If you are creating a note as the seller of real estate, your objective is to either eventually sell it, or hold it and collect the payments. Whatever the goal always think like an investor as you structure the note. Investors want the best yield at their chosen level of acceptable risk. Therefore begin the process with your investment and risk tolerance in mind because until you sell your note if that's your intent - you're an investor. And investors either make money or lose money and you want to put yourself in a position to make money.
You want an agreement that will protect your investment if something goes wrong and the type of legal documentation you utilize will play a major role in accomplishing that task. Real estate laws differ from state to state as do the type of documents utilized in each state within the context of owner financing so you need to do your homework. Contact a Title company and find out about your state and determine the best legal document to use in writing up the deal. For example, in New Mexico the primary document of choice utilized in creating a note is the Real Estate Land Contract. This agreement is very advantageous to the seller (ie. Grantor) because if the buyer defaults the Grantor actually repossesses the property as opposed to foreclosing which is a much longer and arduous process. The type of legal document you use will determine what legal action you can take if any of the following occur; the buyer constantly pays late, the buyer doesn't pay property taxes or insurance and how to take the property back in case of a default. Consult with a real estate professional in your state to get solutions to these potential problems before they arise.
Your property is zoned residential, commercial or industrial with the former providing the best collateral choice for marketability and the later the least desirable. Commercial and industrial notes are typically more complex and risky so if your intent is to sell your commercial note, just remember it will generally demand a higher discount to offset the risk.
Taxes & Insurance
If there is a structure on the property you want to make sure the insurance and property taxes stay current. I have my personal mortgage on my home with a local credit union and they do not provide escrow service so every year before January 31st I have to come up with a large lump sum of cash to pay my property taxes - it's a pain. You want to eliminate that additional stress on your buyer so it's always best to have them included in your buyer's monthly payment along with the insurance. I realize this will raise the payment substantially but the buyer goes into the deal with the understanding of the real cost of living in the property and will normally adjust their monthly budget to meet the obligation. If you plan on using an escrow company to collect the payments, part of their service will include making the monthly payment to the insurance company and escrowing taxes for annual payment. It's a service that can bring tremendous peace of mind.
The buyer's credibility and equity position ultimately determines whether a note is marketable for sale. Therefore, always run a credit report on your buyer before consummating the deal. Once you know your buyer's credit you can decide if you're willing to become his lender. The buyer's down payment determines the original loan-to-value ratio and is important in that if your buyer struggles to make the payment early in the process he's less likely to bail out if he has made a sizeable down payment so try to get as large a down payment as possible. Here are a few red flags pertaining to your buyer to look for at closing. If selling to husband and wife, make sure they are husband and wife and have both executed the note and Deed of Trust individually. Don’t permit one to sign for both as this is not permissible or binding on the spouse in every state, plus you don’t even know for sure they’re married. If selling to a Corporation or LLC, make sure you get the buyer's (ie. officers) on the note and deed of trust as individuals. If a Corporate officer signs only as a corporate officer this doesn’t bind them individually if the note defaults. If you're selling a commercial or industrial property to a corporation that's going to setup shop in your building, push for a personal guarantee from an officer of the corporation, even if it's a not-for-profit. In most instances this is the determining factor as to whether or not such a note is marketable for sale.
In years past providing owner financing was rewarded with a 10% or higher interest rate but with conventional rates so low for so long, buyers now expect lower rates in the secondary market. The interest rate just like everything else about the note is considered negotiable until closing but remember a higher interest rate will lessen the discount if you eventually sell your note. However, be cautious not to violate state usury laws where applicable. For example, Texas has not established specific usury caps for consumers but this does not mean that there are not certain restrictions on the books in Texas dealing with lending practices and interest rates. Therefore, check with a real estate professional who knows your state's lending restrictions before you set your interest rate. You don't want to unknowingly break the law.
Note Term/Balloon Payment
The length of term along with the interest rate will affect the payment amount and most buyers are more concerned about the size of the payment than anything else in the agreement. If you finance your buyer for 20 years or longer it's best to require a balloon payment at year seven at which time the entire amount is due. If you end up selling your note and the investor believes the buyer will be able to refinance when the balloon comes due it can substantially increase the cash value of the note.
There is a good amount of information on this page that can help you create a marketable note, if that's your intent. However, I cannot reiterate this enough; consult with a real estate professional in your state before closing the deal. One conversation with a pro can save you a life time of regret.
The information on this page is only a general guideline to creating a marketable real estate note and is NOT in any way to be considered legal advice. Real Estate laws differ from state to state and it is imperative that you seek to know, understand and apply all your state's legal requirements pertaining to your situation and legal agreements before you close any transaction. The best way is to accomplish that task is to seek assistance from a real estate professional in your state. That being said, if you are creating a new note to help facilitate the sale of your property you've come to the right place. The information on this page although an abbreviated overview, should serve you well, whether you intend to hold the note or sell it.