For most noteholders thinking about transferring a note, it is the first time that they have done it, and they have lots of questions about the value of their note, the process involved, and knowing how to find the best note buyers. While the note sale process is nowhere near as complicated and time consuming as getting a bank loan, it is not widely understood by most people outside of the industry. This article is intended to be helpful in calming any fears and giving you insight into the note sale process.
What Is A Mortgage Note?
A mortgage is a legal document that secures a specific property. A mortgage note is the document specifying items such as the payment amount, interest rate, what happens in case of default, etc. The mortgage note accompanies a mortgage or deed of trust.
Factors In Pricing A Mortgage Note
When contacting a note buyer, the note holder should be aware that they will be receiving less than the note balance when their note is purchased. The difference between the note sale price and the unpaid note balance is called a discount. The discount reflects the risk that a note buyer perceives when deciding how much to pay for a note. The primary risk factors considered by Seascape and other major note buyers are:
- Equity – The amount of equity in a given property is the property value less the amount of any unpaid loans and liens. Equity is created by the purchaser putting in a larger down payment, by the number of payments that have been made, by any improvements to the property, and by general market conditions. A higher amount of equity usually means less risk for a mortgage note buyer, so a better price can be given to the note holder.
- Property Type – Certain property types are statistically less likely to have a default than others. An owner-occupied house is the safest type while raw land is much more risky. Commercial properties, improved land (power, water, access to roads), and mobile homes with land are on a spectrum between those types. If everything else is equal, our offer for a note on a house will be higher than that for land.
- Payer Credit – Higher credit scores are indicative of a person’s ability and willingness to make obligatory payments. Just as banks, insurance companies, and others use credit to decide whether and how to work with a customer, so too do note buyers. A note buyer is most concerned with the credit score of the payer rather than that of the note holder. If the payer has a high credit score, the note holder will get more for their note because the note is considered to be safer and default is less likely. For notes where the payer has signed on behalf of their LLC or corporation and given no personal guarantee, the note is considered more risky and the discount will be bigger.
- Note Interest Rate – Because mortgage note buyers include their required rate of return in their calculations, a higher interest rate will generate a better offer for the note holder. That said, while a note with an 8% rate will be judged more favorably than one with a 4% rate, a note with a double-digit rate that is far above market rates may be looked upon with suspicion by a note company underwriter.
- Note Term – As long as a note term is above three years, a note with a short term is viewed more favorably than a longer term note. So, a note with a final payment being due in 10 years will receive a better offer than one with a 30-year amortization. If having a shorter amortization period would make the monthly payments too big for the payer to afford, then a longer amortization with a balloon in 5 or 10 years can help. Be aware that federal law may limit your choices with balloon payments, so talk with an attorney.
Risks Of Holding A Note
While there are advantages to holding a note for people who like the regular income and don’t need all of the cash now, it is important to be aware of the risks. The most important risks are:
- Default – The payer stops making on-time payments and will not bring the note current. There are ways to address this issue. Foreclosure should usually be a last resort, as it is expensive and time consuming, and wrecks the payer’s credit
- Property Damage – Since the property is the collateral for the mortgage and mortgage note, you will want to make sure that the property stays in good condition. If the payer damages or destroys the property and then defaults, you may not be able to get the old value if you have to resell the property.
Opportunities From Pursuing A Note Sale
People decide to part with their mortgage notes for a variety of good reasons. The most common ones are:
Other Investment Opportunities – These often come about when a note holder wants to buy another property, invest in a business, or pursue some other new investment.
Age – When people retire or are getting elderly, they frequently want to simplify their lives and don’t want to mess with collecting payments from a note. Plus, when they pass away, they don’t want their spouse or heirs to have to deal with the note. Other family members often don’t have the requisite knowledge to manage the note.
Estate – Related to the item above, people might receive the note as part of an estate. They want to get a lump sum of money now to make it easier to divide up assets.