Seller-financed mortgage notes fall under the umbrella of creative financing. The creative aspect leads to notes of all shapes and sizes.

The value of a note is determined by several factors unique to each, one of the most important of which is … Note Performance.

Let’s dive deeper into this topic to better understand its impact on value.

Performance = Payment History

If you’ve read any number of our previous blog posts, then you likely already know that the payment history (especially verifiable payments) has a marked impact on the value of a mortgage note. The borrower’s credibility is boosted each time they make an on-time payment, which in turn makes the note more valuable to an investor.

On the flip side, a note with a troubled payment history will be less valuable to investors, with some rejecting it altogether.

So, a note’s “performance” refers to the reliability (or otherwise) of the borrower’s payments over time.

Performing versus Non-Performing Mortgage Notes

In a perfect world, your seller-financed buyer proves to be a model borrower, sending in their mortgage payment on time month after month. Life is easy for this borrower’s lender. Unfortunately, not all borrowers are this reliable.

Performing Mortgage Notes

A note is considered “performing” when the borrower makes timely payments on or before the due date each month for a reasonable period of time, say 12 months or longer.

Tip – Be sure your borrower’s payments are “verifiable”, meaning there’s a trustworthy electronic or paper trail of the payments sufficient to prove to a potential note buyer that they were indeed made as advertised. The simplest way to insure this is to have the note serviced by a licensed third-party loan servicer.

Performing notes are the gold standard – ideal for both note sellers and note buyers.

A timely payment history speaks to the borrower’s commitment to their promise (to pay) and to the property, both of which make it less likely they will default on the debt in the future.

Sub-Performing Mortgage Notes

Traveling down the note performance highway, our next stop is the foggy town of Sub-Performance. Notes are considered “sub-performing” when they’re somewhere in the gray area between performing and non-performing.

Sub-performing notes come in a variety of flavors.

A hiccup in the borrower’s income is a common problem that leads to a missed mortgage payment and, in turn, the label “sub-performing” being assigned to the note. This outcome could also be the result of an unexpected life event like a loss in the family or a financial setback like a large medical expense.

At this point, it’s up to the servicer (or note owner) to reach out to the borrower to work out a plan for bringing the loan current again. Communication is key during periods of sub-performance. It’s important to let the borrower know that it’s in everyone’s best interest to allow the borrower some flexibility to get back on track.

Some borrowers can become habitual sub-performers, repeatedly getting behind a month or two on payments and then catching up just before the note becomes officially delinquent. Perhaps they have a legitimate reason for the sporadic payment schedule (like seasonal income), or perhaps they just don’t manage their finances very well.

Whatever the specific reasons, a sub-performing borrower will almost always lower the market value of a seller-financed note. The note owner will need to decide if the discount required to sell the note outweighs the headaches of managing a sub-performing borrower.

Non-Performing Mortgage Notes

The seller-financed note owner’s worst nightmare is for the monthly payments on their note to cease. Their life as a note owner can go from carefree to a major pain very quickly.

A “non-performing” note is usually defined as one in which the borrower is 90+ days delinquent on their payments. If all reasonable attempts by the loan servicer to get the borrower back on track have failed, the note owner must make the tough decision regarding how to proceed.

One strategy is to perform a “workout” of the non-performing note, which involves any of a number of possible strategies aimed at either “rehabbing” the existing borrower or helping them to exit the property. This approach can seem like a lot of work for the typical single-note owner.

Luckily, owners of non-performing notes do have another option. They can most always sell their non-performing note, albeit at a pretty steep discount, to get at least some of their money out of this transaction gone bad.

You might wonder why any note investor would buy a non-paying mortgage note. If it’s not generating any income, what value can they possible see in such a purchase?

It just so happens that some note investors actually specialize in non-performing notes. They have the experience and professional connections necessary to perform the workouts to either rehab the borrower or take the property to foreclosure or some other resolution. This process can be lengthy and expensive which results in higher financial risk for the investor. However, since non-performing notes are purchased at a pretty steep discount, the investor is typically able to absorb the added expense and still make a healthy profit on the transaction.

Everyone who sells a property with seller-financing has high hopes that their borrower will pay faithfully for the life of the loan. Sometimes it doesn’t work out that way, but it’s good to know that there are always options regardless of the performance status of a note.

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