Understanding the True Value of Your Mortgage Note: What Factors Influence the Price?
As strange as it may sound, valuing a private mortgage note is a lot like pricing a used car. Factors like make, model, and mileage – plus the car’s features and condition determine its value.
What’s important is whether there’s demand for a car like the one you’re selling and how reliable it is. Who wants to be stranded on the side of the road in a 1977 Pacer?
While there’s no “Kelly Blue Book” for note pricing, the process for determining its value is much the same – especially when it comes to reliability.
The 3P’s of Mortgage Note Valuation
Real estate notes, mortgages, deeds of trust, and installment sale contracts are priced based on these three factors:
- People
- Property
- Paperwork
We’ll explore each area together, but for the “TL;DR” readers out there, understand that a note is an investment in the future – and predictable, low-risk, investments are the most valuable.
People (Who’s Making the Payments?)
It would be hard to argue that Ferraris aren’t flashy and fast, but it would also be hard to imagine a family buying one to take the kids to school or using it to bring the groceries home.
Besides being a bit cramped for a family of four, owners of exotic high-performance vehicles are on a first-name basis with their expensive mechanics. They don’t “just go” in the same way a Honda CRV or Ford Explorer might.
As note investors we predict how likely it is that whoever is making the payments will continue to make them in the future.
What do we look at?
- Payment History: Are the payments current? Have they been late in the past?
- Credit: How successful is the payer at managing other credit obligations?
Sometimes the payer is a company or LLC rather than an individual. In those cases, we look to see if a person with a good credit history has personally guaranteed the note’s payment. If there’s no personal guarantee, you can usually still sell the note, but the pricing will reflect the additional risk.
Finally, because most people prioritize making payments for a home they live in over perhaps an investment property or vacation home, notes secured by owner occupied real estate are viewed as less risky and therefore more valuable.
Property: (What’s the Collateral?)
Question: Who or what is the ULTIMATE payer on a real estate secured note?
Answer: It’s the real estate.
Real estate note investors want to know that IF the payments stop, and IF there’s a need to foreclose, the property can make them whole.
You might think that a note investor is just as happy owning the property as owning the note, but that’s seldom true. If an investor wanted to own properties, wouldn’t they just look for properties to buy instead of notes secured by properties?
But there’s no doubt that valuable collateral securing a note provides two advantages:
- It incentivizes the payor to keep making payments. Why would they want to risk losing something they value?
- It secures the investment. If an investor is owed (for example) $100,000 and their investment is secured by something worth $200,000, the investor has a way to get paid… eventually.
Pay attention to the word, “eventually.”
If an investor ends up owning the property, then they must put up with the headaches, expenses and time involved in selling the property. For that reason, properties in desirable areas that are easy to sell are seen as better note collateral than those in remote or higher crime areas.
The same can be said when it comes to property types. It tends to be easier to sell traditional single-family homes for instance than raw land or some other types of real estate.
Paperwork: (What Are the Terms and Can the Lien Be Enforced if the Payer Stops Making Payments?)
The Terms
Every investment involves risk and reward. Generally, the higher the risk, the higher the potential for reward.
If a note was written (for example) at a 5% interest rate, but market pricing and that note’s specific risks require a higher return, a note buyer will pay less than the note’s current unpaid balance to achieve a higher return. This is called discounting.
The paperwork – specifically the promissory note or installment purchase contract will contain the terms. One note may have given the payer a 10% interest rate and 60 months to repay, and another may give the payer a 3% rate and 360 months to repay.
The terms of a note play a big factor in its value. Generally speaking, higher interest rates and shorter amortization terms result in smaller discounts.
Tip: Before you create a note with a high interest rate and short repayment term because you know it could sell for a higher price, remember that a note is only as good as the payer’s ability to make the payments. If the monthly payment comes to $2,000/month but the payer can only afford $1,000/month then the note is pretty much worthless.
The Property Lien
A note buyer is going to make sure they wouldn’t have any problems:
- Proving what’s owned by the payer
- Enforcing their lien if there’s a need to foreclose
- Receiving clear title to the property if it’s taken back
How does this affect pricing?
It’s not uncommon for “gaps” to exist in things like payment records, or for legal documents to contain omissions or be lost entirely. Also, there can be title issues that require clearing up.
Given time and money, many issues can be repaired. Or there can be lingering issues such as steps skipped when the property was sold that carry ongoing risk for any investor who might buy the note.
To ensure top value for your note:
- Always work with title companies and attorneys when selling your property and setting up seller financing.
- Work with a licensed mortgage loan originator to verify your payer’s ability to repay and provide required disclosures.
- Add an assignable “Lender’s Policy of Title Insurance” purchased at closing.
- Keep detailed records of every payment received (cancelled checks or bank statements) and keep your original documents somewhere safe such as with a loan servicer, escrow company, safe deposit box or fireproof safe.
- Require that your payer keeps a current hazard insurance policy in place and provides you with annual statements of coverage. In some areas additional coverage may be required due to risks such as fires, floods, hail and hurricanes.
- Monitor property taxes and ensure they are current.
How Can I Determine My Mortgage Note’s Value?
There’s an easy button for this – just ask us. And ask others too.
You’ll find that established and reputable note buyers will ask similar questions and provide similar pricing.
By reading this article and knowing what to expect, you won’t be caught off guard and you’ll be ready to provide information so that the price you receive is accurate and reflects the parameters of your mortgage note or installment sale contract.
For a free quote, call us or fill out our easy online form.