Creating High Quality
Mortgage Investments
If you are financing the Purchaser of your property, now is the best time to learn how to create a high quality mortgage investment. You see — a privately created mortgage is a written contract between a person who has sold property (the "Seller" or "Mortgagee" — that's you) and the person who bought that property (the "Purchaser" or "Mortgagor"). It is very important to remember that once the mortgage has been created and signed, none of its terms can be changed and a major part of what determines its market value has been defined!
Financing the Purchaser when you sell property is not complicated. There are a number of financial issues that need to be negotiated, but your Attorney will handle all of the legal terms designed to protect your investment. The most common mistake we see property Sellers’ make in this area is underselling the service they are providing. Understand that when you finance the Purchaser you are providing them with a tremendous service, as well as saving them time and money. You should expect to be compensated for this service with favorable mortgage terms.
Purchase Price — The purchase price of the property will be negotiated between the Seller and Purchaser. Because you are assisting the Purchaser acquire the property, you should be entitled to receive its fair market value as the sale price. Don’t allow yourself to be put in the unfavorable situation where the purchase price is negotiated down below market value -- and then, the Purchaser asks you to finance the property for them as well.
Down Payment — The down payment is the Purchaser's initial investment in the property. The larger his down payment, the more motivated he will be to protect his investment. This would include properly maintaining the property, keeping the property adequately insured, keeping the property taxes paid and making timely payments to you. The down payment should be at least 10% of the selling price. However, a larger down payment means the Purchaser has more equity and owes less, both of which make the mortgage more secure and more valuable. Consider carefully: Would it be wise to sell your property to a Purchaser who is unwilling or unable to financially commit himself or herself to the property you are selling?
Interest Rate — The interest rate on your mortgage should be a function of the type of property being sold, the credit worthiness of the Purchaser and the number of scheduled payments. The rate should be at least equivalent to the interest rates currently being charged by banks on similar properties and for similar terms. Preferably, at least 1% higher! Remember, the Purchaser may not qualify for the best bank rates and by having you finance the property for them they will also be saving a significant amount on closing costs.
Purchaser's Credit Worthiness — Just like any creditor, you have the right to information that shows the Purchaser has an adequate source of income to pay the mortgage obligation. Get references, find out where he or she works and his or her annual income, and obtain a credit report showing how promptly he or she is paying current debts. If selling to a person with less than a commendable credit record, insist on a larger down payment. As a service to people who are using owner financing, The Mortgage Buyer, lnc has created a Credit Application that can be completed by the Purchaser for this purpose.
Amortization — How long a mortgage note is scheduled to run is referred to as the note's amortization. A note's amortization depends on the size of the note, the size of the monthly payment, and the interest rate being charged. (The higher the interest rate and/or the smaller the monthly payment, the longer the amortization will be.) For you, the Seller, the shorter the amortization the better. To shorten the length of the note, you can increase the down payment and/or the size of the monthly payments. It is important to keep in mind, however, that the Purchaser should be able to reasonably afford the monthly payments. Over burdening the Purchaser with a high monthly payment would not be wise and could eventually lead to problems for both of you.
Balloon Payment — You may also consider including a "balloon payment" due in 5 to 10 years. This technique will shorten the term of the mortgage and make it more valuable. A balloon payment means that the full amount owed will be due at that time. Even in the case where the balloon is not able to be refinanced (paid in full by the Purchaser), it gives you an opportunity to increase the monthly payment and the interest rate (or both), as well as set a new balloon payment one or two years down the road. As a service to both you and the Purchaser, try to avoid setting a balloon date that is too near. A good rule would be to schedule the balloon payment to occur after the Purchaser has acquired at least a 20% equity position in the property.
Escrow for Taxes and Insurance — Lending institutions generally require the Buyer to pay one-twelfth of the estimated yearly real estate taxes and insurance costs per month in addition to the monthly payment. At the end of the year, they then have the money on hand to pay the taxes and insurance. This is also the wisest thing for you to do when using owner financing. Collecting escrow payments will require more work on your part, but it will prevent the undesirable situation of the Purchaser making the monthly payment to you on time while the tax and insurance payments are not being made.
Closing the Sale — Having a competent Attorney handle the closing for you is very important. Both Seller and Purchaser will be responsible for paying their customary expenses. The Purchaser, however, should be responsible for paying all the costs of creating the mortgage financing. This would include paying the Seller's attorney to create the mortgage note. As Seller, the mortgage protects your collateral. It is therefore; extremely important that your Attorney create the document and that you understand it thoroughly.
Prior to closing the sale, it is also important for the Seller to have a complete set of records on the sale and the Purchaser.