1. Not getting a big enough down payment
When structuring a deal, you need to be thinking of not only what will go right, but what might go wrong. You may think you are helping out the buyer when you finance 100% of the purchase price, but you are putting yourself at risk. If the buyer doesn’t have anything invested in the property, he has nothing to lose by stopping payments to you. Even if you get 10% down, it may not be enough. If the buyer stops making payments, you have to foreclose, AND the buyer trashes your place before he gets out, the amount of money you made on the down payment may be gone with legal fees and repairs before you even have time to think about it.
There is a reason that mortgage companies usually ask for 20% down and only finance 80%. Follow their lead.
2. Not checking out your buyer with proper underwriting
The time to worry about a loan and the borrower is before the loan is made.
Get to know your buyer as much as possible. Someone who has given you indications of being deceitful or unreliable is probably going to continue to be that way when working with you, even if credit scores and employment histories are impeccable. On the other hand, someone with good character with bruised credit just might be worth the risk.
Get permission from the buyer to check his credit report. Learn to read a credit report. Has the buyer been late on a lot of payments recently? Have there been any recent foreclosures or charge offs? Does he have the ability to pay? Are the ratios between his income and expenses similar to what a mortgage underwriter would expect?
3. Not using professionals to help complete your transaction
Use a lawyer to help you draft your documents. Use a title company to close your transaction. Use a real estate broker to negotiate the deal.
These professionals know all of the ins and outs of their profession. The money you spend on them will keep you safe and legal.
4. Not planning an exit strategy in case of changing circumstances
Suppose you sold a $100,000 piece of property with 5% down. Right now, you may be happy with taking a note for $800 per month for 20 years at 8% for your $95,000 note. But, what if you need some cash and need to sell your note? A note buyer would not want to buy a note with 95% Loan To Value. Or at least not without a steep discount.
A better strategy would be to create two notes, a first for $80,000 and a second for $15,000. You might even write the second with a faster amortization so that the buyer’s payment goes down in a few years when the second is paid off. An investor who would buy your note would be more willing to buy your $80,000 note than a $95,000 note.
5. Not maintaining accurate records of payments or hiring a servicing agent
Make sure that you keep track of every payment the buyer makes to you. Let the buyer know how much principal and interest is calculated for each payment. You don’t want the buyer telling you after ten years that the note is paid off, and you still think he owes $3,000.
A better solution is to use a company that services these notes. A disinterested third party will give confidence to both the buyer and the seller that the balance is correct. A servicing company will also collect 1/12 of the taxes and insurance each month, and make sure that both are paid on time. A servicing company will also report interest paid and received accurately to the IRS.
Avoiding these five mistakes will help make sure your owner financed real estate transaction is safe and profitable.