April 08, 2008
I received a phone call last week from a gentleman who found us on the internet. Although he didn't have a note to sell, he was in the final stages of selling his property to a family friend, and wanted some advice on how to structure the note. After detailing how he planned to go about it, I realized he needed far more than advice - he needed a tutorial.
Most people who have ever lent money to family or friends will tell you to never lend money to family or friends. Nonetheless, a fair percentage of notes I see involve a sale of property between friends and family. In almost every circumstance, the buyer comes out with a far sweeter deal than the seller. The caller from last week was about to do the same thing.
First, he hadn't planned to ask for a down payment. Money was tight with his buyer, and he figured he'd be the nice guy and let them keep what savings they had. Second, he was only planning to charge them 5% interest, since that was still better than he could get with a passbook savings account and it would make his buyer's payments affordable. Third, he was going to write the note for 30 years, again to keep the payments as low as possible.
This scenario may work for some people. After all, if they don't need the money, 5% is a better return than any bank will give you. Unfortunately, this seller really needed the money, but knew his buyer couldn't qualify for a loan because of his poor credit. He was financing the purchase with every intent to sell the note soon thereafter. Based on the terms he was proposing, I told him he was creating an unmarketable note - nobody would buy it. If someone did take a chance on it, he would probably get (at best) 50 cents on the dollar. Putting it mildly, that wasn't really what he wanted to hear.
After five minutes of conversation with me, my caller was thanking me profusely for providing some insight into how he should deal with the transaction. I told him he should get as much money as possible as a down payment. Without getting a down payment from the buyer, what kind of investment does the buyer really have in the property? How would the purchase be any different from simply renting the place? (other than making it exponentially more difficult to foreclose and evict?) I also stressed the need to charge an interest rate commensurate with the risk he was assuming, knowing the buyer had poor credit. Lastly, I convinced him to use a local title company or attorney to close the transaction, so that standardized documents would be used and every penny would be accounted for on a closing statement.
Buying notes is just part of what we do. I feel it's just as important to provide helpful instruction on how to write a quality, marketable note. Not only does it protect the seller from "giving away the farm" when selling the property, but there's a good chance they'll come to me when they're ready to sell it.
Protect yourself if you are considering seller-financing your property. You are already doing your buyer a service by agreeing to take back the note. Don't let your generous nature give way to foolish charity because the buyer is a friend or relative. After all, unless the deal is good for both buyer and seller, it's not a good deal at all.
Make it a great day.
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