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Safekeeping the Original Mortgage Note

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Can you easily locate the original mortgage note?

This important legal document should be kept in a safe place, and here is why!

The promissory note is a promise to pay or IOU from the property buyer. It spells out the amount due and terms of repayment. In legal jargon it is known as a negotiable instrument. Similar to a check, the original must be presented to collect or prove ownership.

If the seller desires to sell and assign the payments to a note buyer, the investor will ask for the original note to be provided at closing. The promissory note is then endorsed over to the investor. Similar to endorsing a check, the holder signs on the back of the note.

Sample Note Endorsement on Back of Original Mortgage Note

Pay to the order of, (Insert name of investor), without recourse.

 

Dated this ____ day of _______, 2011.

(Seller Signs and Dates)

Sometimes the note endorsement is executed on a separate piece of paper, also called an allonge. The allonge is then attached as a permanent rider to the original note. The endorsement enables the investor to prove they are a holder in due course, with the same rights of repayment as the original note holder.

An investor may also ask for the original recorded mortgage or deed of trust at closing. However, if this original is lost, an investor will usually accept a certified copy from the county recorder’s office.

A lost original note, on the other hand, can cause a problem. In most states the note is not recorded. If the original note becomes lost a note investor may ask for a duplicate or replacement note to be signed by the payer or maker. This means going back to the person that owes you money and asking them to resign. This relies on their cooperation and can cause delays.

The investor will also ask for a lost note affidavit from the seller or note holder, stating the note has been lost and it will be presented if found at a later date.

Some investors will consider accepting just the lost note affidavit with a copy of the original note.  However, this is increasingly rare as a lost original note can create problems foreclosing should the buyer stop making payments.

The best option is to avoid losing the note by keeping it in a safe deposit box or a fire and waterproof safe. Some sellers elect to have the original held by their attorney or a third party servicing agent for safekeeping.

Whatever method you choose, be sure to keep the original mortgage note in a safe place that is easily located!

 

Avoid Three Seller Financing Mistakes

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Would you rather have $97,000 to sell your $100,000 note or only $80,000? The difference in usually comes down to the big three. Here’s the three biggest mistakes note sellers make and how to avoid flushing money down the drain.

Mistake #1 – Failing to Check Credit

The payer’s credit report lets you know how timely they have paid bills in the past. This is a good indicator of how they will pay on a seller-financed note. It also has a huge impact on how much an investor is willing to offer, should the seller ever decide to sell the note payments. Sadly, many sellers never check credit when offering owner financing.

The seller financing solution?

Have the buyer fill our a simple one page application that grants permission to pull their credit upfront or ask the buyer to pull their own credit and provide the report. Whenever possible, avoid accepting owner financing from any buyer with a credit score below 650 (above 700 is ideal).

Mistake #2 – Charging a Low Interest Rate

Money today is worth more than money tomorrow. A simple look at escalating food and gas costs will show a dollar today won’t buy as much next year or the year after! This concept, known as the time value of money, plays a large role in investor note pricing.

All factors being equal, an investor will pay more for a higher interest rate note. We’ve seen sellers charge 5% or less on notes. Imagine the discount when an investor wants a 10% yield!

The seller financing solution?

Charge at least two to four percent above the standard bank loan rate for a similar loan transaction. Be sure to take into consideration the credit, property type, and down payment, which may justify further increases in the interest rate.

Mistake #3 – Low or No Down Payment

The down payment determines how much equity the buyer has in the transaction. The greater the equity, the less likely a buyer will default. There is a reason banks require mortgage insurance whenever a buyer puts down less than 20%!

In desperation, some sellers will even accept a zero down payment. Unfortunately, these buyers have even less at stake than a renter. A renter at least has a security deposit along with the first and last months rent!

The seller financing solution?

Require a down payment of at least 10% to 20% at closing.

So these are the BIG three when it comes to valuing a seller financed note. Sure other things come into play (including property type, seasoning, terms, etc) but these are the three that impact pricing the most.

While a seller might not be able to find a buyer that meets the ideal in each category, they can attempt to compensate for any deficiencies. For example, a lower credit score might result in a higher down payment and interest rate. A great credit score might result in a more favorable interest rate.

Just remember that when the buyer receives a break, it’s coming out of your pocket as the seller!

Seller Financing – How Much Can The Buyer Afford?

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Many sellers accept owner financing without any idea of how much the buyer can actually afford to pay.

The last thing a seller wants is to stress over receiving monthly payments or worse, getting the property back through foreclosure.

3 Ways to Calculate Payment Affordability Before Accepting Seller Financing

The amount a buyer can afford to spend on a house depends on their income, overall debt, cash they can put down, credit rating, and the mortgage terms.

There are three different calculations that are traditionally used by mortgage companies to determine how much house a buyer can afford. These are known as the Income Rule, the Debt Rule, and the Cash Rule. While owner financing does not require the strict use of these rules, it makes sense to utilize the standard as a guideline. (Better safe than really sorry, right?)

1. Income Rule

If you ask a real estate agent or lender for an estimate of how much house a buyer can afford, they’ll typically use a version of the Income rule. The Income Rule says that the monthly housing expense — which is the sum of the mortgage payment, property taxes, and homeowner insurance premium — cannot exceed a percentage of income.

This is often referred to as the front-end ratio and ranges from 27 percent to 30 percent for most lenders.

If the maximum percentage is 28 percent, for example, and the monthly income is $4,000, the monthly housing expense can’t exceed $1,120 (4,000 x .28 = 1,120). If taxes and insurance on the home are $200 per month, the maximum monthly mortgage payment is $920. At 7 percent interest for a 30-year loan, that payment will support a loan of $138,282. Assuming a 5 percent down payment, the maximum price of the home this buyer can afford would then be $145,561.

2. Debt Rule

The Debt Rule says that the total debt expense – which is the sum of the total mortgage payment plus monthly payments on existing debt like cars, credit cards, etc. – cannot exceed a percentage of income.

This is often referred to as the back-end ratio and ranges from 36 percent to 43 percent.

If this maximum is 36 percent, for example, and the monthly income is $4,000, the monthly payment can’t exceed $1,440 ($4,000 x .36 = 1,440). If taxes and insurance are $200 a month, and existing debt service is $240, the maximum mortgage payment the buyer can afford is $1,000. At 7 percent interest and a 30-year loan, this payment will support a loan of $150,308. Assuming a 5 percent down payment, the maximum price of the home would then be $158,218. (You’ll notice that’s significantly higher than what we calculated using the Income rule.)

3. Cash Rule

The Cash Rule says that the buyer must have cash sufficient to meet the down payment requirement plus other settlement costs.

If the buyer has $12,000 and the sum of the down payment requirement and other settlement costs are 10 percent of the sale price, then the maximum sale price using the cash rule is $120,000 (12,000 divided by .10 = 120,000).

Since this is the lowest of the three maximums in this example, it would be the affordability estimate that is safest to use for this scenario.

Putting It All Together for Seller Financing

How much house a buyer can afford is easy to overestimate if you ignore one of the three rules. Don’t make the same mistake as many of the mortgage lenders that ignored these standards in past years.

Granting loans to buyers that could not afford the payment played a large role in the current sub prime toxic mortgage mess that is currently in the headlines. There is no federal bailout program for sellers accepting owner financing.

Play it safe and be sure the buyer can afford the house payment before accepting payments over time.

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