Different Demographic Better Results

As explained in the last issue, seller financing can be an extremely useful option to sell a house in a slow real estate market. Unconventional private lending is a great way to increase the overall sales closing ratio. When the property owner is willing to "carry back" a note, it is often possible to obtain a higher selling price and reduce the time needed to find a buyer. Plus, creating a note secured by real estate can give the seller a steady, interest-generating income stream for their long-term future.

The Challenge: A Different Demographic

Home owners who are ready to offer a private loan in order to sell their houses are still faced with a stumbling block: how to find buyers in need of seller financing. Most property owners don’t have any experience in finding individuals interested in buying a "high ticket" item like a home directly from the owner.

When property sellers work within the established real estate agent process to find buyers and close a deal by "traditional" methods, it is generally safe to assume that the vast majority of these customers will qualify for bank financing. In order to pursue private seller financing to sell a home, however, a property owner will need to attract home buyers who do not have adequate credit to buy real estate – a significantly different demographic.

The key to successfully orchestrating a seller-financed real estate deal is getting the right buyers through the door – just like a traditional property sale.

In order to get motivated buyers interested, the seller will need to use a targeted marketing technique designed specifically for the "unconventional buyer’s market". The most effective advertising method to tap into this distinctly separate pool of buyers is surprising to some.

Unconventional Marketing

The seller’s best strategy for finding their credit-challenged buyers would be to list the property in places that are frequented by individuals that do not have a real estate agent. The newspaper is one of the best places to start putting out the word.

The majority of home buyers looking for seller financing start by searching the "For Sale By Owner" ad listings in the local paper. Seller financing originated and took off via this print medium. Even in today’s Internet-dominated business world, newspaper advertising continues to be an effective means to reach those looking for seller financed deals, so it makes sense to start the advertising here. A simple sale ad including the line "seller financing available" or "credit issues OK" should help to generate genuine interest from the right potential candidates.

Orchestrating the Deal

Once interested buyers start coming around, the seller can choose to work with the party that brings the most to the closing table in terms of the down payment. Of course, larger down payments are better than smaller amounts, but it is entirely up to the property seller to decide what is acceptable.

Once the details of the initial payment, payment term, interest rate, and any necessary clauses are established, the buyer and seller could create a new seller-financed note. If the seller needs money immediately to pay their down payment, the note terms can be specifically tailored to ensure that it’s attractive to cash flow buyers. Once the newly-created note is sold, the property seller will have "cashed in" their future monthly payments for an immediate lump sum of cash.

The details of the note creation are easily handled with standardized boilerplate or the assistance of an attorney; some note sellers are able to manage the sale of their home without any paid legal counsel at all. In fact, once the seller understands the potential advantages of seller financing and takes the proper steps to market the property to the target buyers, the final steps in cementing the note deal are usually much easier than expected.

Understanding The Note Buyers Mindset

Market pricing for real estate cash flows

Banks and other financial institutions purchase cash flows on a regular basis. These payment streams are often purchased without a discount. Aside from a change of recipient address for their monthly payments, the transfer is completely seamless to the payer.

These payment streams are usually purchased from institutions with similar lending parameters. This means that the buyers are familiar with the credit rating and demographic of the payer, as well as the structure and critical metrics of the mortgage. If the buyer of the loan is comfortable with the risk, then no discount is needed.

Imagine this situation, though: if the buyers were purchasing sub-prime mortgages, they wouldn’t be as comfortable with taking on the note because it represents a possibility for higher risk. Logically, any offers to pay off a note holder upfront in exchange for the right to collect future payments will typically be "discounted," meaning the purchase price will be somewhat lower than the current note balance.

The discount is necessary in order to counterbalance the risks . limited equity, a payer with low or no credit score, possible foreclosure, or having to foot the bill for legal actions and then sell the property via auction.

Why the discount?

A discounted purchase price does two things: it limits the amount of capital the buyer has tied up in that mortgage, and it reduces the amount of money the seller receives for their cash flow.

If a mortgage buyer has purchased a mortgage at a discounted price, then the overall risk is lower, because there’s less to lose in a bad foreclosure situation. Logically, the riskier the mortgage, the deeper the discount required to get potential buyers interested.

Ideally, the buyer of a secured note should be able to foreclose on the property and re-sell the house to recoup the entire initial capital amount. But, there are substantial expenses involved with foreclosure to take into account. The discount should make up for these extra costs, but it will not compensate the buyer for the hassles associated with the foreclosure situation.

As a result, many buyers will require an even deeper discount if they feel that a foreclosure situation is likely. The price must be low enough in order for the deal to be worthwhile for the buyer to get involved with the deal in the first place.

The note buyer market

The majority of seller-financed mortgages are sub prime loans; as such, they are considered by banking standards to be high risk. As a result, many lending institutions will not be interested in purchasing these private payment streams.

The good news is that there are plenty of other buyers who are interested in purchasing the monthly payments at a discount in order to take advantage of earning a yield percentage that is unavailable elsewhere – 20%, 30%, or sometimes even greater. These risk-tolerant buyers are comfortable with the foreclosure process when it becomes necessary, and know that seller-financed notes represent an unparalleled wealth building opportunity.

In order to achieve a yield commensurate with the risk involved, these savvy buyers will often offer less than the remaining balance on the note when purchasing these privately-held mortgages. As mentioned earlier, the discount increases the overall attractiveness of the note to the buyer.

There are exceptions, though – in some cases, prime notes with great equity, attractive security property, and an interest rate substantially higher than the market average will bring a high price.

Note buyers’ priorities

Typically, buyers consider their risks in three general ways.

#1. Time-Value of Money. The note buyer’s primary concern comes from the principle regarding the time-value of money – the factor that determines the amount of time it will take to get their initial purchase cost back. Longer terms usually have lower payment amounts, and it takes longer for the buyer to get their funds.

#2. Equity. Second on the "risk list" is the property value and the amount of equity in the deal. A small amount of equity creates an insignificant safety net for buyers should the note go to foreclosure. So, many will offer lower prices to create artificial equity and a lower Investment to Value (ITV).

#3. Payer quality. Buyers will look at the payer and the potential for default. Does the payer evidence a good recent history for steady payments and a consistent job history, despite a poor credit rating? Even if the payer’s financial performance is not stellar, it isn’t necessarily a problem as long as there is plenty of equity to protect the note buyer’s capital. But when there is no safety net, the buyer will need to discount a note heavily if the probability of payer default is perceived to be high.

Strategies For Strong Resale

When property sellers need to receive as much cash as possible immediately for the down payment on their next house, it is critical to anticipate this need in order to use seller financing to their advantage.

Getting top dollar for a note

In a typical seller-financed closing, the seller only receives cash from the down payment at the time of sale. This amount could be used to pay the real estate agent and put the remainder toward their own down payment on another house, but in many cases, the amount received is not enough. In addition, sellers who uses private financing to close the sale will not get the full amount financed when the note is sold.

Most sellers need as much money as possible when they “cash out” their newly created note, so their objective is to sell the note at the lowest discount possible. And to do this, they will need to create a secured cash flow that is attractive to note buyers.

Note pricing factors

The size of the discount – i.e., the difference between the purchase price and the remaining balance – depends largely on factors such as the specifics about the payer, the property/price, and the note terms. If the note is created without these important criteria in mind, the seller may have a difficult time finding a buyer to pay the amount that the homeowner needs.

The Payer

Clearly, there isn’t much the seller can do about the “quality” of the payer because most people interested in accepting seller financing are higher-risk borrowers. Still, if there is more than one party interested in buying their property, sellers offering financing can still discriminate based on credit history or the amount of the down payment offered.

The Property/Price

Similarly, the seller can’t change the basic facts about their property – where it’s located, the type of structure, or its age or condition. But, the seller can control the price they set for their property.

Most sellers have a specific amount in mind that they need to get out of a sale. In traditional real estate sales, getting that money usually is determined by the property’s price. But with seller financing, there is another step that is taken before the seller ends up with the total amount of money they were looking for – the note must be sold.

Since private notes are typically sold at a discount, the seller must set their price higher than the amount they were looking for to compensate for the drop that will come with the buyer’s offer. By setting the price slightly higher than market value, the seller can create a note that sells with a minimal discount. Individuals that don’t qualify for conventional funding are motivated to buy real estate, even if the price is somewhat higher than market value.

Increasing the sales price and the implied value of the property will not actually affect the buyer’s discount, but the adjustment could lead to more money in the seller’s pocket.

A higher sale price means a note with a larger unpaid balance, which could still bring the seller the desired net amount after discounting. Keep in mind that higher sale prices can also lead to larger down payments (as a set percentage of the price), resulting in more money in the seller’s pocket.

The Note Terms

The most important thing for sellers to do is to structure their note so that the buyers won.t be forced to incorporate a deep discount into their offers. From the buyer.s point of view, higher interest rates and shorter terms are preferred. The actual offer made is based on the yield the buyer is looking for; in general, higher yields are associated with riskier notes. The discount is directly related to the difference between the interest rate on the note and the buyer.s desired yield.

While sellers can.t know exactly what a buyer.s required yield will be, the seller can certainly create a note that could minimize the expected discount. Generally, buyers will want to receive a yield anywhere between 12% and 20% on a note. While yield parameters will fluctuate with the market, a 10% yield is typically the lowest they will accept for new notes.

A note creation example

Because buyers usually want to earn a yield above 12%, creating a note with an interest rate under 10% would automatically mean a steep discount when the note is sold.

For example, creating a cash flow with a 3% interest rate doesn.t make any sense if the seller needs to get top dollar for their note, because there is already a seven-point difference between the interest rate and the buyer’s desired yield. In addition, most buyers will create a gap in their favor by yielding at least one point more than the interest rate.

Sellers can also avoid unnecessary discounts by reducing the terms of their notes. Another part of a buyer’s discount is based on the time-value of money principle, meaning that notes that take longer to be paid off will usually be discounted accordingly. An ideal term for a private secured note is between five to ten years (60 to 120 months).

Conversely, it isn’t a good idea to shorten the term down to two years or less because a foreclosure situation will be created – the monthly payment will likely be too steep for the payer to keep up with for long.

By keeping the eventual note buyer’s criteria in mind when creating a private note, property sellers can ensure that their real estate note deal works out the best for them. and that they net the highest amount possible when a cash settlement is reached.

Summary of Seller Financing

The benefit of seller financing

Many home owners dread being involved in a situation where a property they’ve listed for sale has been sitting unsold for too long. The basic reason is usually the same – the asking price is too high for the market conditions.

In these situations, the seller is forced to lower their price in hopes of making the property more attractive to buyers. Unfortunately, this technique doesn’t always work to sell the real estate, especially if the seller is unwilling to "discount" their house by much, or if the market is weak.

A great solution for the seller is to open up to an entirely different segment of buyers by offering seller financing. This way, the property owner can often sell their house for their desired asking price (or even more), and find a buyer more quickly than with conventional real estate methods.

Some homeowners are hesitant to offer seller financing services because of a lack of understanding about how private financing works.

Like other things that seem complicated on the surface, it’s simply a matter of grasping the fundamental issues specific to seller finance. By following the proper procedures to locate a prospective buyer, create a note, and resell the note to a note purchaser (if necessary), a real estate seller that is willing to "think outside of the box" can sell their home for more money and close the deal faster as well.

Finding a prime buyer for seller financing

The majority of home buyers looking for seller financing look through the "For Sale By Owner" ad listings in the local paper. Even in today’s Internet-dominated world, newspaper advertising continues to be an effective means to reach those looking for seller financed deals. A simple sale ad including the line "seller financing available" or "credit issues OK" should help to generate interest from the right potential candidates.

Doing the deal

Once a serious buyer is "on board" to buy, the seller works with that party to set the terms of the note. It is especially important to draw up the contract to favor the note holder when the property owner will need to immediately resell the note in order to receive a large lump sum of cash for their future payments.

Larger down payments are better than smaller amounts, and shorter terms (5-10 years) and higher interest rates (12%-20%) are usually preferred by buyers. It is the property seller’s option to determine what is acceptable and what terms to which the buyer will agree.

Once the details of the initial payment, payment term, interest rate, and any necessary clauses are established, the buyer and seller can create a new seller-financed note. Creating the note can be handled with standardized boilerplate or the assistance of an attorney, although some note sellers manage the private sale of their home without any paid legal counsel at all.

Once the newly-created note has been reassigned to a buyer, the property seller will have "cashed in" their future monthly payments for an immediate lump sum payment from the note buyer – an amount similar to what they would have received from a conventional sale.

Locating the right note buyer

The best method to find note buyers is using the Internet. Using a popular search engine website with keywords such as "buy monthly payments" or "buy mortgage payments" could lead to many interested buyers.

Enlisting the assistance of a note finder

In the secondary finance industry, a unique group of individuals exists who specialize in locating buyers. These cash flow specialists – often known simply as "finders" – have a unique understanding of what most buyers are looking for. These finders are happy to work with property sellers (or their real estate agents).

While note finders can’t offer any legal advice or assist with the creation of a note, they are qualified to give general recommendations about note buyers’ buying criteria. Most importantly, note finders will be able to help locate a buyer for a newly-created cash flow.

Creating an attractive note for resale

Note payers and note buyers are usually looking for very different things. Most payers would love a "no money down" purchase over 30 years at a low interest rate, but buyers wouldn’t want anything to do with this sort of note because it is a bad deal for them.

An initial down payment of at least 10% of the sale price, a fully amortized term between 60 and 120 months, and an interest rate of 12 to 20% is typically what a note buyer is seeking. These conditions are necessary in order to minimize the discount to the note seller. Note buyers will always reduce the payout amount somewhat in order to counterbalance the risks – limited equity, a payer with low or no credit score, possible foreclosure, or having to foot the bill for legal actions and selling the property via auction.

When property sellers are willing to offer an unconventional, private financed note to sell their house, the end result is often much better than the alternative of lowering the price until a "traditional buyer" finds the deal attractive. Smart sellers who can apply owner-finance techniques will have a huge advantage in closing difficult deals in tough markets.

Seller Financing To The Rescue

The Problem

When it comes to selling real estate, one of the most difficult and frustrating situations for sellers is when market conditions make it nearly impossible to sell at the desired price point. A high initial listing price might be because the seller simply has an unrealistic idea of how their house stacks up against the competition in the area, or because the owner needs to sell for a set minimum price in order to pay off their loan against the property.

With traditional property sales methods, the only way to prevent the property from sitting on the market indefinitely is to keep dropping the price. Unfortunately, this technique doesn’t always work – especially if the seller is unwilling to "discount" their house by much.

In areas flooded with homes for sale, reducing the asking price slightly will not bring the desired result. In fact, it’s common that the property will continue to sit on the market without offers, alongside the multitude of other unsold properties with similarly reduced prices.

Anyone experienced in sales understands that making your product stand out from the crowd is a critical technique for success. But if there’s too much competition offering the same attributes, the only logical way to attract the attention of serious buyers is to drop the price so that your property is a much better value than the competition.

In cases where the seller is too inflexible with their asking price, this is not a practical solution. Without an alternative strategy, the seller is forced to keep the house on the market for an extended period of time with an unrealistic asking price, hoping for the right buyer to come along. And as you know, that "Mr./Mrs. Right" might NEVER materialize!

The Seller Finance Solution

Property sellers who want to both obtain their desired price and close on the deal quickly should consider seller financing. Seller financing is a powerful tool to remedy real estate situations that otherwise look grim.

Many home sellers (and their real estate agents) do not see seller financing as a viable option. In actuality, seller financing can bring new attention to the listing and invite a different group of potential buyers – thereby opening up a unique, untapped market.

A large percentage of people throughout the country cannot get approved for bank funding to buy real estate because of their credit situation. Many of these people are still in the market to buy a house, however. The "credit-challenged" are often frustrated with the limitations of apartment living or being renters; as a result, many are willing to pay a higher price just for a chance to get seller financing and improve their quality of life.

A savvy property seller who recognizes this opportunity can salvage an unfavorable situation and turn it into a bonafide seller’s market. By using this type of creative financing, the seller could actually end up getting more than the original asking price – without resorting to the questionable strategy of patiently waiting for the "right buyer".

Seller finance can enable homeowners to receive a favorable selling price despite bad market conditions. In addition, the real estate agent (if any) gets to close a deal and move on to other sales, while a home buyer with poor credit is able to become a home owner. It’s one of those rare situations where everyone at the negotiating table gets what they want.

Paper Tigers

Many home sellers never consider seller financing because they don’t understand the benefits. There are also common misconceptions that it’s much too complicated to attempt to orchestrate a seller financed deal, or that there are no buyers willing to sign a private note.

Once a property seller takes the time to learn about the basic process, the advantages of offering financing instead of a lower price to sell their property become very clear. Plus, a little education about seller finance will make it apparent that drafting a secured private note is actually a very straightforward process.

The bottom line is seller financing can enable a home owner to "have their cake and eat it too" – i.e., sell at the desired price, close the deal quickly, and even receive additional income from interest payments as well.