Sam Mannino asked:


Seller-Held Private Mortgages & Notes

By

Sam Mannino

During my 40 year career as a mortgage banker, I have been asked countless times to purchase or sell seller-held or purchase money mortgages, taken back by sellers of real estate.  Unfortunately, not all of the sellers have been happy with the results.  I often have to tell them that their seller-held mortgage can’t be sold just yet, or it if can, the amount they will receive for the debt is a small fraction of what they are owed.  Sometimes, I have to inform them that the obligation due them is virtually worthless.

Most of their disappointment could have been alleviated by the person who originally drafted the mortgage.  All too often, these legal documents are drafted by realtors or attorneys who may have not considered the final disposition of these obligations, or are unfamiliar with how a seller-held mortgage is treated in the secondary market.  A little extra care by knowledgeable counsel can make all the difference to a seller-held mortgage.

First, understand that a seller-held mortgage will, in all likelihood, be sold sometime during its lifetime. Rarely, even when the parties are family members, does the holder of a seller-held mortgage wish to hold the note the entire term.  More commonly, they want to cash out at some time in the future, which can be accomplished in a number of ways.  The mortgagor might sell the property, and the note can be paid off.  In addition, the mortgage might be subject to a call provision after a set period of time.  However, it is far more likely that the holder of the seller-held mortgage might experience a change of heart, and simply want out of the deal.  In that case, he must try to sell the mortgage.

Purchasers of seller-held mortgages, and yes, there are some, most commonly look for two points:  1) obligations that have been seasoned for a year or more, and 2) a good payment history.  Holders of these seller-held mortgagers need to be informed that good record keeping can pay off in the long run.  They need to know that mortgage buyers will want to run their own credit checks on the borrower and make inquiries as to employment.  (Keep this in mind when you are drafting the original obligation.)  Finally, they will wish to retain a higher yield than most seller-held mortgages carry.  The reason for this is that most seller-held mortgages carry a higher risk than institutionally generated mortgages.  Makers of seller-held mortgages commonly carry higher debt rations, have poor credit, or make little or no down payment.  If a seller-held mortgage carries a market interest rate, the purchaser of that note can only achieve a higher yield by discounting the purchase price below principal.

Holders of seller-held mortgages can do themselves a world of good simply by thinking like a bank at the inception of the debt.  They may wish to allow their borrowers a higher debt ration than a bank, but they should never allow more than 40 percent of a borrowers’ gross monthly income to be applied to first and second mortgage payments, taxes and insurance.  Anything more and the borrower simply can’t afford the property.  When it comes to checking the borrowers’ credit, it is imperative that you thoroughly search for any previous foreclosures.  In addition, avoid any borrowers with really bad credit within the past two years.  Finally, require some down payment.  Remember, if you do have to foreclose, that the down payment represents a real safety net.  Vacant and/or abandoned real estate does not appreciate.

Drafters of seller-held mortgages must be sure to include two key clauses. First, they must make sure the obligation can be assigned by the holder of the mortgage and note, without further permission from the borrower.  It never ceases to amaze me at how often this important language is overlooked or omitted altogether.  Second, if the note is to be marketable at all, the holder and assigns, must be able to make further inquiries regarding both the borrowers’ credit and employment in the future.  Two year old credit reports are worthless, and unfortunately, so are the mortgages which have relied upon them.

A final word of advice, experienced attorneys often receive referrals from local realtors to assist in the drafting of these seller-held mortgages.  But, more often, the interest of the realtor making the referral is not the same as the holder of the seller-held mortgage.  The realtor simply wants to close the sale.  We must keep in mind that the document that is drafted will be in place many years after the closing.  It is then that the work of a competent attorney will reveal itself. A little planning and preparation along with the advise of competent legal representation are the keys to a successful transaction… Remember, people don’t plan to fail, they just fail to plan.

Sam Mannino is the managing director of Investors First Capital and was elected as director emeritus of the Pennsylvania Financial Services Association.  He has served on many committees and advisory boards for the financial services industry.  He is a registered lobbyist for the financial services industry and a business–against-government reform group, Stop-Them.org.  He is life-long resident of State College, Pennsylvania.



JAMES