What determines the fair market value of a seller-financed real estate note? Is it the interest rate? Yes. Is it the value of the property? Yes. Is it the credit worthiness of the borrower? Yes.

I’ll bet you’re seeing a pattern here. There’s not just one single factor that determines the value of your note. It’s actually a combination of several factors including interest rate, payment terms, property type and equity, the borrower’s credit, and note seasoning.

That last one, note seasoning, might sound a little unusual (thinking salt and pepper?). However, as we’ll discuss in this article, it turns out to have a significant impact on note pricing because it can give considerable insight into the future performance of the loan.

What Exactly is Note Seasoning?

In the world of notes, the term “seasoning” refers to the duration and quality of the note’s payment history.

Think of seasoning as the note’s reputation. While performing their due diligence on a note, an investor will look at indicators like:

• How long the borrower has been making payments
• Timely receipt of payments (no missed payments)
• The ability to verify the payment history

Looking back at the borrower’s payment track record gives the investor insight into what kind of payers they are likely to be in the future.

Verified Payments

What does it mean to say that payments are “verifiable”? In short, it means that there has been a trustworthy accounting and documenting of borrower payments over the life of the loan.

The most reliable way to produce a verifiable payment history is to employ a neutral third-party vendor to collect and manage the payments. Ideally, a licensed third-party loan servicing company will be hired to collect payments, process disbursements, perform year-end reporting, and handle borrower communications. The next best option is to use a qualified attorney or accountant to collect and management the loan payments.

Let’s assume the seller is old-school and insists on collecting and managing the borrower payments themselves. Is it still possible to deliver a verifiable payment history to a prospective note investor?

Let’s just say it’s possible but virtually never easy.

These “self-servicing” sellers will need to keep a copy of every check or money order received from the borrower. Copies of the corresponding bank deposit slips should also be kept. Anything and everything that proves payments were made (and when) should be kept. Cash should never be accepted as payment since it’s impossible to reliably track.

Along with this meticulous payment documentation, the seller would need to maintain regular and accurate records showing the date and amount received for each payment, how the payment was applied (principal, interest, escrow), and the new unpaid balance after each payment. The seller must be prepared to present this documentation to the prospective note investor as proof of the borrower’s reliable payment record.

How Does Note Seasoning Work in Real Life?

In general, the longer a note has been seasoned, the better. A track record of 12 or more months of on-time payments is acceptable to most investors.

Let’s be clear … that means 12 months in a row of on-time payments. It doesn’t mean “late, but eventually” or “skipped months and then caught up.”

A sporadic history will have an impact on the investor’s willingness to purchase the note (and certainly will impact the offer price).

However, even with seasoning or payment issues, most seller-financed notes still have selling potential. As mentioned at the top of this article, the value of a note is determined by multiple factors with seasoning being just one variable in the equation.

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