In the last few months, several real estate brokers and investors have asked me how a note should be put together. In other words, if they are involved in a real estate transaction, and the seller is offering "owner carry" financing to the buyer, what should the terms look like? How does someone know that he is charging the correct interest rate, or getting the number of years right? Bottom line, whether the seller wants to keep the note as an income source, or sell it eventually for cash, how does he know he is doing the "right thing?"

Like any transaction, it is give and take. Both parties should feel as if they benefit and receive a fair shake. But the truth is that the buyer wants or needs owner financing for a reason, and that usually means he cannot obtain conventional financing from a bank. So the seller is being accommodating by offering to be the bank, and provide the financing that the buyer cannot obtain on his own. Both parties should understand this, and agree that the terms should recognize that the seller is taking an added risk he would normally not consider.

Consequently, in pure business terms, the buyer should not be treated as a preferred risk. This is probably the biggest mistake sellers make in today's market. The buyer may be a good financial risk, but if a bank says no, and the seller says yes, the terms must reflect this reality.

With real estate prices probably not yet stabilized, the seller needs to ask for a big downpayment. What is big? Ask for twenty percent or more. He may not get it, but maybe he will. No one knows unless he asks, and asks strongly. Just because the buyer says he doesn't have a lot of cash, does NOT mean he can't get the cash-somehow.

Ask.

The interest rate must reflect the added risk the seller is taking. If the seller feels he will want to sell his note in the near future, an 8-10% interest rate will be looked upon much more favorably by a note investor than a 4-5% rate. The higher the better.

If the seller feels more secure knowing he will get his investment back "sooner rather than later", he should try to negotiate a short payment period. If the buyer can stomach the monthly payment required for a 10 or 15 year period, then the parties should try to arrange that rather than a 20 or 30 year period. Shorter years favor the seller, longer years favor the buyer.

If a seller wants his money back quickly, and suggests a balloon payment after 10 or 15 years, the key question to ask is "will the buyer be able to come up with the balloon payment when it is due?" In today's market, the answer is probably "no he won't." What do you do then? Probably renegotiate. Is that the situation the seller would want to be in? Balloon payments were in favor when prices were climbing and refinancing was easy. Both parties need to look at balloon payments carefully and realistically.

Lastly, a seller has a right to know what kind of financial risk his buyer truly is. Remember, the seller is the bank. He should complete a credit check on the potential buyer, and either raise or lower his comfort zone based on the result. This is a business transaction and the parties should approach it as such, protecting themselves as much as possible as they work towards completing the deal

It is clear that I am saying the terms should favor the seller. I believe the seller should communicate that fact to the buyer, then work with him to hammer out the best possible deal for both. Be upfront, negotiate, then smile and shake hands when it is all done.

Hope this helps you.

Sincerely,

Denny Stanz

760-245-5366
760-245-5367 fax
dennystanz@verizon.net
www.CaliforniaNoteBuyerLLC.com