The antithesis of the mortgage industry would be a lender encouraging owner-financing. Why would a lender who makes money arranging loans encourage the Seller and Buyer to arrange their own financing? Because you, as the mortgage broker, can then assist the seller to “cash out” that mortgage note, and earn a commission. I tell brokers it may be the worst-case scenario for your sellers, but in today’s credit market, it may be the only-case scenario.
Many mortgage brokers may not be aware of how they can make money in a seller-financed scenario. Let’s go through the steps of what a mortgage broker needs to do to “cash out” a first lien mortgage note for their client.
1. What is owner financing? Some mortgage brokers are not familiar with creative financing – particularly new mortgage brokers - and their first question may be what is owner financing? Owner financing is simply when the seller of the property agrees to take back a promissory note and a mortgage (or deed of trust) from the buyer of the property. The seller’s property becomes the security for the repayment of the buyer’s obligation. It’s an I.O.U., similar to what any bank would issue. While a mortgage can be in any order of priority for repayment, typically only the first position mortgage note is saleable. Generally, investors will only consider a second position mortgage note when the total outstanding balance of the first and second mortgage note added together equal less than 80% loan to value (LTV).
2. How does this work? The Buyer agrees to give a down payment between 5 – 10%. Typically 100% LTV is not possible because most note investors want to see the Buyer have something to the deal, which generally reduces the possibility of default. The seller then agrees to take back a first mortgage, and in some cases, even a second mortgage, to make the deal work. The first mortgage will be the mortgage an investor can purchase. The second mortgage will not be purchased, but can provide the seller either additional income on a monthly basis or can be treated like a CD, ballooning in a few years at a good rate. Below are examples of how notes should be currently structured, with the recommendation that a second mortgage may need to be carried by the seller. Six months ago a second mortgage was not required in most instances, so check with your investor to determine the current status regarding a purchase structure.
3. What documents are required? If closed properly, the seller would have received a promissory note and a mortgage or a deed of trust signed by the buyer(s), the HUD-1/ settlement sheet, and if they planned ahead, they should also have a lender’s title policy since the seller is acting as a lender. The investor will need to see each of those documents prior to the closing of the transaction. Some investors also offer what is known as a “Near Simultaneous Closing” or “NSC” where the mortgage note may be purchased at the closing table over a 3 – 15 day period. NSC’s typically require that a least one payment be made during escrow.
4. Can you work with the sellers and buyers to suggest what would work best? Yes. Provided below are three scenarios for NSC’s. However, even a seasoned note in this day and age may require a similar structure before it can be purchased. If the note is seasoned and still not saleable, and if both the buyer and seller are cooperative, a note can be recast to make it more appealing to an investor. For example, something that is to balloon in 6 months may be recast to balloon in 3 years. In some cases the investor may wish to increase the yield, but can compensate the buyer by lowering the number of payments and overall cost of the loan. Remembering that the five (5) variables of the time value of money (PV, FV, N, I, PMT) can be controlled to produce the best results for all parties.
5. What terms are you looking for? Investors must see three initial items: a) Average credit with a minimum credit mid-score of 600, b) Minimum note value of $50,000, and c) To minimize the discount a note rate of at least 9%. Here are three examples:
FULL PURCHASE 80-10-10
Property Type: 1-4 Family and Mobile Homes w/ Land.
Down Payment: 5-10% cash down from Buyer.
Second Mortgage: 10% Seller Carry Back 2nd Mortgage.
First Mortgage: 80% Seller Carry Back 1st Mortgage, which is purchased at a discount. Flips are allowed.
Advantage: Seller has 5 - 10% CASH from the down payment AND Seller gets CASH for the 80% first mortgage note AND the payments on the second note - or the balloon of the second at a good rate in a few years.
FULL PURCHASE 70-25-5
Property Type: 1 - 4 Family (No Mobile Homes)
Down Payment: 5% Cash Down from Buyer
Second Mortgage: 25% Seller Carry Back 2nd Mortgage.
First Mortgage: 70% Seller Carry Back 1st Mortgage, which is purchased at a discount. No flips allowed, but assignment of options or contracts are permitted.
Advantage: Seller has 5% CASH from the down payment AND Seller gets CASH for the 70% first mortgage note AND the payments on the second note - or the balloon of the second at a good rate in a few years.
PARTIAL PURCHASE 95-5
Property Type: 1 - 4 Family (No Mobile Homes).
Down Payment: 5% Cash Down from Buyer
First Mortgage: Seller Carry Back of 95% 1st mortgage note. The investor purchases part of the note (called a "partial") up to 65% of the property's value. The note holder keeps the other part. Flips are not allowed, but assignments of options or contracts are permitted.
Advantage: Buyer needs smaller down payment. Seller gets CASH from down payment and CASH from purchase of the partial. Seller also keeps the "tail" of the note, which can be sold at a later time or kept to receive payments at a good yield.
6. How does a mortgage broker make money? The great part about working with selling financing is you get to set your own commission. The investor will quote the price for which they will pay for the seller’s note, and you subtract your commission before you give the offer to the seller of the note. You may ask how much should I subtract? Well, it’s the question of how much will the market bear? It needs to be enough to make it worth your while, yet not so much the seller refuses to do the transaction. You know the parties best so you are in the best position to negotiate the purchase.
7. What happens when the seller agrees to sell their note? First the investor provides a note purchase agreement with the seller for the purchase of the mortgage note. The investor will give you a side agreement for the commission you have negotiated. The investor will need the credit information about the buyer who will be the Payor on the mortgage note. Most investors look specifically – and almost exclusively – at the three credit scores of the buyer. The credit report is usually not as important. This works for many buyers who somehow have good credit but a bad credit report. The investor then orders its own appraisal or broker price opinion. Under the terms of most note purchase agreements if the property does not appraise for at least the value set out in the note purchase agreement, they do have a right to ask for payment of its costs, so no one should be encouraged to hold out the value to be higher than the current market value. Next the investor needs to see a standard note and mortgage reflecting the terms of the agreement. The buyers can sign and the copies can be kept in escrow pending the investor’s approval. If the investor does not approve the purchase, then the seller could refuse to close if the contract makes the sale of the property contingent upon the sale of the note. Remember, the investor’s assessment is based on three areas: the paper, the people (the buyer) or the property. The investor’s next step is to order the lender’s title policy, if it’s not already in place. The lender’s title policy is the one item that the seller must pay for, and which is deducted from the quoted price. After the investor has checked the credit of the payor (the people), approved the forms, including the insurance certificates and the lender’s title policy (the paper) and approved the appraisals or BPO’s (the property), the investor is ready to close. Sometimes the entire process can be completed in less than one week; typically it might take 15 – 30 days.
8. How does the closing proceed? The seller can select their own escrow agent (a title company or an attorney) and does pay for that cost, or some investors provide a free escrow service. Funds are wired to the closing agent according to the agreements; the mortgage broker’s fee is typically wired to the broker.
For more information contact us at info@NationalNoteAssociation.com
Divina K. Westerfield, JD, is the Manager of Private Mortgage Association, Inc. (http://www.privatemortgageassociation.com/ ) She oversees its investment in owner-financed notes. Dr. Westerfield is active in residential and commercial real estate investing and has worked in the banking industry since 1984. At that time, she represented international banking interests while residing in Riyadh, Saudi Arabia and working as an attorney for the largest law firm in the Middle East. Contact her at Manager@PrivateMortgageAssociation.com or 1-800.527-1938.
Sunday, October 21, 2007
Saturday, October 20, 2007
REO, Non-Performing, and Performing Portfolios
The "big deal" right now is matching up big buyers with big sellers. What do I mean by "big?" In this particular case its buyers that want $10 million portfolios of REOs, non-performing notes, and/or performing notes in weekly stages, up to over $1 billion dollars. Makes your head spin doesn't it! The key is finding the direct buyer and finding the direct seller. WE HAVE FOUND BOTH. We have direct connections to many banks and funds that have REOs, non-performing and performing notes available.
The non-performing notes are the cheapest, because they have yet to incur the cost of bankruptcy and are still tangled up with a sometimes messy borrower. Yes, in some cases the payor has said they will sign a deed in lieu of foreclosure, but when asked to do so, there is no promise they will if they know they can live there paying only the utilities until after the foreclosure and an eviction takes place. In fact, as a practicing attorney I told my clients to stay as long as possible because it was free rent and they could save up the difference for the move. Most had already declared bankrupcy, so they weren't incurring more personal costs to stay there for free. If a deed in lieu of foreclosure is not signed by the owner, then foreclosure is required and that can be a 2 - 6 month process in many states. Because there is a time element with non-performing notes, they can be purchased in large increments at a low 17 - 35% LTV with 3 points based on face value. That's quite a buy for the fund which can cover the costs of foreclosure, renovations and holding until resale.
Portfolio orders can be narrowed to certain areas of the United States (i.e. coastal states, New York City, rust belt, etc.). About 3 - 5 days after a letter of intent is delivered and proof of funds is provided, the investor will be provided a spreadsheet of assets to review and have a brief due diligence period. HOWEVER because there is constant bidding on these packages, UNLESS/UNTIL a deposit is made, the portfolio is first contract to purchase wins. Closing is usually very quick - be prepared to use the funds you've shown because portfolios have a short time fuse for closing.
REOs is the next type of portfolio, with a higher LTVs since the foreclosure or deed in lieu of foreclosure have been completed. REO packages are coming out in the 35 - 65% LTV range, again with 3 points of face value. The REO package can also be narrowed to specific geographic locations.
The performing note market usually has the highest LTV and is in a very competitive market, as both institutions and private note buyers wish to invest in these instruments. Remember, these are first position notes, as the knowledgeable investor usually won't touch a second, unless the CLTV is 80% or less. In this credit crunch, institutional note buyers have tightened their funding requirements and are insisting that the mid-credit scores be above 600. Private investors may be a bit more lenient based on the entire credit report history, since medical bills and student loans can decrease credit scores, but may not be detrimental to the payor's ability to make their house paymetn. The sale of a subprime (below 600) note to institutions may be possible when seasoning has occurred, i.e. after 6 months to a year of payment.
If these sound attractive to you but you may not wish to get $10 million packages, the alternative is to invest in a fund that is purchasing these packages. Private Mortgage Association (http://www.privatemortgageassociation.com/) does have a new fund opening for just this type of accredited investor: interested in the foreclosure market, but not wanting a hands-on management of the assets. If you are an accredited investor (see the PMA website to determine if you qualify) ask for a copy of our offering memorandum when it is available to determine whether this will meet your investment needs.
The non-performing notes are the cheapest, because they have yet to incur the cost of bankruptcy and are still tangled up with a sometimes messy borrower. Yes, in some cases the payor has said they will sign a deed in lieu of foreclosure, but when asked to do so, there is no promise they will if they know they can live there paying only the utilities until after the foreclosure and an eviction takes place. In fact, as a practicing attorney I told my clients to stay as long as possible because it was free rent and they could save up the difference for the move. Most had already declared bankrupcy, so they weren't incurring more personal costs to stay there for free. If a deed in lieu of foreclosure is not signed by the owner, then foreclosure is required and that can be a 2 - 6 month process in many states. Because there is a time element with non-performing notes, they can be purchased in large increments at a low 17 - 35% LTV with 3 points based on face value. That's quite a buy for the fund which can cover the costs of foreclosure, renovations and holding until resale.
Portfolio orders can be narrowed to certain areas of the United States (i.e. coastal states, New York City, rust belt, etc.). About 3 - 5 days after a letter of intent is delivered and proof of funds is provided, the investor will be provided a spreadsheet of assets to review and have a brief due diligence period. HOWEVER because there is constant bidding on these packages, UNLESS/UNTIL a deposit is made, the portfolio is first contract to purchase wins. Closing is usually very quick - be prepared to use the funds you've shown because portfolios have a short time fuse for closing.
REOs is the next type of portfolio, with a higher LTVs since the foreclosure or deed in lieu of foreclosure have been completed. REO packages are coming out in the 35 - 65% LTV range, again with 3 points of face value. The REO package can also be narrowed to specific geographic locations.
The performing note market usually has the highest LTV and is in a very competitive market, as both institutions and private note buyers wish to invest in these instruments. Remember, these are first position notes, as the knowledgeable investor usually won't touch a second, unless the CLTV is 80% or less. In this credit crunch, institutional note buyers have tightened their funding requirements and are insisting that the mid-credit scores be above 600. Private investors may be a bit more lenient based on the entire credit report history, since medical bills and student loans can decrease credit scores, but may not be detrimental to the payor's ability to make their house paymetn. The sale of a subprime (below 600) note to institutions may be possible when seasoning has occurred, i.e. after 6 months to a year of payment.
If these sound attractive to you but you may not wish to get $10 million packages, the alternative is to invest in a fund that is purchasing these packages. Private Mortgage Association (http://www.privatemortgageassociation.com/) does have a new fund opening for just this type of accredited investor: interested in the foreclosure market, but not wanting a hands-on management of the assets. If you are an accredited investor (see the PMA website to determine if you qualify) ask for a copy of our offering memorandum when it is available to determine whether this will meet your investment needs.
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