You recently inherited a home, mortgage free. A family member tells you he would like to buy the home, and asks if you would be willing to carry the note and accept NO cash down payment.

Your answer is “No”.

If you live in another state, your answer is “Definitely No.”

If you don’t trust or get along with this family member, your answer is “Hell No.”

There may be a few people who can handle this situation where all works out well. But, my experience tells me that you are best served by finding a realtor, selling the property to a qualified buyer, cashing out and moving on with your life. Plus, any emotional attachment you have will now dissipate over time, which may be the best reason to not sell to a family member.

If you are deciding to carry a note, one of the provisions you must have in your note language is an Acceleration Clause. This clause will say that if any payments are not made or your payor is actually in default, the entire note balance – not just the skipped payments – will “accelerate” and become due and payable now. This clause should operate as a shield protecting you and your buyer from adverse consequences. Your attorney or Escrow officer can advise you on the appropriate language.

Most Promissory Notes will contain a provision that many note holders don’t truly appreciate the protection it provides. It’s called a Severability Clause.

Here is what the Legal Information Institute, Cornell Law School says:

“A contract provision that keeps the remaining portions of the contract in force should a court declare one or more of its provisions unconstitutional, void, or unenforceable.”

Now you know.

One of the provisions you must have in your promissory note is a Late Payment Charge. The wording will be something like this: “If any Installment Payment is not paid in full by Buyer within 15 days after the same is due, then Buyer shall pay a “late charge” of 5% of the amount of such late installment payment for each month or fraction thereof that said Installment Payment is beyond due date.”

The purpose is to convey to your buyer that you expect payments to be made when due, and if not, a penalty will be assessed and enforced.

What interest rate should you have on your owner carry promissory note?

At least 3% higher than current mortgage lending rates. Since you are not cashing out and may be tied to your note for the next 10-20-30 years, this is one of the ways you protect yourself. Plus, should you decide to sell your note, a higher interest rate will help in getting the best possible price for your note.

Here is what you DO NOT want to do. Several years ago, we closed a transaction with a professional man who sold a home to a friend. The terms were 10% down, 0% interest, 30 years! The discount was huge, but after discussion with family and an advisor, he accepted the offer. He realized that by trying to help a friend he hurt himself.

The terms must be strong, fair and protective of your interest.

The note business has a lot of risk to it, so we better be confident that we have done our homework before we finalize a note purchase and send that wire transfer.

If you have gone thru the mortgage lending process in order to buy a home, you know firsthand the feeling of being “investigated” before your loan is granted. The note buying process is less invasive, yet some potential note sellers feel that if they tell us the note terms and all payments have been made, we should be able to give them a price for their note. When I respond “Well, I want to know everything you know”, I usually get a lot of silence on the other end of the phone.

Here is what we do – you judge for yourself how it compares to qualifying for a mortgage loan:

Most note buyers purchase notes throughout the United States – they don’t focus on their backyard. We will not personally see the property that is serving as the collateral. We won’t be able to go inside or get a feeling for the neighborhood. If we see interior pictures on line, that is as close as we will get. When we order an appraisal, it will be a drive-by done by a local real estate agent who will not disturb the occupants nor walk onto the property. He may provide some external pictures, provide comps, and give us his estimate of the current market value.

We will not meet with your payor. We will not ask for pay stubs, W-2’s, or tax returns. We will not talk to his employer. We will check his credit and comfort ourselves that the price paid for the note equates to his proven ability to pay and manage his finances. Prior to closing, we will have a courtesy phone call with him to assure him note terms are not changing, get his agreement on number of payments made and current principal balance, and look for assurance from him that he is happy with his purchase.

We will review all your documents. We will require proof of payments received. We will order an updated Title Commitment to ensure Title to the property can pass cleanly. We will require a Hazard Insurance Policy and an Owner’s and Lender’s Title policy. We will service the account professionally, file the required IRS forms annually, and ensure that we and the payor always know the exact account status.

When we are ready to close, we typically allow the seller the option of closing at his title company or closing direct with a notary of his choosing. With the Pandemic, everyone seems to be comfortable with the direct approach, where we overnight the purchase agreement with a cover letter, you sign in front of the notary, provide your banking information and return the original note and recorded deed.

The next day we review your package, take a deep breath, wire your funds and trust we covered our bases.

This is why we ask all those questions!

You want to sell a note you have. I ask if you have an underlying debt. What does this mean?

Your note balance is $80,000. However, when you initially purchased this property, you did not pay cash – you have a mortgage on the property that “underlies” the note you hold. So, can you sell your note in this case?

Maybe.

Let’s say your mortgage balance is $55,000. If we offer 70% or more of the note balance, you would receive a minimum of $56,000. We would require that the $55,000 be paid off so the debt could be extinguished and we would be in 1st position. In my example, you would receive $1000 and the balance would pay off your mortgage.

If the offer to you was less than 70%, you would have to provide the difference at closing. Very few if any note holders would be willing to do this.

Bottom line, the lower the underlying mortgage and the higher the note offer – this would be the best scenario. My experience is that the math is always the determining factor if a note sale makes sense.

Way back in 1998, Bill Broadbent and George Rosenberg published Owner Will Carry, how to take back a note without being taken. On page 10 they said “The Biggest Mistake sellers make is when they sell their property for little or nothing down.”

Everyone wants a margin of safety. If I sell a property for $100,000 and receive a $10,000 down payment, my margin of safety is 10%. If I get no down payment, my margin of safety is 0%. Which position is stronger?

In the 1st case, my PROTECTIVE EQUITY is 10% – in the second, I have NO PROTECTIVE EQUITY. As a real estate or note investment, I want as much PROTECTIVE EQUITY as possible.

This may seem so basic, yet every year I talk to countless number of note holders who disregard this simple premise.

If you have agreed to sell a property and carry the note, one of the provisions in your note language must be a Due on Sale clause.

Simply put, your buyer may not sell or in any way convey the property secured by the note to another without your consent. You are a lienholder. Just like a bank or mortgage lender, you have the right to foreclose if your buyer breaches this clause.

Protect yourself, take care of your business.

The answer to this question is – it depends!

Over the past few years, our closed transactions garnered the seller anywhere from 60% to 90% of the note’s principal balance. That is a big disparity, right? Contrary to what many people think, there is no standard discount. Yes, note buyers are looking for a certain yield or return over the life of the note. But the pricing comes down to a whole bunch of factors – here are some of the key ones:

• Type, condition and location of the property
• Amount of down payment
• Credit worthiness of your buyer
• Note interest rate
• Length or term of the note
• Number of payments made
• Number of payments missed
• Owner occupied or a rental

So, it depends how strong or weak these factors are – the pricing will follow accordingly.

Call me if you would like an assessment of your note.