I get a good many calls from people wanting to sell a note on a property they are flipping. Unfortunately, we as is the case with most note buyers shy away from these transactions. The reason for this is most flipped transactions today show a huge profit making the value of the property questionable. From an investor’s view point, how can a house purchased for say $40,000 and $12,000 of improvements suddenly be worth $100,000 or more. No offense to those hardy entrepreneurial flippers but those kinds of value jumps just scare a mortgage buyer.
You would be surprised at home many private note holders call me and say, “I have a $100,000 note on a home I sold. Can you tell me how much it’s worth?” That’s like saying, I have a 2,000 square foot house for sale. How much is it worth? Like any financial instrument or asset, private mortgage note values can be all over the board. To help clear up much of the confusion, here are the 5 key drivers in determining the value of a note. These drivers are in no particular order.
1. The down payment/equity in the property – A nice down payment and/or chunk of equity really helps the value of a note as it lowers the perceived risk for a note buyer.
2. The amount of seasoning on the note – As with equity, a long period of seasoning lowers the perceived risk for a mortgage note buyer, therefore increasing the note’s value.
3. The credit of the borrower – Decent credit for the borrower not only lowers risk but it may even make or break whether a note buyer will even consider purchasing the note.
4. The amortization period – Long amortization periods make for bigger discounts as note buyers are discounting future cash flows. The further out incoming cash is, the larger the discount. It’s simply a function of time.
5. The interest rate of the note – If you had 2 notes that are identical in every way except for the interest rate, the higher rate note (depending on the difference) will be more valuable. This is due to higher monthly payments that when discounted, result in a higher present value.
So when estimating the value of a private mortgage note, you need to take into consideration the above elements of the note. Better yet, if you’re creating or considering creating a note, be sure and use your knowledge of these drivers so as to create a much more valuable mortgage note. The result will be more money in your pocket, even if you don’t sell the note.
With the crash of the real estate market and complete pendulum swing in requirements to qualify for a mortgage, many home sellers are resorting to owner financing in order to move their property. Once the sale is completed, the seller now has in their possession a valuable financial asset. But managing an owner financed note is hardly a skill most home sellers possess or is taught in school or anywhere else today. As a private note buyer I get calls daily from note sellers wanting to sell a note that haven’t managed their asset as well as they should. Some of the mistakes can make a note un-sellable, or at least for a discount they can accept. Below are the 4 biggest mistakes I see on a daily basis.
1. Not monitoring whether the borrower is current on their property taxes – In a worse case scenario, this mistake could result in a total loss if the home were foreclosed on my the local municipality and sold off before the note holder even knew it.
2. Not insuring that the buyer is current on their homeowner’s insurance as well as has sufficient coverage – If the borrower let their insurance coverage lapse and had a fire, the note holder could again end up with a worthless note. Note holders should not only monitor the borrowers insurance coverage but should be sure they are on the policy as the mortgagee.
3. Not physically monitoring the property – Many property sellers no longer reside in the city the property they sold and owner financed or they live across town. As a result, they rarely if ever drive by the home which is the asset supporting the note they hold. What can and has happened on many occasions is that the borrower may have moved out and is renting the property out to a friend or family member who has a lot less incentive to maintain the property. This could also cause problems if a major insurance claim were made since the property is no longer owner occupied, requiring a different insurance policy.
4. Allowing the borrower to pay their mortgage in cash each month – If the note holder never needs to sell their note, this may not be a big deal. However, if the note holder ever needs to sell their note, they will not have proof of the servicing of the note. This makes a note worth much less and giving the borrower a receipt will not suffice.
There you have it, four mistakes to avoid in order to a) protect the value of a private mortgage note and b) make the note worth more money if you ever need to sell it.
