How To Sell A Promissory Note
History of Promissory Notes
The first banknote type was created in China during the 7th century. What we would today call a promissory note took the form of receipts of deposit by merchants who wanted to avoid the hassle of lugging around heavy copper coinage in large commercial transactions (per Wikipedia). True paper money did not arrive until the 11th century in China.
What Is A Promissory Note
According to Investopedia, “a promissory note is a financial instrument that contains a written promise by one party (the note’s issuer or maker) to pay another party (the note’s payee) a definite sum of money.” It is a debt instrument that allows a company or individual to get financing from a source other than a bank.
A note can range from a simple IOU that you may have used as a child to a multi-page agreement for a commercial transaction in the millions of dollars. In real estate, a promissory note is most often used by individuals or small companies for transactions starting at a few thousand dollars.
What Is A Promissory Note In Real Estate
In real estate, a promissory note is a legal document that is almost always accompanied by a mortgage or deed of trust. A land contract (also known as a contract for deed), which is used in some states, can incorporate the note and the collateral agreement in a single document. A promissory note will show the amount owed, the interest rate and term, the payment amount and due date, and what happens in case of default.
A secured promissory note offers advantages when selling because it is backed by collateral, making it more appealing to buyers and reducing their risk. This type of note is contrasted with an unsecured promissory note, which lacks specific asset backing and presents challenges in collecting payments. The complexities surrounding the sale of an unsecured promissory note include the increased difficulty due to the lack of collateral. Assessing the borrower’s creditworthiness and adjusting the selling price are crucial steps to attract buyers. The sales process for these notes involves detailed evaluations and potential pitfalls in finding willing buyers.
Because the note is an important legal document, it is necessary for the seller of the property to keep the original note in a safe place. If you decide to sell the note at some point, the note buyer will want that original note.
Why Carry A Promissory Note
“Carrying a note” simply refers to the seller of the property using owner financing in a transaction with a payer. Sometimes, the seller and buyer owner finance the transaction to avoid using a bank or other financial institution. Other times, a promissory note is created because the payer has weak credit, because the property is non-conforming with bank regulations, or because the parties wanted to close quickly. Regardless, unless both parties are real estate experts, either an attorney or title company should create the note and related documents.
If you sold a property with owner financing, you may have done so for the above reasons, because you liked getting the steady income, or because of tax reasons. Of course, there are responsibilities that you will want to follow to make sure that your note keeps its value. First, you will want to check at least once per year with the county to ensure that property taxes are being paid promptly and in full. Second, be certain that fire insurance is maintained and current. After all, the property is the collateral for your note. Make sure that any homeowners’ association dues are paid and, for commercial properties, liability insurance may also be needed. Finally, if possible, drive by the property periodically to ensure it is properly maintained.
Why Sell A Promissory Note
When you sold the owner-financed property, you may not have ever really wanted to carry a note. Or, perhaps you initially liked receiving payments but now want to get out of the burden or simply need more cash now for other things. For example, you may want to pay off some credit card debt, put a child through college, or pursue a new business opportunity or hobby. Once you sell a note, you no longer have to worry about the property taxes, insurance, or upkeep of the property.
When you sell promissory notes, there are often different options to consider. There will always be some level of discount when selling the note – meaning that you will receive less than the note’s current balance. The size of the discount depends on risk factors like the type of property, equity and seasoning, payer credit, and the note terms.
You may also want to sell only part of the note. Let’s say that you have a note with a current balance of $150,000 and 14 years of payments remaining. A promissory note investor might offer you $137,000 to purchase all of the remaining payments. However, you may only need $60,000 right now and would like to have a future income stream. In that case, a knowledgeable note buyer may offer you $60,000 to buy the next 6 years of payments. At the end of the 6 years, the note reverts back to you.
Benefits of Selling a Promissory Note
Selling a promissory note can offer several significant benefits:
Lump Sum Payment: One of the primary advantages is receiving a lump sum payment. This immediate influx of cash can be used to pay off debts, invest in other opportunities, or cover unexpected expenses.
Reduced Risk: By selling a promissory note, you transfer the risk of default to the buyer. This means you no longer have to worry about the borrower failing to make future payments.
Increased Liquidity: Selling a promissory note can provide increased liquidity, allowing you to access cash quickly and easily. This can be particularly beneficial if you need funds for a new investment or personal use.
Simplified Record-Keeping: Once you sell a promissory note, the buyer takes over the administrative tasks associated with managing the note. This can simplify your record-keeping and reduce the time and effort required to track payments and other details.
Preparing to Sell a Promissory Note
Before selling a promissory note, it’s essential to prepare thoroughly. Here are some steps to follow:
Gather Documents: Collect all relevant documents related to the promissory note, including the original note, payment records, and any collateral agreements. Having these documents ready will streamline the selling process.
Determine the Note’s Value: Assess the value of the promissory note by considering the outstanding balance, interest rate, and payment terms. Understanding the note’s worth will help you negotiate a fair price with potential buyers.
Research Potential Buyers: Look into potential buyers, such as note buying companies, individual investors, and other financial institutions. Researching your options will help you find a reputable buyer who offers a fair price.
Prepare a Sales Package: Create a comprehensive sales package that includes all relevant documents and information about the promissory note. This package will be essential when presenting your note to potential buyers.
What Happens When You Decide To Sell A Promissory Note?
If you decide that you want to sell your promissory note or are just thinking about it, you will want to do a little research to find the best note buyer. Things to look for to get a top note company include:
- At least 5 years of full-time experience buying real estate notes from note sellers
- Positive reviews on the Better Business Bureau site and on the top search engines. Seascape Capital has an A+ rating from the BBB, and has dozens of positive reviews on that site and on Google.
- In line with #2, do a search for the company and the individual on your favorite search engine, like Google or Bing. Make sure that previous note selling customers have not written negative comments about them.
- Is the note buyer a licensed real estate broker in at least one state? While only California and a few other states require licensing, a licensed buyer of notes will have the knowledge and competence to help you.
- Finally, trust your gut. The person at the other end of the phone line should be knowledgeable about all aspects of the process, be able to answer all of your questions and be customer-service oriented.
Once you have checked out some note investors, select your favorite one to get quotes on your note. As mentioned earlier, the note buyer will look at several risk factors, as well as the loan-to-value ratio, to come up with an offer. Once you and the note company have agreed on a price, you will be asked to email over copies of documents such as the note, mortgage, and closing statement.
Now, the due diligence process begins – all of which is normally paid for by the note buying company. Typically, the note company will first order a drive-by appraisal of the property. This takes 1-2 weeks. Once it is complete and approved, the buyer of the note will want to briefly speak with the payer on the note and order a title commitment. This normally takes another 1-2 weeks.
When the steps above are complete, you as the note seller will be sent the closing documents to complete the transaction and to assign your interest in the note to the note buyer. You would sign them either at home or at a title company, and return them along with the original note. The note buying company would verify the documents, record the assignment with the county, and wire the funds to you. You will receive the wired funds within 1-3 days after returning the documents, and the note sale is then complete!
Finding a Reputable Note Buyer
Finding a reputable note buyer is crucial for a smooth and successful transaction. Here are some tips to help you find the right buyer:
Research Online: Start by researching online for note buying companies and individual investors. Read reviews and testimonials from previous clients to gauge their reputation and reliability.
Check Credentials: Verify the credentials of potential buyers, including their experience, reputation, and licenses. A reputable note buyer will have a proven track record and the necessary qualifications.
Compare Offers: Obtain and compare offers from different buyers. Consider the price, terms, and conditions of each offer to ensure you get the best deal.
Verify References: Ask for and verify references from previous clients. This will give you insight into the buyer’s reliability and trustworthiness.
Will Anything Change For The Payer?
A common question among people considering selling a promissory note is what happens to the payer on the property when a note is sold. The answer is, basically, nothing. The note buyer cannot legally or ethically change the interest rate, the payment amount, or anything else on the note. The only thing that changes once the note is sold is that the payer will start sending payments to the new owner of the note. When the transaction is completed, the promissory note buyer will send a letter to the payer with instructions on where to send future payments.
Protecting Yourself in the Sale
Protecting yourself during the sale of a promissory note is essential to avoid potential risks and losses. Here are some tips to follow:
Work with a Reputable Buyer: Choose a reputable buyer with a proven track record of successful transactions. This will reduce the risk of encountering issues during the sale process.
Use a Sales Agreement: Draft a sales agreement that outlines the terms and conditions of the sale, including the price, payment terms, and any contingencies. A well-structured agreement will protect your interests.
Verify the Buyer’s Credentials: Ensure the buyer has the necessary licenses and experience. This will give you confidence in their ability to complete the transaction smoothly.
Seek Professional Advice: Consult a lawyer or financial advisor to ensure the sale is structured correctly and in your best interests. Professional advice can help you navigate any legal or financial complexities.
Tax Implications of Selling a Promissory Note
Selling a promissory note can have several tax implications. Here are some key points to consider:
Capital Gains Tax: The sale of a promissory note can result in capital gains tax, which is taxed as ordinary income. The amount of tax will depend on the difference between the sale price and the original value of the note.
Interest Income: If the promissory note includes interest, the interest income will be taxed as ordinary income. This can affect your overall tax liability.
Tax Deductions: You may be eligible for tax deductions related to the sale, such as deductions for interest expenses and other costs associated with the transaction.
Consult a Tax Professional: To fully understand the tax implications and minimize your tax liability, consult a tax professional. They can provide personalized advice based on your specific situation and help you navigate the complexities of tax regulations.
By following these guidelines, you can ensure a smooth and successful sale of your promissory note while protecting your interests and minimizing potential risks.
We Buy Promissory Notes: Reputable Note Buying Companies
Seascape Capital and its owner, Alan Noblitt, have been buying mortgage notes since 2002. In addition to unparalleled expertise and knowledge of the industry, no other company will offer you the high level of service and friendliness. Seascape buys notes on nearly all property types and buys in all 50 states. Give us a call at 858-208-7776 or submit information about your note here
