The question of how to create a real estate note comes up on both sides of a real estate transaction – buying and selling. Knowing how to create a note that will yield you the most flexibility no matter which side of the transaction you are on will serve you well in your real estate career.
In traditional transactions, the title company or title attorney will create the note (and the mortgage) for the buyer to sign at closing. While it is always good to use a title company to close your transactions, you may want to create your own paperwork, especially if the terms you are outlining in the note don’t fit in to the standard format.
The paperwork itself is relatively simple. The clauses you put into a note vary depending upon which side of the transaction you are on. You want to tailor the note to match the needs of the payor and payee for every note that you create.
How To Create A Real Estate Note When Buying A Property
When buying a property using a note, you want to avoid signing for the note personally. You want the payor on the note to be a corporation or trust. If you can sign as trustee or as a corporate officer, you cannot be held personally liable for the note. Most conventional lenders won’t allow you to do this. Most private parties either won’t notice or won’t mind, especially if the security for the note is solid.
In addition, since you are going to be the person making the payments, you want to make sure the payments are something that you can afford. If the property won’t cash flow at 8% interest, ask for 5% interest or whatever will make the property work for you. Some people will take interest only payments for the first few years. The point is that you can structure the terms of the note any way you want, as long as the other party is agreeable to it. Very few people write a note hoping that the payor will default.
How To Create A Real Estate Note When Selling A Property
Again, you want to make sure the note works for both parties. When you are selling
a property and holding the note, you want to make sure the payments are comfortable for your buyer. A good guideline is to use the parameters that institutional lenders use. The FHA allows a borrower to use 29% of his income towards housing costs and 41% towards housing expenses and other long-term debt. So for the first or top ratio, take 29% of the person’s income. That amount must cover the PITI payment. Then take 49% of the income, minus the 29% for PITA, the remaining 20% must pay all credit report bills and/or child support.
For example, if your buyer earns $5,000 per month, the highest amount his PITI payment should be is $1,450. His housing payments and other expenses such as credit cards and other long term debt should not be more than $2,450 per month.
Keeping your payments affordable is the key to a performing note.
You also want to make sure the note is properly secured. Never create a note without also creating a mortgage against an asset. When you are selling a property, it is usually used to secure the note. However, you can also ask for additional security, especially if the payor’s credit is shaky or if the property has little to no equity in it.
Some note creators cross-collateralize their notes. If they have a number of notes with one payor (for instance, a hard money lender with an investor), he may put a clause in the note that says if the payor defaults on one note, all the notes can be called due and payable. This is important because when a payor starts to default, all of his debts start to domino. The lender wants to be first in line to retrieve his assets and cut his losses if the payor is going up in smoke.
A Final Note On How To Create A Real Estate Note
Finally, when creating a note in which you are the payee, you want to make sure it conforms to the Uniform Commercial Code so that it can be sold or borrowed against should you want to liquidate it. Notes are assets and you want to make sure that when you create a note, you are structuring it to your best advantage.