Let’s say a note holder is carrying a $100,000 note. The term is for 30 years at 6% interest. The monthly payment is $598.27. The typical language in this Promissory Note will begin as follows: “For value received, the undersigned hereby agrees and Promises to Pay to (seller) the principal sum of ONE HUNDRED THOUSAND AND 00/100 DOLLARS( $100,000.00) with interest at the rate of six percent(6%) per annum on the unpaid principal balance. Payments of FIVE HUNDRED NINETY EIGHT DOLLARS AND TWENTY SEVEN CENTS( $598.27) to be payable in monthly installments commencing (date) and continuing until paid in full.”
Question: What does this note holder have?
Answer: A Promise to Pay $598.27 monthly for 360 months. Nothing more, nothing less.
This may be obvious to you, but it is not obvious to all note holders. Some believe they are holding a cash account or CD equal to $100,000 earning 6%. One of the most difficult concepts for these folks to grasp is that their note is not worth $100,000 in the open marketplace, should they decide to sell. Carrying a note is fraught with risk, the biggest being that the buyer does not pay the $598.27 due next month. Any potential note buyer must assess the risk inherent in the seller’s transaction and then offer a price based upon that assessment. The risk elements include the type and condition of the property sold; the amount of down payment; whether the note terms show a strong commitment on the buyer’s part; the credit worthiness of the buyer, etc. The stronger the transaction is, the better the pricing. The weaker the overall transaction appears, the more the pricing will drift downward from the principal balance.
Price is always a result of risk assessment.
Most note buyers have learned from bitter experience what the result can be if the risk assessment is faulty. When a buyer reneges on his promise to pay, a painful series of events follow if he just cannot continue to pay the $598.27 required. How long will he stay in the property, without paying, before the seller can get him to vacate? What will the condition of the property be when the seller inspects it? What costs will be incurred to bring the home back to marketability status? How long will it take to find a new buyer? What will be the cumulative emotional pain and financial strain?
I speak to hundreds of note holders annually, and I know that some of them have not given serious consideration to the down side of carrying a note. And, unfortunately, some of them sell their property without knowing much about their buyer. Their need to sell overcomes their need to assess risk. With note buyers, the need to assess risk is always stronger than the need to buy.
