How to Create a Mortgage Note for Resale

We have been operating within the secondary mortgage note market for nearly two decades, and one of the most common issues we come across is a note holder who created a seller-financed mortgage note without giving any consideration to what that note would be worth on the open market. The result, more often than not, is a note that either sells at a deep discount or does not sell at all.

When a property is sold through seller financing, the seller creates a mortgage note, which is a legally binding instrument that outlines the repayment terms of the loan (aka the interest rate, the payback period, the payment amount, as well as other relevant terms). That note is a transferable asset, which means it can be held for long-term income or it can be sold to a note buyer for a lump sum of cash on the secondary mortgage market. The terms you establish at origination are the primary determinant of what that note will be worth when and if you decide to sell it.

From our experience, a well-structured note may sell at 85-95 cents on the dollar, while a poorly structured one may sell at 50-60 cents on the dollar, or in some cases, it may not attract a single offer. This guide is based on what we have learned purchasing thousands of mortgage notes at Amerinote Xchange since 2006, and it outlines the specific terms, documentation standards and structuring strategies that will maximize your note's value on the secondary market.

Why Create a Mortgage Note With Resale in Mind?

Seller financing allows a property owner to bypass the traditional bank lending process entirely, which means there is no institutional underwriting, no private mortgage insurance requirement, and the transaction will typically close within two to four weeks rather than the 45-60 days that are common in conventional bank-financed sales. This is a VERY attractive option for both the buyer and the seller of a property.

That being said, what many sellers do not consider at the time of origination is the option to sell that note at a later date in order to receive a lump sum of cash. A note that is structured with resale in mind serves a dual purpose. It protects the seller during the holding period by ensuring sound lending fundamentals (adequate down payment, verified borrower credit, proper documentation), and it preserves the option to convert the income stream into cash at any point in the future. The same terms that make a note attractive to a secondary market buyer are the same terms that reduce your exposure to default risk as the original note holder.

Who Buys Mortgage Notes?

Mortgage note buyers include private investors, institutional funds and specialized acquisition firms such as Amerinote Xchange. These buyers purchase the right to collect the borrower's remaining monthly payments in exchange for a lump sum that is paid to the note holder at closing. The price that is offered is predicated on a risk-adjusted discount applied to the remaining payment stream, which means that notes with lower risk profiles will command higher prices. This is the keystone ingredient to understanding how the secondary note market operates.

What Makes a Mortgage Note Valuable to Investors

When we evaluate a note for purchase at Amerinote Xchange, there are four primary variables that drive the pricing, and these are the same four variables that every note buyer in the country will use in order to determine what your note is worth. We have listed them below along with the ideal range and their impact on the price you will receive.

If you fall short on a single factor, the note will still sell, although at a reduced price. If you fall short on two or more factors, you could be looking at a 40-50% discount from the unpaid principal balance, which is a surefire way to leave a significant amount of money on the table.

How to Structure Your Note for Maximum Resale Value

The terms that are negotiated at the closing table will directly determine what a note buyer is willing to offer you at resale. I cannot stress this enough. The following guidelines reflect the standards that have consistently produced the highest valuations across the thousands of notes we have purchased on the secondary market.

Set the Right Interest Rate

The interest rate on a seller-financed note should be set 2-4% above prevailing conventional mortgage rates. If 30-year bank rates are sitting at 7%, the seller-financed note should carry a rate between 9% and 11%. A rate at or below bank levels will result in a significant discount at resale, due to the fact that the investor's yield is compressed. Keep in mind that the borrower is benefiting from a streamlined closing process as well as flexible underwriting, and a higher interest rate is appropriate compensation for that flexibility. If the borrower wants a bank rate, they need to go to a bank.

Collect an Adequate Down Payment

The down payment is the single most influential factor in a note's resale pricing, plain and simple. A minimum of 20% is what you should be aiming for in order to produce a strong offer from note buyers. A down payment of 25-30% will produce even stronger results. Anything below 15% signals elevated default risk to the investor and will substantially reduce the note's market value.

Keep the Term Reasonable

A 10-year fully amortizing note is the ideal structure for resale. A 15-year term is also acceptable. Notes with 30-year terms and no balloon payment will sell, although at a deeper discount, due to the fact that the longer duration increases the investor's exposure to interest rate risk as well as borrower default over time. The shorter the payback period, the more money you will receive when you sell.

Evaluate Balloon Payments Carefully

Balloon payments can shorten the effective term and improve investor yield, although they also introduce refinance risk in the event that the borrower cannot secure new financing when the balloon matures. Under the Dodd-Frank Act, balloon payments on owner-occupied residential properties are restricted unless the seller qualifies for a specific exemption. If a balloon is included, the amortization schedule should be structured in order to ensure that the borrower builds meaningful equity before the balloon date arrives.

Obtain a Personal Guarantee From Entity Borrowers

When the borrower is a legal entity (such as an LLC, trust or corporation), a personal guarantee from the principal should be obtained. Notes that are secured only by an entity without personal recourse carry additional risk for investors and are priced accordingly. From our experience, the recovery options available in a default scenario are far more limited without a personal guarantee in place, which is why we price said notes differently.

The First Lien / Second Lien Strategy

What happens when the buyer cannot provide a 20% down payment? The real answer is that you should try to find a buyer who can. That being said, if you need to make the deal happen and you want to salvage it, there is a structuring technique that can help preserve the marketability of the primary lien, although it is important to understand that this strategy will NOT produce top-dollar pricing on day one. We have outlined an example below.

We want to be straightforward about how a note buyer will look at this deal. Although the first lien carries a loan-to-value ratio of 68% on paper, the borrower only put $30,000 (12%) out of their own pocket. A note buyer is going to recognize that, and especially on a newer note, the first lien will still be purchased at a slightly larger discount than a note where the borrower put down a full 20-25% in cash. The combined LTV may look favorable, but the borrower's actual cash investment is what the investor is evaluating in order to gauge default risk.

Where this strategy becomes more valuable is over time. As the borrower makes payments on the second lien and that balance is paid down, the borrower's equity position grows, which means the first lien becomes more attractive to investors and its resale value increases. This is not a strategy that will get you top dollar immediately. It is a strategy that preserves the ability to sell the first lien at a reasonable price today, while the value of that note improves as the second lien is retired.

We purchase both first and second position notes at Amerinote Xchange, although first-position notes with strong borrower equity (real cash out of the borrower's pocket, not just a favorable LTV on paper) will consistently command the strongest pricing.

Documentation That Protects Your Resale Value

We can tell you from first-hand experience that proper documentation is paramount when it comes to selling a mortgage note on the secondary market. We have passed on deals solely because the seller could not produce the necessary documents. A note with favorable terms but incomplete paperwork will either fail to sell or sell at a significant discount. The following documents should be in place at the time of origination.

1. Promissory note prepared by a licensed real estate attorney. This document establishes all of the loan terms, including the principal balance, interest rate, repayment term, payment schedule, late payment penalties and default remedies. We would strongly advise against using templates obtained from the internet without professional legal review.
2. Mortgage or deed of trust (depending on the state in which the property is located) recorded with the appropriate county recorder's office. This instrument secures the loan against the property and establishes the lender's lien position. An unrecorded mortgage is, for all practical purposes, an unsecured obligation.
3. Lender's title insurance policy. This policy protects the note holder as well as any subsequent purchaser against title defects, undisclosed liens or claims of ownership that were not identified during the title search. Do NOT skip this in order to save a few hundred dollars at closing. The cost of a lender's policy at origination is nominal relative to the risk it mitigates at resale.
4. Property appraisal or broker price opinion (BPO). An independent property valuation is required for investors in order to calculate the loan-to-value ratio. Without a current valuation, the note buyer cannot accurately assess the collateral position, which means you will either receive a lower offer or no offer at all.
5. Borrower credit report. A documented credit score (obtained prior to closing) is among the first items a note buyer will request during due diligence. This should be retained as part of the loan file from day one.

All documentation should be prepared by a qualified real estate attorney or title company. The cost of professional preparation is a fraction of the value it preserves at resale, and it is well worth the investment.

Dodd-Frank Compliance

The Dodd-Frank Wall Street Reform and Consumer Protection Act imposes specific requirements on seller-financed residential mortgage transactions, and it is imperative that any seller considering this route understand how these rules apply to their situation. Compliance obligations vary based on the number of properties financed per year.

• 1 property per year: Individuals and trusts financing a single owner-occupied sale per year may include a balloon payment and are not required to verify the buyer's ability to repay, although interest rate restrictions do apply.
• 1-3 properties per year: Balloon payments are prohibited. The seller must verify the buyer's ability to repay, and the interest rate must conform to applicable guidelines as well as remain fixed for a minimum of five years.
• More than 3 properties per year: A licensed Residential Mortgage Loan Originator (RMLO) must be involved in the origination of the transaction.

It is worth noting that the Dodd-Frank Act does not apply to transactions involving vacant land, commercial properties, rental or investment properties, or sales to non-consumer entities such as LLCs, limited partnerships or corporations. A comprehensive overview is available in our guide to how the Dodd-Frank Act affects seller financing.

5 Mistakes That Kill Your Note's Resale Value

In nearly two decades of purchasing mortgage notes, the following are the most common structuring errors that we encounter on a regular basis, and each one of them has the potential to reduce or completely eliminate a note's resale value. Every single one of these mistakes is avoidable with proper planning at the time of origination.

What Happens When You're Ready to Sell

Once your note has been properly structured and the borrower has established a consistent payment history of 6-12 months, the selling process follows a standard sequence that we have refined over nearly 20 years of acquisitions.

1. Compile the complete loan file, which should include the promissory note, the recorded mortgage or deed of trust, the title insurance policy, the full payment history and the borrower information.
2. Submit the loan details to one or more note buyers for a quote. At Amerinote Xchange, quotes are free, carry no obligation and are delivered within 48 hours of submission.
3. Upon acceptance of an offer, the purchasing entity will conduct due diligence, order an appraisal and perform a title update.
4. The transaction closes and the seller receives their lump sum payment. The typical timeline from accepted offer to funding is 15-30 business days.

You may choose between a full purchase (in which all remaining payments are sold for a single lump sum of cash) or a partial purchase (in which a specified number of future payments are sold while you retain the right to collect the remaining payments after the partial term expires). A partial purchase may be appropriate for note holders who require immediate capital but wish to preserve a portion of the long-term income stream as well.

If you are considering seller-financing a property and you want to preserve the option to sell that note down the road, the information in this guide will put you in a strong position in order to maximize what your note is worth on the secondary market. Structure the deal correctly from day one, document everything properly, and you will have an asset that note buyers will compete for.

If you already have a mortgage note and you are ready to sell, we would be happy to provide a free, no-obligation quote. We have been doing this for nearly 20 years, we maintain a 96% closing rate and there are ZERO fees to the seller. Good luck.

Written by Abby Shemesh

Abby is the co-founder and Chief Acquisitions Officer at Amerinote Xchange. He has been operating within the mortgage note market for over 20 years and has been featured on Yahoo! Finance, MSN Money, Realtor.com, and GOBankingRates.com. See full bio.