With any soft real estate market the seller needs to be more flexible to move the property. If a seller is motivated to sell and tells the world through say an Multiple Listing Service (MLS) and is offering to pay all the buyers closing costs and prepaids and perhaps hold a second mortgage will generate lots of buyer activity. Assuming a natural market exposure has already taken place with no offers resulting then drastic measures have to be considered by a seller. Perhaps the house is now vacant. The sellers by necessity have moved on and need to sell. A series of price reductions resulted in still no activity. Fortunately, the seller’s had made a good purchase five years ago and have some equity to play with. Buyers and/or their agents looking for real estate opportunities need to look for such a situation as with a vacant home, on lock box, lower or not mortgage with perhaps a series of price reductions in the past say 60 days all screams “motivated seller here”.

Many buyers who have jobs and means to make monthly housing expenses have for what ever reasons have lousy credit. Sometimes bad things happen to good people. It could have been a recent forced job change, family illness, auto accident, death in the family causing a one or two month interruption in the family cash flow. Credit FICO scores plummeted in the lower 500 range. Things are turning around now, but the challenged credit history remains. What to do? If a family does not wish to wait two years to turn their credit around there are several possibilities. With these lower scores many B/C Subprime Mortgage Lenders will allow anywhere from 80% to a 95% Loan To Value Mortgage.

At the same time these mortgage lenders may allow a 100% Combined Loan To Value (CLTV) mortgage with the seller holding a second mortgage for the difference. Mortgage markets change all the time based on secondary mortgage experiences with foreclosures and slow payment histories. Right now, this scenario is possible in this current slow real estate market. In addition, the lenders will allow the seller to pay in many cases up to 6% of the contract sales price for the buyer’s closing costs and prepaid expenses such as the annual hazard insurance premium and escrows for the taxes and insurance. In some cases, these credit-challenged buyers using this financing technique can buy a property with little out of pocket. In the past, these buyers may have been kicked to the curb and told to come back when they have some money saved and improved their credit. This does not have to happen today, at least by mortgage brokers who know their products. Buyers need to seek and qualify Realtors and Mortgage Brokers who are willing to go to the wall for them to get the deal done.

Previously, in the red-hot peaking real estate market, this flexible seller help was not existent. Now it is possible with rising housing inventories and motivated sellers that have to act. Opportunities now exist for buyers with challenged credit. It could have been done before, but the buyer would have needed at least 5% down or more and pay for all their closing costs and prepaids. In most cases, having just gone through the financial wringer, no cash was available for this. A minimum of a 580 credit score is needed currently for an 80/20 100% CLTV Combo loan. With the market change, other financial options are available for credit challenged buyers like the seller held second mortgage.

The seller receives the offer at the newly reduced listing price, with the seller paying all the closing costs prepaids and holds in this case a $20,000 second mortgage payable at 10% with a 30 year term and a three year balloon. The payments for this seller held second mortgage work out to be $175.51/month for principal and interest. It should be noted here, that the buyer has qualified for a 2/28 ARM where the first two years are fixed, in this case a rate of 8.75% then the rate based on a six month LIBOR (London Interbank Offered Rate) plus a margin of 6.00%. The current 6 month LIBOR rate used for this index is 5.50%. With the mortgage rate fixed two years the borrower is set up for an immediate rate hike in two years. If nothing changed in the index, the rate at the end of the two-year period would be 8.75% plus 1% or 9.75%. For the next six months a rate of 10.75% the next six months with incremental increases with 1% cap increases every six months thereafter based on the index plus the margin rounded up to the nearest .125%. In this case, the index (assuming nothing changes-we are being kind here) 5.50% plus the fixed margin of 6.00% would command a rate of 5.50% + 6.00% or a total rate of 11.50%. This is no place for widows and orphans or any young couple trying to rebuild their credit. With on time payments for the first 24 months on the first mortgage and the second mortgage and some small appreciation occurs on the appraised value the buyers will need to refinance at the end of the two-year period. Their credit scores will rise with on time payments.

Lenders however, will not consider any seller held second with a balloon payment less than three years. A loan condition of the first mortgage will require the underwriter to see the seller held second paper work as a condition of loan approval. In this case, if everything goes according to plan, then the second mortgage would be cashed out at the end of the second year when the financing for a new first is put in place. If the buyer asks if you will subordinate the second to a new first, just say NO, unless they are not able to get the new financing without your help and they have paid on time and as agreed. Then and only then will the note holder need to help them defuse the issue. Assuming all has gone as expected it is during this loan qualification period the second mortgage holder becomes intimately familiar with the buyers. Since there is going to be a least a two or three-year ongoing relationship with this note arrangement, it will be necessary for the sellers to underwrite the credit worthiness of the buyers and future note payers. We will assume that the seller/note holder is satisfied with the buyer’s ability to repay the second mortgage. It does little good to do this deal, IF the buyers never pay the second mortgage.

The only way for a seller/note holder to enforce the payment of the first is to foreclose the second mortgage and in doing so will need to pay off the first mortgage if that is in default as well. This is indeed a huge challenge. In most cases the seller throws up their hands and walks away only because the buyers aren’t paying the second mortgage either. Depending on the state, a defaulted judgement might be sought, but it could be a long line. Knowing all of this, the seller closes the deal and is relieved of the payment of the first mortgage and gets some cash at closing plus this second mortgage note. The tough time for any lender is timely receipt of the first mortgage payment. Many foreclosures happen the first month. The borrowers scramble to scrape together every penny to get into the property and the first payment rolls around and they can’t make it. Knowing the buyer/borrowers have challenged credit, twelve months of on time payments would be the trip wire for doing anything with this note. To assist the borrower when they refinance keep careful financial records on the payment history by insisting they pay with a postal or bank money order and keeping copies of payment checks.

This supports the case of proving “seasoning” of the mortgage with on time payments. Since this loan will not be reported to the credit bureaus ready proof of payment will be an important part of the borrowers qualifying for a new loan. Keep the note and mortgage, the mortgagee title policy, copy of the survey, copy of the appraisal if you can get it (only for sharing value facts-not for loan purposes), copy of all payment documentation, copy of the buyer/note payers credit report, buyer authorization to pull another credit report if you choose to sell the loan together will all the copies of the note payment checks of the money orders used to pay all collected in a nice neat file.

Moving the clock forward twelve months and being presently surprised, the payments were made on time as agreed. Things had improved in the buyer/borrower’s credit and they both had received pay raises in their jobs. If a seller/not holder cannot wait for the two or three year period, whichever occurs and wants to do something with the note then there are some possibilities. In review, the note was for $20,000.00 with a rate of 10% per annum with a payment of $175.51/month and a thirty-year term with a 36-month balloon payment. At the end of twelve months the balance is approximately $19,888.82 with very little amortization. Keeping in mind the shaky credit of the borrower, but quickly improving and the property has now appreciated to showing a value of 110% of the original purchase price. An investor MAY take a fly on this, due to credit considerations, at a yield of say 25% yielding $15,256.26 less transfer costs with a balloon of $19,603.33 in 24 months.

This is a hit of ($19,888.82-$15,256.26-$800 in transfer costs) $5,432.26 netting the note holder $15,256.26-$800 = $14,456.26. Keep in mind the note holder also received 12 payments at $175.51/month for a total of $2,106.17 for a total return of $14,456.26 plus $2,106.17 in payments for a total return of $16,562.43. If a note holder wanted to buy a new or used truck, depending on the model, cash could command a discount and avoid a lot of finance charge. Cash talks.

Another scenario if the current note holder wanted to buy another property the full face value of the note could be used as part of the down payment. If it would happen to be an income property the power of leverage would be at work with greater than say a fully taxed interest income versus buying an income property with depreciation, interest deduction and property appreciation potential. In all cases, these scenarios have to be done with no recourse. Always in every instance of selling paper the note payer is the best candidate as a note buyer. If you can give the note payer say a $2,000 or a $3,000 discount rather than the professional note buyer there may be someone in the family who can step up and take advantage of the offer. It’s always good to check with the note payer first. Somehow, they may be able to make it happen. Instead of accepting $14,456.26 a note holder might get $2,000 to $3,000 more than what the market offers. It can’t hurt to ask.

There are options for second mortgage note holders other than just waiting for the payments each month. Many note buyers upon completing a note purchase will immediately contact the note payer and offer to cut the note rate in half if they note payer will double their payment or if somehow they can make triple the payment they offer to make the interest zero. The note holders will need to deal with the “imputed interest” question on their own. The bottom line for the note buyer is if the note payer agrees the interest rate yield is spiked even higher far above the discounted rate. The note payer saves interest and accelerates the accumulation of equity so that in the two year period can refinance and avoid the huge payment shock to follow. It’s a “win-win” situation for both parties. These are some of the techniques pioneered by champions of the “paper game”. Sometimes the note can be originated in three or four small notes. Also a note could sell 36 months of payments and keep the balloon. That would yield a little cash in this instance and the balance at the balloon payoff. A 25% yield on 36 payments would be worth $4,414.36 less transfer costs plus the balloon at 36 months would be approximately $19,630.33. There are many options for note holders of seller held seconds. It’s all in a means to an end to sell the property.

Dale Rogers

By: Dale Rogers