Seller Financing May Be Gold Mine For Private Capital

Seller Financing May Be Gold Mine For Private Capital

Industry looking at opportunity created by changing mortgage rules.

BY LEW SICHELMAN | CONTRIBUTING WRITER, NATIONAL MORTGAGE PROFESSIONAL

Investors in private mortgages are licking their chops over what some see as a pending tidal wave of note sales in the coming months.

They believe many sellers will be forced to finance their own sales – or, in the parlance of the trade, “hold the paper” – because their buyers won’t be able to qualify for a mortgage from traditional lenders.

“More than half of the loans made in 2019 would not meet today’s criteria,” says Sarah Strochak, a research analyst in the Urban Institute’s Housing Finance Policy Center.

Some sellers will be content to collect their money bit-by-bit over the months, as though they were landlords. But note-buyers think those who want their proceeds sooner, and in one lump sum, will want to sell their paper, even if it means putting less cash in their pockets.

“A seller-held tsunami is on the horizon,” says William Mencarow, publisher of The Paper Source newsletter.

BIDING TIME

Scott Arpan of Advanced Seller Data Services, a supplier of leads for seller “carry-back” notes, believes a slew of paper will hit the market in the coming months.

“History shows we will see a flood of new notes,” Arpan says. “Unless the economy can quickly return to full employment, many (buyers) will suffer damaged credit even when they are responsible borrowers.”

The question for sellers, then, is how to create a financing vehicle that investors will want to take over if and when the time comes to sell it.

For starters, they should spend the money to have a local real estate attorney create the necessary, statespecific documents. Absent that, sellers should find a paralegal to handle the task, or search the legal websites. Their house is too valuable to rely on standard forms sold at office supply stores.

Realize, too, that they’ll have to sell at a discount, otherwise there’s no reason for an investor to take the mortgage off their hands. And the price they pay depends on any number of variables. The closer the paper is to bank quality, though, the smaller the discount. Says Mencarow, most legit notebuyers are looking for seasoned

notes – those that are at least six months old, and that have been paid on time. Even more important, however, is what is collected each month. The monthly payment is “the single most powerful financial aspect determining the value of a note,” according to Mencarow.

THE RIGHT NOTES

An amortized note is more valuable than one with a balloon payment at the end of the loan’s term, he adds. In other words, all else being equal, a 10-year note with a large monthly payment and no balloon is worth more than a 10-year note with a smaller monthly and a balloon payment at the end.

According to Mencarow, a single-family house in a stable neighborhood and occupied by a borrower with an excellent credit record and an unblemished payment record is “the best collateral possible.”

Some note-buyers might use a different hierarchy. Either way, a seller will want their mortgage to be in the first lien position, because if you have to foreclose on your borrower, you’ll want to be the first creditor to be paid from the proceeds of the property’s sale. That’s why a first lien is more valuable than a second -- and a second, though not as valuable, is more so than a third.

In taking back paper, the seller becomes the lender. Consequently, they should check out the buyer in the same way a conventional lender would. That means asking for a full-blown credit report, which the buyer pays for.

Sellers should also check the buyer’s employment history, looking for at least two years at the same company (or at least in the same field). Ask for their tax returns, a list of all assets and debts, rental history and perhaps even a criminal background check.

Why go to all this trouble? For one thing, they will be protecting themself from dealing with someone who doesn’t pay as promised. But for another, someone who buys the note will want to know the same.

THE UNDERWRITE STUFF

Mark Donoghue of the Americus Financial Group says he pays “careful attention to our due diligence and underwriting.” Nathan Turner, also known as “the Canadian Note Guy,” says his pencil “is a little sharper” these days. And Kevin Clancy of the American Funding Group requires a borrower interview before closing the deal.

“We’re very concerned about a borrower’s ability to pay,” Clancy told The Paper Source recently. “Last week, we were buying a nice residential note in Florida. Our final step was a payor interview. When we talked to the borrower, he asked if we could defer payments as he has lost his job. We can’t buy a note when the borrower doesn’t have income.”

Sellers should always seek as large a down payment as they can obtain. Just like a conventional lender, they’ll want their borrower to have as much skin in the game as possible. After all, the more money the buyer has in the deal, the more difficult it will be for him or her to walk away.

“Equity, equity, equity,” says Donoghue. “This remains our No. 1 risk characteristic.”

The property’s location also may determine the ability to sell the loan to an investor, at least for a better price. For example, Donoghue is not buying in California, New York, Connecticut and a few other states. And Gene Powers of Nationwide Secured Capital is shying away from places related to large airline and tourism employment.

Paige Panzarell, aka “the Cashflow Chick,” says she has always been careful about buying paper in states where it is difficult or takes too long to foreclose. And she may eliminate even more states over the coming months.

Fuquan Bilal of NNG Capital, which buys mostly second liens, is also retooling in anticipation of a strong market starting in the third quarter, as sellers begin a search for liquidity. “It will be a buyer’s market again real soon,” he told The Paper Source.

Lew Sichelman has been covering the housing and mortgage sectors for 52 years. His syndicated column appears in major newspapers throughout the country. He also has been the real estate editor at two major Washington, D.C., dailies and spent 30 years on the staff of National Mortgage News, formerly National Thrift News.