The creation of paper:Let's change this scenario slightly. It's the same property and the same people are involved. Art still wants to buy Jane's property All the amounts are the same but instead of going to the bank for a loan of $80,000, Art goes to Jane and asks here to hold the $80,000 first mortgage. When Jane says, "Yes, Ill hold the mortgage," she is creating paper---a personally held mortgage. Jane would then be lending Art $80,000, though she would not give it to him in cash. The technical term for this is a purchase-money mortgage ---this is a mortgage that is given to assist the purchase of real estate. It is a fairly universal term for paper. Even in trust-deed states, we refer to this kind of transaction as a purchase money mortgage. Jan gave Art an $80,000 mortgage to assist in the purchase of real estate. Let's look at this deal from both sides and see why Art and Jane might want to arrange financing between themselves and not involve a bank. Why would Art rather go to Jane than the bank? There are many reasons. One could be that it takes a lot less time to arrange a mortgage with Jane that it does to get a bank loan. Jane doesn't have to go to a loan committee to get approval to lend Art money. Jane won't charge Art points or fees for the loan. Jane won't check Art out the way a bank might. Sure, she should do a credit report to make sue he is a good risk, but it won't be anything like the bank might do. Art and Jane can sit down and work out all the terms and conditions between themselves. They can decide the interest rate, the terms of the mortgage, and how much Art will pay Jane each month. The bank is not nearly as flexible as Jane can be. It's clear it would be a great deal for Art to go to Jane instead of the bank. But is it a good deal for Jane to hold the mortgage> If Art had gone to the bank and cashed Jane out, she would have had an additional $80,000 cash. What's she going to do with this money? Unless she has something specific in mind, like paying cash for another home, she'll probably put it in the bank and earn 5 or 6 percent on the money. If she holds the mortgage herself, she'll earn more than 11 percent on her money, using the figures in out example. She'll collect $775 each month for the next 360 months. There aren't many investments around that will guarantee you a return in excess of 11 percent. So, one reason Jane might hold the paper herself is for the cash flow over time. If she's looking for retirement income, this is a wonderful deal for her. Even if she plans to buy another house, she might want to carry the paper for income. Her $50,000 in direct cash from Art's down payment would be more than enough for a down payment on another house, especially if she's looking for something smaller. She might find it a tax advantage to deduct mortgage payments on here new house while collecting interest from her loan to Art. Another reason this might appeal to Jane is that she will be getting a lot more than $80,000 back over the next thirty years. In fact it will be over three times the original $80,000, for a total of $279,000. This makes holding paper very attractive. The third reason Jane might hold this paper is the tax advantage involved. She may go to her Tax advisor and ask his opinion. He will weigh the benefits of taking the $80,000 now and paying capital gains and the other associated taxes against collecting the money over time. Jane's tax position may change over the years, but it may be wiser to collect the money over time instead of cashing out. Now Jane has three very good reasons to hold the note herself. Jane has agreed to hold the mortgage. She is now acting like the bank. Since this transaction is just between Jane and Art, they could have negotiated any kind of deal they wanted. The loan could have been amortized for twenty years, or ten, five or any other period. They could have computed payments as if the loan were amortized over thirty years but required that the full remaining balance be paid after five years---a balloon payment. They could write the loan in any legal way they agreed to. No one else is part of this deal. It's jus the two of them. At the closing there is no banker, just Jane and Art, and possibly their attorneys. Art gives Jane his $50,000 and signs the promissory note and mortgage or trust deed for the balance of $80,000. Art owns the real estate and Jane owns the $80,000 promissory note, mortgage and $50,000 cash. The actual mortgage and note used by Jane is exactly the same as the one the bank uses, except that Jane's name it on it and there is no bank involved. Jane is now free to move to the other side of town or the other side of the U.S. and as long as she stays in the fifty states, it will only cost Art a first-class stamp to send her the $775 check each month. If Jane moves out of the country, she'll probably set up a U.S. bank account to handle her funds so Art will mail his check to the bank or the trustee of the account. Either way, Jane gets her money and Art has no hassle making his payments. Let's skip forward and assume that twelve months have gone by since Jane sold the property to Art. He's made 12 payments, always right on time. Everything is going fine. Jane has just heard about a great new investment she would like to get involved with, but she will need more cash than she has available. She may need cash for any reason, but let's assume that here son-in-law is starting a business and needs cash. She trusts his judgment and sees it as a great investment, with a possible return far greater than she's getting from Art's payments. As she tries to figure a way to get some cash in a hurry, she realizes, or a financial advisor tell here that the paper she holds could be a way to get some fast money. Jane wants to sell the paper and cash out. Jane searches the newspaper classified ads and the internet. She comes across the National Notebuyers web page, e-mails them and says "I have a mortgage I'd like to sell. Do you want to purchase it?" Richard from National Notebuyers calls Jane and asks for the details of the mortgage. Jane explains that a year ago she sold a house to Art and took back a mortgage for $80,000, with monthly payments of $775 for thirty years, but now she would like to sell it. After giving Richard all the information, Jane tells him that at the closing a she was given an amortization schedule listing each of the 360 payments she was to receive. According to her amortization schedule, after 12 payments have been made, the remaining principal balance is now $79,658.84. Jane says that if Richard gave here a check for $79,658.84 she would sell him her mortgage. At this point Richard has a little explaining to do. Richard doesn't plan to buy this mortgage for $79,658.84. Richard won't pay that amount because he'll be receiving his money over the next twenty-nine years. the time value of money affects the value of paper. Richard has to explain to Jane why here mortgage is not worth face value, and why the dollars she receives twenty-none years from now will be worth as much as the dollars she receives today. Richard still isn't quite sure Jane understands, so he asks her how much she paid the last time she saw a movie. Jane says it was about seven dollars. In ten years, the cost of a movie has gone up five dollars! The only real difference is that it's ten years later. Have movies gotten so much better that they can justify a five-dollar increase? Or is the dollar just buying less today? With this or similar examples, Richard can show Jane that the money her mortgage will earn ten, twenty or thirty years from now will be worth much less that it is today. This is how Jane will see that Richard's offer is a fair price. Richard is not discounting Jane's paper because he just wants to. He's discounting it because he has to, for sound economic and financial reasons. Now Richard has to make an offer to Jane. There is no fixed amount, nor legal amount, no amount he is required to offer. If Richard were to buy a used car, he might go to one the blue books and decide from that what he would offer to buy the car. Before Richard begins his actual negotiation, he get as much information about the mortgage, the property and Art's payment record as Jane can give him. If Jane doesn't have the all the information, he will ask her to get it and call him back. Richard uses a Mortgage Quote Sheet to ensure that he remembers to ask all the questions and get all the answers. When he has the information he needs, he's ready to negotiate. He doesn't negotiate from lack of knowledge, which would be terribly risky. The mortgage quote sheet is also one of Richard's most important tool because it enables him to get all the information he needs on one sheet of paper. It provides him with a chart of the things that will determine whether or not the deal is worth doing. Because he's making an offer based on what Jane tells him, and Richard doesn't know whether the information is accurate or whether Jane is hiding something from him, his off is conditional upon the validity of the information and the appraisal, and his approval of everything. Richard tell Jane he can offer $50,000 for her $80,000 mortgage. Jane, understandably, is shocked. Even with Richard's explanation of the time value of money she'd expected a lot more. Jane may decide she doesn't need to sell, or she may realistically look at the benefits of cash now versus cash twenty-nine years from now. For this example, we'll keep it simple and assume Richard offered and Jane accepted. When Jane first called Richard, she expected to get the full face value of her mortgage, but she didn't understand the time value of money. Now she does and realizes that if she wants to cash out, she'll have to take a discount to sell her mortgage. She needs the money, so she decides to go ahead with the deal at $50,000. At the closing Jane will get $50,000 in cash, everything conditional on whatever Richard has stated when he made his offer. To name a couple of conditions they would be a appraisal on the property and a credit check on Art. When the deal closes, Jane assigns her mortgage to Richard and/or Assigns or Assignee. She is paid $50,000. and walks away. She has nothing further to do with the note or Art or her old house. Richard owns the mortgage, the right to twenty-nine years of $775 per month, and all other rights written into the mortgage. The title company goes to the county recorder's office and request it to record an assignment of mortgage, which shows that Jane has assigned her mortgage to Richard, and Richard is now the owner of that mortgage. This deal is not fantasy. Deals like it take place all over the country each and every day Does Jan really feel the discount? It depends. If Jane takes the money to Las Vegas and gambles it away, did she lose the value of those dollars? Yes. But suppose she take that money and invests it in a growing company her son-in-law has started up. The company prospers and within two years she triples her money. Did she effectively see the discount on that mortgage? No, because she used the money wisely. In two years she earned more that 50 percent of the money she'd have gotten in thirty years from the mortgage. Who are we, Richard, or anyone else to judge what she should or should not do with the money? It's totally up to her. We do know one thing: she's going to sell her mortgage, not because of ignorance, but because she needs the cash now! Richard is able to provide that service. A bank will not provide it. No lending institution can provide it. They will not lend against a personally held mortgage. Do you have questions?
|
