How Much is Your Mortgage Note Actually Worth?
If you provided seller financing, you may wonder about selling a note to free up cash for other needs. One question is: how much is your note actually worth and how do buyer determine value of mortgage notes?
Don’t assume the value is equal to the principal owed on the note. In fact, a note’s value depends on a number of different factors.
Is Your Note Sellable?
Investors invest money in assets to earn an acceptable return. Notes are the same. That’s why most notes can be sold.
But if investors can’t make money on a note, they won’t buy it. Believe it or not, some notes offer zero return on investment.
What determines a note’s value are the borrower and the collateral.
What matters about the borrower is the down payment, credit score and ability to pay.
Collateral is the physical property associated with a note. Different types of collateral have different levels of risk.
What matters is, how marketable is the collateral? For example, single-family residences are more valuable than land tracts.
Why the Down Payment Matters
Did the buyer make a down payment when you entered into an agreement with them? The percentage of down payment received plays a big role in whether the note holds any value at all.
The higher the down payment, the more “skin-in-the-game” a buyer has, and the less risky the investment is.
Investors typically look for a minimum 10% down payment. Down payments of 20% or more increase the value of a note.
What is the Buyer’s Credit Score?
Does the buyer have good credit? Investors use credit scores to measure creditworthiness and risk levels. The higher the score, the less risk of a loan default.
Ideally, investors look for credit scores of 580 or higher. Higher scores bring a higher mortgage note value.
What is the Buyer’s Ability to Pay?
An investor may look at the borrower’s ability to pay as a means to determine risk.
Key factors are:
- Whether your buyer has a job and how long they’ve been there.
- The buyer’s debt payments versus monthly income.
Recourses vs. Non-Recourses
Sometimes the buyer of a property is a family trust or corporate entity, not an individual. If that’s the case, an investor will seek an individual guarantor for the loan.
Why? Because if the legal entity stops making payments, there is still an individual who is legally responsible. You can pursue payment from them.
Was the Note Originally Legal?
When Dodd-Frank became law in 2010, it restricted seller-financed loans while allowing certain exemptions.
If the loan was completed before Dodd-Frank, or completed with exemptions from Dodd-Frank restrictions, the note is fine.
If not, and the note was illegally originated, it is worthless to an investor. Check with an attorney to ensure your note is in good standing.
How Do You Determine the Value of Mortgage Notes?
If you can sell your note, the next question is how will an investor determine its value?
People too often assume that a mortgage note’s value is equal to the unpaid principal balance. That’s not true.
In fact, the value of mortgage notes is highly variable, depending on 6 key factors:
- Down payment
- Terms – the principal, interest rate, amortization and balloon, in the terms of a note
Seasoning refers to a borrower’s payment history.
Do they make payments on time every month? Do they pay by check, cash or automatic debit? The answers determine the note’s status and affect the note’s value.
Notes are classified 3 ways:
- Performing when all payments are timely.
- Sub-Performing if some payments have been late or missing.
- Non-Performing if payments have stopped altogether.
Investors use third parties to verify the seasoning of a note. Make sure you can prove the borrower’s payment history on paper.
Do you have all the legal documentation pertaining to the note, including the note, any deeds and a title policy? Is all the paperwork in hand?
A title policy insures the lender against the risks of previously undiscovered tax liens on the property, unknown restrictions on a property’s use, mistakes in the public recording of ownership, fraud or forgery.
Title policies usually cost 1% of the note’s face value. If you did not buy a title policy when you originated a note, you will have to buy one before you can sell a note.
Investor Yield Requirement
The investor yield requirement (IYR) is how much money am investor wants to earn from a note, based on the level of risk. The note’s interest rate does not equal the yield.
Most investors look for an IYR of at least 6% to 8%. Anything less may hurt the value of a mortgage note.
Interest Rate on the Loan
If the interest rate on the loan is too low, expect to get less for your note.
Why? Because seller-backed financing is a way to complete a sale when buyers cannot get traditional bank financing.
Higher interest rates make up for the risk involved with a buyer whose credit score may not be stellar or whose job may not be stable. Ideally, interest rates should be between 7.5% and as high as 12%.
Keep in mind that rates cannot exceed the maximum allowed under the usury law of the state where the property was purchased. Rates that exceed the maximum would make a note worthless.
Even though a borrower might modify their loan and secure a different interest rate, an investor purchases a note “as is,” with no guarantee that modifying a loan is feasible.
What is the payback period of the note? Is there a balloon payment?
The longer the term, the less valuable the note. Investors don’t typically want to be tied to a 30-year investment.
Shorter-term notes – such as 5 years – in which investors can recoup their investment faster are worth more than longer-term notes.
Does the Perfect Note Exist?
The short answer to this question is “No.” If a perfect note existed, no seller would part with it!
Sometimes, positive aspects of a note offset negative ones. For example, a high down payment or excellent payment history can make up for a poor credit score.
Investors must accept that other negative aspects are simply unchangeable facts of a note. Investors make adjustments for ITV (investment to value) accordingly. ITV is the amount an investor can prudently invest, based on the “as is” value of the note.
Obtaining title insurance and filing an affidavit of a lost note can resolve the problem of a loan with missing paperwork.
Proven re-establishment of good payment history on the part of the borrower can mitigate negative seasoning.
But no redeeming factors can offset a small down payment, an interest rate that’s too low or an extended amortization.
What are Typical Note Prices?
Since prices are determined by quality and multiple factors, note pricing varies among investors. Investors receive a discount on notes, based on the value of the unpaid principal to account for future payments not yet received.
Above average notes are less common. They require the following aspects:
- First position notes
- Credit scores of 700 or above
- Excellent payment history
- High down payment
- Payback period of less than 15 years.
Qualifying notes are valued between $0.87 and $0.97 per $1 of the remaining principal owed.
First position notes that don’t meet the requirements above typically sell between $0.70 and $0.85 per $1 of the remaining principal owed.
If you want to offer seller financing to a buyer, consider the many factors that determine a mortgage note’s value. Ensure your buyer will meet their end of the deal.
Considering all these factors before you make a loan ensures the investment will have value, should you decide to cash it in before its maturity date.
We offer you a simple, practical way to invest in real estate, based on best practices from top investors.
With Alvernia as your guide, you avoid the “trial and error” approach and the need to spend on specialized real estate education — so you free up more capital to invest.
Alvernia serves as your guide to real estate investing, bringing you expertise, practical experience and street smarts. We answer real estate investors’ questions in our monthly blog.