Preamble

This information provides general outline of the "seller carry back" financing in conjunction with further sale of created debt instruments in the secondary market. Dollar Express Corporation will not be responsible for any damages or claims of any kind which may result from use or misuse of this information by a reader.
 

1. Considerations when he/she decides to sell his/her real estate property
 
A.  The seller wishes to receive cash for his/her real estate and expect the buyer to take care of financing either through a bank or a mortgage company. The sale takes place when the buyer agrees on the price, qualifies for conventional financing, has an ability to put enough cash down.

B.  Basic situations leading to a "seller carry back" financing take place if he/she wants to invest into future cash receivable, or is dealing with the family member, or carries it over as a part of a divorce settlement, or is forced by certain circumstances, such as:

• The seller needs to sell the house quickly
• The buyer does not qualify for conventional financing
• The buyer is unable or does not desire to put any cash down
• Both parties wish to simplify this transaction without involving any third party

"Seller carry back" financing can be facilitated by:
 
• Origination of the Real Estate Lien Note and Deed of Trust (home owner responsibilities are to be carried out by the buyer)
• Rent & Buy Contract (home owner responsibilities are to be carried out by the seller)
• Lease with Purchase Option Agreement (same as Rent & Buy Contract)

2. Benefits of the "seller carry back" financing

• Since the seller and the buyer are the only two parties to reach an agreement it is always a better chance to sell the house quickly
• The seller remains in control of the situation with the property and debt instruments. In a foreclosure situation the seller may repossess and resell this property
• It is a good investment secured by real estate (average 9% annual interest rate compared to 5.5% interest on a CD)
• If the seller needs a lump sum of cash for any personal or business reason, such cash may be received for the sale of a partial of future payments receivable or the entire note
• Creates a possibility to reduce closing costs at the time of a sale

There is three basic issues to be addressed before any decision can be made on which option to chose and how to structure the sale:

• Property considerations
• Sale considerations
• Financial considerations

A. Property description:

The subject property shall demonstrate "pride of ownership", i.e. be in a good condition. It is good to mention all improvements which have been done since its purchase by the seller, if any. Detailed description of the subject property, description of the subject area, and the particular subdivision will also be necessary at the time of evaluation of the owner financed note. Qualification of the subject property commanding a better Investment-to-value ratio depends on whether it is:

• Single Family Owner Occupied Residence (The best case)
• Multiple Family Residence (Less attractive case)
• Rental (The worst case)
B.  Tax Appraised Value

For the primary evaluation of the owner financed note it is important to know what is the recent tax appraised value of the subject property (land + house). Tax appraised value does not represent a fair market value of the property but at least shows its primary value.

C.  Fair Market Value

Before any decision is made on the primary or secondary financing, or refinancing, any lending institution or investor will calculate the risk associated with this transaction. In addition to a credit rating of the buyer (risk of foreclosure) it is necessary to determine a fair market value (risk of loss of the funds provided by the lender or investor). "Drive-by" appraisal of the subject property allows the lender or investor to evaluate the note and collateral. In any situation the seller is strongly recommended to order an appraisal before structuring the sale. Typical cost of the drive-by appraisal is $210 to $280.

D.  Title

The seller is recommended to obtain title insurance policy covering full value of the property before the sale takes place.

A.  Assumptions
 
• The subject property is a single family owner occupied residence, is in  good condition and located in a good neighborhood.
• Appraised value of the house and land is $40,000
• Title is owned free and clear
• No current liens on the property
• All taxes and insurance policies are paid
• Sale price is offered at the appraised value or $40,000
B. Sale with the use of conventional loan

Property Value:                             $40,000
Sale price:                                     $40,000
Loan to Value:               Down:      Financed:

A credit 95%      $2,000      $38,000
B credit 90%      $4,000      $36,000
C credit 80%      $8,000(*) $32,000
(*) Usually the seller has to carry back a 2nd Lien Note because this buyer does not have that much in cash to pay.
Brokerage fee:       $2,400
Closing costs:        $2,500
Net cash to Seller: $35,100 minus cash required from the seller (**)
(**) A or B Down Payment does not pay brokerage fee and closing costs.
2nd Lien Note:      $8,000
(C credit)
Net to Seller:         $32,000 (The Seller pays brokerage fee and closing costs)
Net cash to Seller: $27,100 (Plus $8,000 receivable over the term of the 2nd Lien Note at full risk)

2nd Lien Note represents a risk of foreclosure which the lender does not want to carry and in case of foreclosure this money most likely will be lost due to  subordination to the 1st Lien Mortgage.

C.  Sale by owner may eliminate brokerage fee, reduce closing costs (no loan origination costs), and allow to compromise sale price, down payment and mortgage terms as further described. It creates a 1st  Lien (senior) position.

A.  Mortgage terms
 
1st Lien (B credit)
Date of the Loan:       January 1, 1998 (assumed)
Face Amount:            $36,000 (assumed)
Interest Rate:             8% (assumed)
Amortization Term:    30 years or 360 months (typical)
Monthly Payment:      $264.16 (calculated)
Balloon:                     None (fully amortized note)

1st Lien (C credit)     2nd Lien (C credit)
1/1/98                       1/1/98
$32,000                    $8,000
8%                            10%
30 years                    15 years
$234.80                    $85.97
No balloon                No balloon
 

Since the buyer with C credit has to pay taxes, insurance premiums and two mortgages the lender and seller will have to make sure that this buyer can afford such payments. Balloon(s) can be used to reduce the monthly payment, but  the equity will not be growing up quickly enough to improve the Loan-to-value ratio.

B. Compromising sales and mortgage terms by owner financing the sale.
 

Property Value:          $40,000
Sale Price:                  $40,000
Closing cost:               $1,200 (assumed)
Down Payment:          $4,000 or 10%
Owner financed:         $36,000
Mortgage terms:         1/1/98
    360 payments
    8.5%
    $276.81 per month
1st Year receivable:    $2,800 (at sale)
    $3,321.72 (first 12 months)
    $6,121.72 (total)
Balance after 1 year:   $35,727.85 (for sale)

Objectives to compromise sale price and mortgage terms:

• The buyer does not pay the loan origination cost up front, so the seller may ask for higher interest rate (9%, or 9.5%, or 10%).
• The buyer does not have the money to put $4,000 down, so the seller may ask for $2,000 down and may increase the face amount on the note by $2,000.
• The buyer has C minus credit and does not have money to put down, so the seller may try to increase the interest rate and/or face amount.

New assumptions:

Adjusted sale price:     $42,000
Down payment:           $2,000 or 5%
Owner financed:          $40,000
Closing costs:              $1,200 (assumed)
Mortgage terms:          1/1/98
                                   360 payments
                                   9.5%

     $336.34 per month
1st Year receivable:     $800 (at sale)
     $4,036.08 (first 12 months)
     $4,836.08 (total)
Balance after 1 year:    $39,753.34 (for sale)
 
C.  Other considerations.

Origination of the 2nd Lien at a time of sale (conventional financing):
• 2nd Lien Note can not be sold if its balance is less than 50% of the 1st Lien balance. Generally, only 50% of the 2nd Lien Note balance could be recovered by sale in the secondary market.
• The seller might consider a combination of the conventional loan of 30% of the amount to be financed (1st Lien) and take back the 2nd which will represent 70% of the owed principal balance. In case of foreclosure the 2nd Lien balance is partially recoverable. Generally, when the 2nd Lien sells in the secondary market the investor pays off the 1st Lien and takes control over the entire loan, which make the sale of this 2nd Lien more realistic.
• The seller might consider borrowing, say 50% of the money against  the subject property, create a 1st Lien Note, and then create a Wraparound Lien Note for 100% with the buyer (Full amount of the monthly payment is receivable from the buyer, half of this amount is payable to the bank by the seller). In this situation the seller remains in control over the foreclosure situation as it is always an option to pay off the 1st Lien, repossess and further resell the property. Generally, Wraparound Lien Note sells easier.

 A.  Evaluation

Owner financed notes represent existing loans which may be sold to the institutional investors. That is why instead of Loan-to-value ratio, Investment-to-value ratio (ITV) is used.

Before any purchase quote can be provided by an investor the entire evaluation process has to be completed. Typically, for the property described above funding might be available in the amount of 85 - 88% of the outstanding balance or appraised value whichever is less.

B.  Discount

Typically, discount is ranging 10% (high equity) - 20% (low equity) of the outstanding balance to be purchased. This discount includes all costs and fees and seller receives net cash in the amount 80 to 90 cents on the dollar, subject to a minimally reasonable outstanding balance.

C.  Documentation
 
See typical list of necessary documents and information.
 
D.  Examples

Funds recoverable at the sale of the owner financed debt paper:

Example A
Cash at sale:                                                               $27,100
1 year collection:                                                         $1,031.64
Sale of the 2nd Lien balance of $7,757.61:                  $0
Total:                                                                          $28,131.64

Example B
Cash at sale:                                                               $2,800
1 year collection:                                                         $3,321.72
Sale of the entire note (80 c on the dollar of Balance):  $32,000
(Discount of the balance = $3,727.85 or 10%)
Total:                                                                          $38,121.72
Effective discount:                                                       $1,878.28

Example B (a)
Cash at sale:                                                               $800
1 year collection:                                                         $4,836.08
Sale of entire note (80c on the dollar of Fair MV)        $32,000
(Discount of the balance = $7,753.34 or 20%)
Total:                                                                          $37,636.08
Effective discount:                                                       $2,363.92