When sellers provide owner financing, their primary concern is usually, "How do I make sure the buyer will pay me?"
While many factors play a role, time and experience have shown that there are five major factors to consider when taking back a note, contract, or other form of seller financing.
1. Buyer's Credit - Whether someone has paid his or her bills on time in the past is a good indicator of how timely he or she will make future note payments. A seller should always review the buyer's credit prior to accepting a buyer's promise to pay. The seller can obtain a signed authorization from the buyer to pull credit through a reporting agency, or the seller could simply ask the buyer to obtain a copy of his or her report for the seller's review.
2. Down Payment - The more money buyers put down, the more they have vested in the deal. The greater equity, the lower the likelihood the buyer will stop paying. When people have little to no equity, they are more likely to default, which can result in the seller taking back the property through foreclosure.
3. Terms - The terms include interest rate, payment amount, frequency, and the due date for payment in full. There are also late fees, default clauses, requirements for insurance, and other standard provisions. While the terms can be whatever the buyer and seller agree upon, it is generally better to set terms deemed favorable to a note investor.
4. Documentation - In addition to putting the terms in writing, the documents evidence the lien. The obligation to pay (or IOU) usually takes the form of a promissory note, which is secured by a mortgage or trust deed recorded in the county records. A qualified legal professional familiar with the state laws should prepare the closing documents.
5. Servicing - Tracking the payments, interest, and balance is often referred to as servicing the note. In addition to collecting payments, a servicer should verify the real estate taxes and insurance are kept current. The seller can perform servicing; however, many prefer to hire a third party company to handle this process.
In addition to protecting the seller, these same five factors play a large role in determining how much a note investor will pay for the note should the seller ever wish to sell or assign their payments.