In our last installment, we met John, a Florida attorney who wanted to purchase a $200K home. The seller (Jane) needed $50K down, but was willing to take the balance in monthly payments. And to complicate matters even further, not only did John not qualify for conventional bank financing, but he didn’t have $50K either! THAT’s when we learned about “simultaneous closings” – the creation and simultaneous sale of seller-financed mortgages used to circumvent the traditional lending route.
You may also remember that our example concluded with the fact that Jane (seller) ended up carrying both a 1st and a 2nd lien – she sold off the first at a slight discount to generate the $50K that she needed in cash, and she held on to the 2nd for monthly cash flow. To be more specific: Jane carried a 1st lien for $55K and a 2nd lien for $145K. She sold the 1st for $50K, and kept the 2nd.
Did Jane take a discount when she sold the 1st?
Absolutely! But you’ll notice that while she sold the note for only about 90 cents on the dollar, her actual discount on her $200K home was only $5K! That equates to about a 2.5% discount on the entire property – one that is normally absorbed by sellers in either negotiations, or Realtor fees. And, she received two major benefits for that 2.5%:
- Her house stayed on the market less time because more buyers qualified to buy her home than if they had taken the route of traditional financing.
- Because she was willing to concede and offer seller financing, she was able to be firm on her price and get full value for her home.
Think about it…for you, the real estate investor, it’s a great deal! As the seller, you get the benefits outlined above. As a buyer, you have the ability to generate a down payment, avoid conventional financing and all of its rules and fees, and even better – there are times when you can even put money back into your pocket at closing!
No, I really didn’t stutter – this is a GREAT tool to reimburse you for part or all of your down payment, your closing costs, and sometimes, even put some money in your pocket to rehab the property. Here’s how it works:
Going back to the previous example, you’ll see that the notebuyer (in this case it was SMI Funding) purchased a $55K note for $50K. Please note: regardless of the eventual sales price of the note, John is still obligated to repay the entire $55K. So…
What if the note was created for $60K, and purchased for $55K? Remember, John is obligated to repay the full $60K, but in this example, Jane (seller) only needs $50K. Where does the other $5K go? In John’s pocket! In a way…he is borrowing the money to reimburse himself for his closing costs. And, because it is borrowed, that $5K that he receives is tax-free.
Now you may be thinking, “Hey Bob! This sounds like a pretty good deal for John, but what about the seller? Is she going to want to take a $10K discount?” [[SPECIAL NOTE: Even though John is borrowing $60K on the 1st and $140K on the 2nd, Jane is only receiving $50K now, and a 2nd lien for $140K. In other words – she took a $10K discount.]]
She may or may not…but here are a couple of very convincing points: First of all, the $10K discount to her only represents 5% of the property’s sales price. Second, if you add up all of the payments that she will receive on the 2nd lien, they will more than adequately make up for the small discount.
That’s all there is to it! Well…kinda’…
You see, the important thing to remember is that ANY time you are structuring a note for either the purchase or sale of a property with the intent of selling that note at or after closing, it is IMPERATIVE that you first check out the structure with your notebuyer. Notebuyers (and there are several across the country) buy notes based on their yield – as such, a note with a low interest rate will sell for less than an otherwise identical note with a higher interest rate. In this case, the needs of the seller and the buyer are opposed; the buyer wants a low payment and interest rate, resulting in the seller getting less money for his note. On the other hand, if the seller wants to sell his note at a higher price, the buyer must accede to a higher payment (which makes the note worth more).
The best way to avoid all of this hassle is to go over the note’s structure and terms with your notebuyer BEFORE you consummate the deal. I can’t tell you how many times some well-meaning seller has agreed to carry paper at a ridiculously low interest rate, only to be shocked at the low, low, low price he is offered for the sale of his note.
Now then – do you think you understand the basics? If not, please reread the first part of this column as well as last month’s installment. In short – buyer and seller create owner-financed 1st and 2nd liens; seller sells the 1st lien at the closing table and receives cash; he retains the 2nd lien for cash flow. Seller sells property more quickly, buyer doesn’t have to qualify for conventional financing, has less closing costs, and can often put money in his pocket at closing.
And don’t fret if you aren’t yet an expert on the creation and purchase of notes; that’s why Ron and I created Paper Power! And this time, Ron is not charging for the class because this is one of those little-known subjects that he feels it imperative that you know!
For me? As a real estate investor, I realized early-on that I was leaving a whole bunch of money on the table by NOT understanding the nuances of the underlying financing and its creative techniques! And as I celebrate yet another birthday (they just keep on coming!), I’d like to give you the gift of my 35 years of expertise in hopes that you’ll use it, and when the time comes, pass it on to other deserving folks.
Now then, as a final teaser for the upcoming workshop, we’ve all heard the adage that the “greater the return, the greater the risk” when it comes to investing.
What if I were to show you a way that the “greater the return, the LOWER the risk”?
Come to class and invest 3 days with us. I guarantee you – you’ll be glad that you did!
This is great. Looking forward to the Paper Power class.