Creating a Note and Selling it - Posted by Brian (IN)

Posted by Jeff on October 21, 1998 at 09:40:46:

I’m currently involved in a program that could be of some help. In essence it’s a seller financed 1st mortgage for anywhere from 65 to 90% that is sold at the closing table. There is no problem setting it up so that all transactions are simultaneous. (i.e. your purchase from seller, and then you becoming the seller. You would then be the party creating the owner financed mortgage) This allows the seller to payoff any underlying 1st. There is a second created that will be paid to the seller. The 1st mtg. must be structured specifically in order to have it purchased with this program at the closing table. They have just started allowing the sell price to be raised above appraised value in order to compensate for the discount of the 1st mortgage and all fees. This allows the seller to receive the entire 1st mortgage price without apparent discount. The program is almost entirely FICO score driven, with scores as low as 500 being eligable. There are no debt ratios, no minimum income requirements, or requirements for where the down payment comes from. (except it can’t come from the seller) The information is rather lengthy to post here, but you can send me your info by email and I will send you what I’ve got. If you send approximations of what the sale price is, the appraised value of the property, the type of property, the expected FICO score on the buyer, and expected down payment I can give you an idea of which area of this program you could use.

It should be noted that a small second mortgage behind a large first mortgage (with high LTV) will be hard to resell. You would be required to take a very large discount if it were to sell at all. You might do better just to keep it for the cash flow. The terms of the second are completely open to negotiation between the seller and the buyer. It does not effect the 1st mortgage or this program at all.


Creating a Note and Selling it - Posted by Brian (IN)

Posted by Brian (IN) on October 21, 1998 at 07:40:48:

This is area is a great addition to the sight. Thank you John Behle for sharing your experience.

My Question:

I just put a fixer upper under contract and am trying to sell it to another investor prior to closing. The property basically needs cosmetics so it might also be good for a first time home buyer. I am going to run an ad in the paper, something like Handyman Special with seller financing. I am considering taking 5% down, carrying back a note for 15% and having the buyer get a new 80% mortgage.

My hope in doing this is to get the maximum price out of the property. Is there a better way to offer owner financing?
How do I create a note (do I need to see a lawyer)? What terms make a note of approximately $10K-$15K attractive to resell it in the secondary market? Who do I contact to resell the note?

Thank you for any advise, this is my first deal.


The “dead zone” - Posted by John Behle

Posted by John Behle on October 21, 1998 at 10:50:50:

The top 20% of equity in a property is referred to as “Dead equity.” This dead equity zone is because it is hard to finance. It used to be nearly impossible, but now it is just hard.

Note buyers usually draw the line around 80% LTV. Some will go higher, especially in an appreciating market, but not too many. So, 5% down means you are creating a 15% second in back of an 80% first. Few buyers will look at that. Right now, institutional lenders are much more flexible, so the best approach for getting cash out of a property would be a higher LTV first or a second from an institution. You can then “wrap” the remaining equity and have some cash flow from the note, but it won’t be real saleable until property values increase by 20-30%.

“Dead Equity” has always been a challenge for an agressive real estate investor, so creative ways have been developed to “bring it alive”. One is to use that equity to buy another property.

When I first started, I had great success “rolling equity” from one property to another. I bought property A for $5k down on a 80/10/10 deal. I got an 80% first, put 10% down and the seller took back a 10$ second. It was $5k down because I didn’t know any better yet. I fixed it a little and then created a third against property A to totally buy out the equity of property B. I then created a second against property B to buy out the equity of property C.

This one option just uses the equity to trade for other equity. If you sold property A, then this “dead equity” note can be used in the same manner. You can trade the note or use it as collateral to buy other property. The key is just a motivated seller and a property that is a decent deal.

To turn the “dead equity” note into cash, you trade for a more liquid asset that you can sell or finance. In a sense, you trade dead equity for “live equity”.

For tax and negotiation reasons, the best bet is to use the note as collateral, not to trade it. I say trade so people understand what’s going on (maybe), but you generally do not want to give up ownership of the note and the seller doesn’t want it either from a tax point of view. It’s too extensive to go into here, but it would be considered “unlike kind property” in a 1031 exchange, if it were not the seller’s residence. It could also invalidate what can be attractive “installment sale” provisions.

Even if that were not the case, you never want to sell or give up possession of a note. You kill off too much potential future profit (the goose that laid the golden egg.)