Education

Loan Terms and Conditions

Let’s look at all the key factors that should be considered including Interest Rates, Structure and Length of Loan. When we compare a private loan to a conventional loan from banks you want to have your terms higher. Typically, owner financed loans are used because the bank loan does not work for the property. This can be from the banks underwriting requirement, selling price or buyers inability to qualify for the bank loan. A good rule of thumb would be 3%-7% higher than current bank rates. There is a risk in seller financing that warrants the higher rate. Currently a good rate would be between 10%-15%. This is also tied back to the size of the down payment and the buyers credit score. Again, the higher the interest rate the better the selling price of the note on the secondary market.

The best structure of the note should be a down payment with regular monthly payments for a fixed period at a specified interest rate. There are other structures such as interest only with a balloon payment of the principle, but they are riskier. With a large down and a good exit strategy for paying off the balloon payment they can be a good investment. If the buyer is relying on improving their credit rating to qualify in the future for refinancing to pay off the loan the value of the note on the secondary market will be lower. However, there are buyers that look for these opportunities as they are not bothered with facilitating a foreclosure. In the case of a balloon payment the state the property is in becomes part of the value equation. It is easier to stay away from these types of loans unless you are familiar with all of the rules of your state and the problems that could come down the road.

The easiest loans to sell are 5-10-year loans as the secondary buyer’s investment is shorter. When creating the note, you need to consider your requirement for cash flow and balance that out with the possibility of selling the note in the future. If you are good with the cash flow for ten years and may want to sell it after that then a 15-29-year note can be a good choice. If you do 15-30 year fully amortized loan it is saleable but at a higher discount. If you have collected payments and interest for 10 or 15 years already this discount is less relevant. The basic rule is the longer the term the bigger the discount as the buyer has a longer wait on their ROI.

Credit Rating of the Borrower

Secondary note buyers will be very interested the credit score of the original note buyer. These scores come from (Equifax, Trans union and Experian) sometimes referred as the Tri-Merger score. Let’s look at what these scores mean 600 or lower is Poor, 601-675 is decent, 676-720 is good, 720-780 is great and 780 or above is excellent. For example, if the Tri score is 660, 642, 601 note buyers would use 642 as the note pricing score. Most note buyers like to have that middle number above 600 but there are buyers that go as low as 525. The drawback is the note will be severely discounted. Try to stay above 625 and make sure you keep records of the buyer credit rating when they buy your property. If you are creating a note be patient and try to get that middle score to 720 or higher. It will get you a higher selling price if you sell your note in the future. Just because the buyer has a 720 score does not ensure that a bank will finance them. In addition to credit score bank look at DTI (Debt to Income) and LTV (Loan to value) as part of their underwriting criteria. It is very difficult for borrowers today to even qualify for bank loans which give property sellers opportunities to be the bank. There are other tax advantages for being the bank that you can discuss with your accountant. (Side note: if your accountant says it’s too difficult or risky then find a better accountant.)