Structuring a large seller-financed note so a note buyer will actually take it

Question

Take a $320k house with a buyer bringing 10% down, producing a $288k note, with the seller planning to sell the note after roughly twelve months of payments rather than hold it long term. Two structuring choices tend to come up together: rate, say 9% versus 10.5%, and amortization structure, a 30 year amortization with a five year balloon versus a straight 20 year full amortization. Note buyers commonly want investment to value at 80% or lower, and a 90% loan clearly does not meet that on its face, while a balloon structure can help the note's resale price by shortening the buyer's effective duration. Those two preferences pull against each other in a single structure. Raising the down payment to 20% to hit the ITV target often loses the buyer entirely, since that buyer is frequently the kind of borrower paying above market rate precisely because conventional lending will not approve the deal. The workable middle ground tends to be pricing the note buyer's discount into the sale price rather than the structure itself, keeping the down payment where the buyer can actually close, and letting the balloon and the rate do the work on the secondary side.

Rena Expert · Accepted Answer

The two comments don't conflict, because they're measuring different things. Your 90% is loan to value at creation, the note balance against the property value. Investment to value is the note buyer's number, their purchase price against the property value. If they pay 82 cents on a $288k balance, that's about $236k against a $320k house, so their ITV is 74% even though your LTV was 90%. The discount is partly how they get to their ITV. That's why the broker can want 80% ITV and still look at your file.

The balloon helps and hurts. It shortens duration, which the buyer likes, and it concentrates most of the value in one distant payment, which gets discounted hardest. If your goal is the best price on a full sale, run both structures through the buyer's target yield rather than guessing. The 10.5% coupon on a 20 year full amortization usually prices closer to par than 9% on a 30/5, because more cash arrives sooner and the coupon gap to the buyer's target is smaller.

What will actually decide this file is not structure. It's the valuation the buyer orders and the compliance file. They'll get their own drive-by or full appraisal, and seller-financed sale prices often sit above what an appraiser supports, which recalculates their ITV against you with no warning. And if the buyer occupies the home, a federally regulated originator issue or a state licensing defect in how the loan was made can make the note unsellable at any price. Get that reviewed by a licensed professional in your state before closing, not after twelve payments.

Also price the partial. Selling forty eight payments and keeping the balloon may beat every full-sale number you're comparing.

karen_whitfield · Answer

You've built a 10.5% real estate secured receivable with a house under it and your first instinct is to sell it for 82 cents. I'd hold that and let it pay. Different objective, I know, but say out loud what the cash is for before you accept the discount.

joe_delgado5 · Answer

@karen_whitfield because cash now is what lets him do the next one. I run thin and I'd take the partial every time. Sell forty eight payments, keep the tail, and the tail is free money if the borrower refinances early anyway.

carlos_nunez · Answer

A variant worth adding to this. Say the buyer's 10% down comes from a family member as a documented gift. Does a note buyer treat that as a real 10% or as zero down with extra steps? Anyone here know how that gets looked at?

omar_haddad · Answer

@chriswalton8 the appraisal point is the one I'd worry about most. Half the houses I see sold on carry paper have a kitchen that photographs well and a roof with four years left. The note buyer's inspector notices, the value comes in soft, and your ITV math moves against you. Whatever deferred maintenance you know about, assume they find it.

bmoreno23 · Answer

Can someone spell out ITV once more? I follow LTV, and I think the difference is that ITV uses what the note buyer paid rather than what the borrower owes. Is that it?

megan_doyle15 · Answer

And seasoning just means how many payments have already been made on time?

dmitri_248 · Answer

@chriswalton8 before you argue about rate, check three clauses in whatever draft you're using. Whether the note is freely assignable without borrower consent, whether there's a prepayment penalty (a buyer pricing a five year balloon cares a great deal about that), and whether the security instrument carries a due-on-sale provision. Carry paper that stays silent on assignability is a common flaw, and a note buyer's attorney will use that silence to reprice the whole file.

Structuring a large seller-financed note so a note buyer will actually take it

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