creating note for max resale - Posted by chan lipscomb

Posted by Michael Morrongiello on November 12, 2000 at 22:56:15:

Sue:
Most notes if they are structure correctly with the right buyer, buyer credit, down payment, LTV, note terms, etc., can be sold for around 92%-95% of their balance. In my book that is not a “large discount”. Along with a minimal discount are the primary issues of being able to exert greater CONTROL over the whole marketing and financing aspects of the properties sale.

Using seller financing as both a marketing tool to attract buyers, and a financing tool to be able to close quickly, are tangible issues that certainly have value. Additionally with Seller Financed transactions there are typically NO application fees to pay, points to pay, warehouse or underwriting fees to pay,tax service fees, excessive document preparation fees to pay, prepaid funds needed to set up escrow accounts to pay, etc. and in essence no lender “junk” fees.

To be in a position to sell a property Today to an interset buyer, offer that buyer internal financing, and close the deal in a few weeks, as oppose to having a prospective buyer obtain their own financing does have its advantages over waiting for the fickle “sub prime” mortgage brokers and lenders to respond.

To your success,

Michael Morrongiello

creating note for max resale - Posted by chan lipscomb

Posted by chan lipscomb on November 07, 2000 at 18:30:51:

i am getting ready to sell a house. i have a $50K first mortgage that i am going to wrap. the house appraised at $96, that will be my asking price. i would like some input on what i can do to make my wrap bring top dollar. i assume i should pull credit on the buyers, any guidelines on what i should look for as far as credit scores, etc? does the amortization have a big effect on value? balloon? i am planning on marketing at 10% down and 9.9% interest. should i carry back a 5% second so that the first i am selling is 85% ltv? any other tips would be appreciated.

chan

Re: creating note for max resale - Posted by David Butler ANN

Posted by David Butler ANN on November 08, 2000 at 20:39:53:

Hello Chan,

Looks like Mike pretty much covered all the good ground on this… but it’s an awful lot of ground to cover - and the issue comes up so much, I thought I could add a little more clarification to what Mike has reviewed.

First, pull up ANN’s FREE report, NOTE GRADING/PRICING Guidelines at: http://notenetwork.com/at.cgi?a=118510&e=Reports/Note.Pricing.Guidelines.html and study that information inside and out. Once you internalize that, you’ll have a pretty good feel for your note pricing and structuring decisions.

Also, you might benefit greatly from reviewing ANN’s FREE report, HOW TO BEAT THE FLOOR PLAN MAN, at:
http://notenetwork.com/at.cgi?a=118510&e=Reports/How.To.Beat.The.Floor.Plan.Man.php3

Although written primarily for MH dealers, the discussion on how to create good notes is readily transferrable to real estate notes as well, and covers a lot of ground.

Other basics in creating notes…

  1. include a substantial late payment penalty provision subject to whatever your state law allows.

  2. include a prepayment penalty, subject to whatever your state law allows.

  3. use a balloon payment structure when possible, to cut the long-term discount on the backend of the payment schedule. Here, you want to be careful to structure it to make sense. Always be sure to have a clearly defined exit strategy documented in your package… for example - a fellow with a 575
    FICO, showing a 45%/50% DTI, isn’t really a valid candidate for a three year balloon, or even a five year balloon in my book. That doesn’t mean some investor wouldn’t take it, but you are looking for the highest probabilities of maximizing your price on selling the note - so stick to what makes the most sense, right?

So… if you write a balloon note on a buyer like that, you pretty much want to have some solid evidence in file that would indicate that the probability of timely balloon payment is high, despite this Payors poor current financial condition.

Otherwise, if I took a note like that, knowing that the probability of timely balloon payoff is remote, I am going to want a deep discount - knowing I am either going to have to extend the note past the balloon date (voluntarily - or possibly involuntarily in the case of Payor’s bankruptcy), which diminishes my yield spread; or alternatively, I am going to be faced with foreclosing on the property - in which case, I definitely want to be paid handsomely for my time and trouble :wink:

  1. Annual payment increases (interest rate increases can work in some instances, but the laws on these are pretty sticky) are another good alternative, but again, only if it makes sense with regard to your Payor.

  2. Assignment of Rents clause - you should always include that in the security agreement.

  3. Military Personnel - I am pretty sure that the Soldier & Sailors Civil Relief Act is still in full force, and Jon Richards is too. This Act provides that no property owned by a serviceman can be foreclosed upon without the consent of the court if the serviceman: (1) incurred the obligation
    BEFORE he entered the military, AND (2) foreclosure is attempted while he is on “active duty”, or within three months after discharge from the military. Honestly, this exemption rarely affects too many foreclosure actions - on the other hand, seems like we have seen a lot of “active duty” firefights going on around the globe since 1990. Title companies and foreclosure attorneys (or trustees) don’t always get it right.

So, I like to have the Payors sign a Declaration of NonMilitary Service with clauses that stipulate that the note was created AFTER the Payor entered into military service, or that each of the debtor parties to the note is not now, now was he/she at any time in the three months prior to the creation of the note, a person in military service as defined in the ACT.

All of the above items help reduce negative factors from the note, and help protect the risk rates assigned by an investor.

Remember this too - HARD equity (down payment) is always king. 5% is poor, 10% is fair, 15% good, 20% is much, much better. But as Mike mentioned, credit profile and debt-to-income ratio are often equally or more important than pure credit score. As a note buyer, I would rather see a 5% down on a 650 Fico Payor who has a DTI below 40% with a good income history - than I would with a 600 Fico Payor with 10% down, sitting at a 45% DTI with some sketchy income history. Can you see the trade-offs?

Too much discussion to go into here… but, don’t get confused by ITV vs. yield either. Many buyers indicate that they will pay up to 90%/95% ITV of the note balance. They very well may, if all the clauses above are included, the term is five years or less, AND it still hits their yield requirements. The lower between their risk rate, and their ITV comfort zone will ultimately dictate the price they are willing to pay!

And keep in mind that private notes are very similar to subprime loans in many respects. On a loan amount under $100k, with an A grade subprime buyer, he’s looking at approximate 10.49% at best, with 4 to 6 points in origination fees… borrowing from you, he doesn’t have those fees - so you want to scrape some of that off for yourself if possible, either by getting full purchase price or slightly higher, or getting a higher rate on the note to offset the discount you are going to take when you sell the note.

Also, in another issue I have addressed very extensively the last few months… the markets are changing. Related to that - simultanteous closings, and notes with less than 12 months seasoning have been an area that is rife with fraud, especially in the rehab sector. Investors who got their feathers burnt are becoming much more wary, and smartening up a great deal in their underwriting criteria.

Again… study our NOTE GRADING/PRICING GUIDELINES at:

http://notenetwork.com/at.cgi?a=118510&e=Reports/Note.Pricing.Guidelines.html

Learn those to the tee, and you should be able to figure out the most everything very quickly on your own.

Best of luck, and have a profitable day!

David P. Butler

Issues to consider… - Posted by Michael Morrongiello

Posted by Michael Morrongiello on November 07, 2000 at 21:17:12:

Chan:
You are on the right track in some regards to your proposed note deal.However until we know EXACTLY what type of buyer we are dealing with it will be tough to pinpoint a definitive answer to you.

Asking for 10% cash down is important especially if the proposed buyers have a sloppy credit profile and lower than 600 FICO or BEACON credit scores. If you are willing to carry a small 5% 2nd lien that will also help. Clearly an 85% LTV 1st lien will be more marketable than a 90% LTV mortgage unless there is EXEMPLARY credit involved on the buyer.

In order to mitigate the discount on your proposed note deal my suggestion will be to pay special attention to the employment, stability, overall credit profile, and credit scores of the buyer. Additionally, that interest rate on the note should be increased from your suggested 9.9% to around 11% or higher (depending on the proposed buyers credit?).

A balloon payment 120 months downstream might add a little value to the note as well.

To your success,

Michael Morrongiello

Pricing Notes based on Grade - Posted by Steve Smith

Posted by Steve Smith on November 09, 2000 at 17:53:08:

David,

I have your book, Tin Can Alley, and I have worked through how to grade Mobile Home Notes (and I guess notes in general). Once you get the grade of the note, what rate of return do investors generally require for each grade? I am just looking for a general guideline. For example, do most investors require at least a 75% yield on notes where it rates as a “D”?

Many thanks.

Steve

Re: creating note for max resale - Posted by Ben (oh)

Posted by Ben (oh) on November 09, 2000 at 05:52:08:

David. I enjoy reading your comments.

With respect to the fraud in the origination side of subprime industry can you provide me with your best guess percentages of those responsible. For example, is it 100% the appraisers , or 50/50 underwriting/ appraiser, or 10% appraiser, 90% investor.

What percentages are legitimate transactions and which are fraudelent? Or perhaps a combination?

Why is 12 months the magic number for seasoning?

Also, contact me for note business. Send mail and I will forward my office number.

Re: Issues to consider… - Posted by SueC

Posted by SueC on November 10, 2000 at 08:31:03:

Michael, I am reading on this list and others that given the situation as you’ve described above, with those kinds of terms it would be possible to find a subprime lender to lend to the buyer, rather than take a deep discount by selling the note. Why it is more useful here to to sell the note?

It seems to me that if Chan wants to sell the note, he is not looking for income from the interest on the wrap. So why shouldn’t he just find a lender for his buyers and save the discount? (Esp. if he is going to take a small 2nd back himself to make it more attractive?)
I’m trying to learn more about this, so thanks in advance,

Sue

Re: Pricing Notes based on Grade - Posted by David Butler ANN

Posted by David Butler ANN on November 09, 2000 at 21:38:28:

Hello Steve,

Hey great! Couple of things though. First, if you double check your copy of TIN CAN ALLEY, you’ll see that the next paragraph after you establish the grade (on page 30, Section II), goes on to tell you how to use the grade, applying it to the property categories, which you’ll find on pages 31 and 32 of Section II).

Review those pages carefully… you’ll notice both the ITV limits and the approximate wholesale yield spreads. Remember though, the lower of the two different numbers will be the determining factor. For example, following through TIN CAN, and determining on a category 5 property for D grade note… you’ll see that investor is likely to remain 50% or below ITV against wholesale value of the property. That tells you that if the wholesale value of the home is say $20,000, the most the investor will put into the deal is $10,000. Now, say the note has $17,845 remaining balance, payable at 15% with 228 months left, and investor requires 40% yield on that note… he is only going to pay $7,100.
What if the note amortized over 180 months with 168 payments left? He’ll pay $7,500. How about 144 months with 132 payments left? He’ll pay $8,000. And on a five year note with 48 payments left, he would pay $10,200.

But, in the last case, $10,200 exceeds the maximum ITV which, as we saw earlier is $10,000 on this deal. So, the investor would wind up with a slightly higher yield as a result of the maximum ITV as opposed to yield requirements.

By the way, you may want to check our NOTE GRADING/PRICING Guidelines at: http://notenetwork.com/at.cgi?a=118510&e=Reports/Note.Pricing.Guidelines.html

as the yield requirements have grown higher over the past few months, and are different from that column on page 31 Section II of TIN CAN ALLEY at the present time… especially on the lower grade paper.

Hope that helps, and best of luck!

David P. Butler VP Broker Relations
America’s Note Network

Re: creating note for max resale - Posted by David Butler ANN

Posted by David Butler ANN on November 10, 2000 at 13:46:41:

Hello Ben,

Hey… that’s an unusual question! Actually, fraud the last several years has occurred across the board to some degree - as it historically has during easy money cycles. The last big instance of course was prevalent across the lending industry in residential, commercial, and development projects… which ultimately led to the RTC mess. The latest scandals out in Maryland reflect a similar happenstance, and are occurring primarily in conventional markets rather than pure subprime lending scenarios, as I understand it.

But… in the subprime industry, the problems aren’t related to fraud so much as they are a result of a very poorly thought out business model. Like the “flame-out” dot.com collapses, subprime lenders were throwing money at market share, and simply making loans that make no sense. And securitization is ultimately to blame. It camoflauged investors who bought these (in?)“securities” from “feeling the pain” until it became too late.

Underwriting guidelines in mortgage lending aren’t determined by a Ouija Board. They develop over years of historical research and trend analysis. Several things become clear. Two of the biggest precursors affecting default and recovery relate directly to LTV and DTI, and they can be high impact factors regardless of credit. That’s why high LTV loans (over 80% LTV) in conventional markets carry some form of mortgage insurance to mitigate lender losses (PMI, MMI, VA guarantee, etc).

That second factor, DTI (debt-to-income ratio) is equally important, and too many investors don’t pay enough attention to it. Historically, the safety limits were pretty clearly defined at 28/36, meaning housing cost should not exceed 28% of gross (not take-home) pay; and total long-term debt payments (including housing) should not exceed 36% of gross monthly pay. The evidence has been pretty clearly established that once you go over those limits, the risk of default rises geometrically. The last eight years however, the limits began to drift upwards. So far, in this booming economy, it hasn’t had a measurable detrimental effect in conventional markets.

The problem in the subprime markets is that they began making high LTV loans, at DTI’s that ran from 40% to 50% combined debt load, TO POOR CREDIT RISKS. That’s a lethal combination. And not a great many of these loans had mortgage insurance behind them - those insurance guys are in business to collect premiums, not to pay claims - so not too many insurance people were excited about taking those kinds of high risk bets.

As to fraud percentages, I honestly don’t know. But, as far as intent… I would have to say that 100% of lending fraud has to be put on the shoulders of the borrower (or the “flippers” in the private note markets… even though they are not the ultimate Payors), except in those cases where organized “rings” of service providers are involved in scamming underserved illerate folks buying their own homes at inflated prices (such as the Maryland instances).
Outside of these organized professional rings, to what degree others participate is open to conjecture.

As to the 12 month seasoning “custom”. The powers that be determined that is the “minimum” amount of time to determine some kind of pattern with regard payment history. But history also indicates 12 months really is a poor predictor. In both residential and mobilehome lending, the empirical evidence is overwhelming that 36 months is the clearest indicator of likely mortgage history. If I remember correctly, something like 75%+ of all residential(including MH) defaults occur in the first 36 months of a purchase mortgage’s lifespan. (and down payment is closely related here too… about 75%+ of these defaults come from borrowers who made down payments below 20% - and jumps to almost 90%+ for borrowers making less than 12% down payments)

In fact, as I explain in my FREE report, THE COMPLETE GUIDE TO UNDERSTANDING YOUR CREDIT RATING AND CREDIT REPORT, the Fico (Beacon/Empirica) scoring model doesn’t add points for your mortgage rating until you reach 12 months, and you don’t receive the maximum points for mortgage rating until you reach 36 months of clean payment history. http://notenetwork.com/at.cgi?a=118510&e=Reports/

Hope this answers your questions at least somewhat!

David P. Butler VP Broker Relations
America’s Note Network
dbutler@notenetwork.com