to the investor is computed at their required yield, using the payment required over the amortized period and the present value is then computed, that PV is then the amount that can be given.

    I appraised seller financed notes for the State of Missouri, there really isn't a rating of A+, such are usually assigned by brokers from a marketing aspect, what they call a good or great note may not be in the eyes of another investor.

    Buying directly from a note holder who originated a note or financing contract is much lower too, 50-70 cents on the dollar, 1st position, but much has to do with seasoning, how long that note has been paid, the history and the current collateral values. Yes, most seller financed notes are made at higher LTVs.

    But, the first thing to consider now, post Dodd-Frank, is compliance, was that note originated legally? That can be hard to determine, some seller are exempt from origination requirements, but proving that originator was exempt should be looked at much closer than a statement by an attorney or the originator or any third party. A note that is illegally originated is worthless!

    The "cost of capital" matter, to me, implied borrowing to buy a note, brokers can do that, not unlicensed "investors" it really drills down deeper to an investor's opportunity costs, alternative investments with similar risks assumed.

    Seller financed mortgages can have balloon payments after half the principal amount has been paid.

    Ability to pay will be more of an issue than a credit score along with payment history. Credit is viewed to the type of loan more than to an overall score, a borrower could have a car repo, with 2 over 90 days on a credit card, that won't yield a decent credit score, but if they have never been late on a mortgage payment, they have the ability to pay, job history is good, the LTV is valid, you could have a better note than someone who has a qualifying score with less credit history. It's subjective.

    Note valuations are not a 6 or 10 step process, very similar to appraising real estate from subjective and objective aspects and each note is different. Due diligence needs to go way past what some note broker may classify a loan at to market it. :)   

    1. This was a very informative answer!  Thank you