Creating a valuable financial asset
This article explains an alternate way to finance the purchase of real estate, and a way to creation a financial asset that can provide monthly income at a rate above traditional rates available in today's market. Our discussion is about private party promissory notes used to finance the purchase of real estate. This alternative type of finance has several names-"private party financing", "seller financing" and "owner-carry financing".
You can create this investment (financial asset) by selling a property and not having the buyer borrow from a bank; you can become the bank and earn the interest. Or, you can buy an existing note from a private party who did the financing: you can become the lender, and earn the interest yourself. Mortgage notes (bank notes or private promissory notes) are a major component of every real estate transaction. If you creation or own the note that puts you in financial control of the transaction. At a later date you have the option of selling the note if the need for cash arises, or keeping it for monthly income.
Maximizing the value of the note
Like any item made or constructed, the note's value to you, and to others if sold, depends on how well it is constructed. A poorly constructed note, like a poorly constructed house, is not a very desirable asset. There are several important factors that will enhance value if done correctly, or significantly detract from value if done poorly. The cash you get from your note if you hold it, and how much cash you get for your note if you sell it, depends on these factors:
The most important consideration when originating or purchasing a note is the quality of the borrower. Two elements determine the quality of the borrower, (1) having the financial capability to keep the payment promise, and (2) having the right attitude toward the importance of the promise. If the borrower does not have the ability to keep the promise to repay, the value of the note is diminished, regardless of having a positive attitude; and, if the borrower has the financial capability to pay, but does not have the right attitude toward making the payments, the note's value is diminished. Get a credit report on the buyer. Make sure the buyer doesn't have a history of late payments, non-payments, lawsuits, or judgments. Financial capability and personal attitude are the two critical factors.
The real estate pledged (by mortgage or deed of trust) is the back-up protection securing repayment if the borrower is unable or unwilling to repay. It is the safety-net. The collateral should have a market value of at least 125% of the loan amount: $100,000 loan requires $125,000 collateral security; stated differently, the loan amount should be, at most, 80.0% of the value of the collateral. Be certain that a sufficient down payment has been made.
The interest rate should be at the least 1.5 X the prevailing bank rate for a similar loan. Example: bank rate is 5.5% X 1.5 = 8.25% rate for a private party real estate loan. The borrower is willing to pay the higher rate because the bank is unwilling to make him the loan; the private party loan is his only option. This rate is fair because the borrower has been labeled by the bank as a "high risk borrower". The private party lender is assuming a greater risk by making the loan.
Providing private party real estate financing to a qualified borrower, supported by adequate collateral security, at an appropriate interest rate is a sound investing strategy. Don't overlook this opportunity!
Lawrence (Larry) Tepper specializes in the valuation and appraisal of promissory notes, mortgage notes, and debt cash-flow instruments nationally for banks, trust companies, self-directed IRA accounts, estates, attorneys, CPAs, and individual investors.
Consulting Services-Free Appraisal Price Quotes
EDUCATION AND TRAINING
Law Degree /Accounting Minor University of Denver
Managing Colorado Real Estate Broker-- Promissory Notes Specialization CCIM)
35 + years of national promissory note and mortgage note appraisal and valuation for Banks, Trust Companies, Attorneys, CPA's, Estates, Trusts, Executors, Administrators, and Financial Advisors.