Buying Existing Loans

 

Last week, I shared information about hard-money loans, which are loans that often work when conventional loans won’t. This week, I’ll talk about buying and selling notes secured by real estate, a close cousin to real estate-backed, hard-money loans.

If you sold a property and carried the financing, you are now the proud owner of a note secured by a deed of trust. The note outlines the terms of the obligation, including length, monthly payments, interest rate, and when any associated balloon payment(s) will come due, among other things. (A balloon payment is a payment that amounts to more than double the value of a regular payment, and is usually planned as the final payoff at the end of the loan.)

The main job of the deed of trust is to tie the specific loan to the real estate that secures it. In a seller carry-back situation, the real estate is normally the property you sold. When you sold the property and carried the financing, there may have been good reasons to do so: a higher sales price, a faster sale, a better return on investment than was available from other investment sources; or maybe the sale could not have happened at all without seller financing. Now, however, things have changed. Your princess may be about to graduate from high school and hoping to go to college, or perhaps you want to remodel your home or take advantage of an exciting investment opportunity.

Whatever the reason, you’re currently in a position of needing cash. Happily for you, that note secured by a deed of trust is a negotiable instrument. That means you can sell it.

Depending on a number of factors, you will usually get something less than the outstanding balance owed. If the financing you provided was at a low rate or had an especially long term, the note’s sales price will almost certainly be less than the outstanding balance. If the loan-to-value (LTV) ratio is high—calculated by dividing the total loan amount by the value of the property—you can also expect to sell the note for less than the outstanding balance. Still, cash in your hands may be worth more than the value of the note.

If you choose to sell the note, these transactions are typically handled by a licensed broker who charges a commission for arranging the sale. Like a real estate transaction, it should be handled in a professional manner, making sure all escrow instructions are carefully drafted and followed, and title insurance is secured.

As a buyer of this note, you should have your broker verify that the value of the property supports the loan, and that fire insurance and property taxes are accounted for. And most importantly, confirm that the seller does, in fact, own the note—and that there are no liens that might encumber the note. Your broker can also provide a financial analysis to let you know what the rate of return will yield if all the payments are made in a timely manner (including any balloon payments).

When the dust settles, the sale of an existing loan can be a reasonable source of cash for the seller and an attractive investment option for the note’s buyer.

If you have questions about real estate investment, sales or property management, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com.

Dick Selzer is a real estate broker who has been in the business for more than 40 years.