You can sell all or part of a note to fund a property purchase, for instance to cover the down payment. Get the amount right, so you sell no more of the note than the purchase needs, and get the timing right, so the note sale funds before your purchase has to close.
Is the trade a good one?
Selling a note has a cost: buyers pay less than the balance owed, so that the payments give them the return they want on their money. Before you pay that cost, be clear about what you gain.
The trade has something to offer when a larger down payment gets you a property you could not otherwise buy, or meaningfully better loan terms on it. It also suits someone who would rather own a property they control than a debt owed by someone else, and a buyer of a home whose value to them is more than financial.
It tends not to work when:
- You could fund the purchase from savings or a modestly larger mortgage at a rate below the return a note buyer would want.
- You are selling a reliable note to buy an investment whose return is a hope and has no figure attached.
- The note’s monthly payment is what would have made the new mortgage affordable.
The third of those is easy to miss. If a lender is counting your note income when deciding what you can borrow, selling the note removes that income, so ask your lender how they treat it before you sell anything.
Work out the amount first
Start from the purchase and work back. Add up the down payment, the closing costs on the purchase, any work the property needs straight away, and a reserve. Subtract what you already have. The remainder is what the note has to raise.
As an example with round figures: a $40,000 down payment, $8,000 of closing costs and a $7,000 reserve come to $55,000. With $15,000 in savings, the note needs to raise $40,000.
If that figure is less than the note would sell for whole, ask about a partial. In a partial the buyer pays a lump sum for a fixed run of the coming payments, and the note is assigned back to you once those have been collected. The income pauses and then returns, some years after you have moved in. Whether a partial is on offer depends on the note, and mostly on how dependable the payer has been. If one is, how many payments you should sell follows from the amount you have just worked out.
Fitting two closings together
A note sale is its own transaction with its own steps, and plans come apart when the purchase contract assumes those steps will run to a date.
- You send the note details and buyers price it.
- You accept an offer and sign a purchase agreement.
- The buyer checks the file, which is called due diligence. They review the note and the recorded mortgage or deed of trust, verify the payment record, order a title report and get a value for the property behind the note.
- Closing documents are prepared and signed.
- The sale funds. The money is sent to you, or to the closing agent for your purchase if you direct it there.
The third step is the one outside your control, since a missing document, a title problem or a slow valuation each add time, and those are the things that decide how long it takes to sell a note. We do not promise a number of days, and a purchase contract should not be built around one.
Practical ways to protect yourself:
- Start the note sale before you make an offer on the property. Pricing commits you to nothing, and knowing your number lets you shop with a real budget. Send us the note details along with the amount you are aiming for, and what comes back tells you whether the note can raise it and whether that takes all of the note or part.
- Get your note file complete now. The original note, the recorded security document and a payment record with dates are what the buyer’s checks begin with, and the full list of documents is short.
- Allow a margin in your purchase contract. Talk to your agent or attorney about a closing date with room in it, or a condition tied to the note sale funding.
- Hold off signing the note sale until the purchase looks solid. An unsigned offer leaves you free, though buyers do not hold offers open indefinitely. A signed agreement is a commitment, and if the purchase then falls through you may not want the cash.
What a mortgage lender will ask
If you are borrowing for the new purchase, the lender will want to see where your down payment came from. A note sale is a legitimate source, and it leaves a paper trail: the purchase agreement for the note and a closing statement showing the amount paid to you. Keep both.
Lenders have their own rules on how long money must be in your account and what documents they accept. Tell your loan officer early that part of your down payment will come from selling a note, so their requirements do not surprise you a week before closing.
A caution on tax
It is tempting to assume that moving money from a note into real estate is treated like swapping one property for another. A note is a different kind of asset from the property it came from, and selling it can bring forward tax that you had been paying gradually as the payments came in. The rules depend on your situation. Ask a CPA before you sign, and build any tax into the amount you need to raise.
Other ways the note could fund the purchase
You could offer the note itself as payment. A property seller is free to accept your note in place of some cash, but one who understands notes will value it at what a note buyer would pay and not at its balance, and one who does not is unlikely to want it. Selling the note for cash is the simpler transaction.
You could also wait for a balloon or payoff. If your note has a large payment due soon, or the payer has talked about refinancing, the full balance may be on its way without any discount. A purchase that can wait for it avoids the cost of selling altogether.
Buying property is one of a number of situations in which selling a note makes sense, and if your purchase is tied to a move, the guide to those covers that as well.
While you are still looking at properties
The order that protects you is amount first, price second, property third. Do the sum in the section on working out the amount, have the note priced against that figure, and only then make an offer on a property. Before you do, take the price to your loan officer with one question: how will the note income, or the loss of it, count in my application?
Related questions
Can the note sale proceeds go straight to my property closing?
Usually you can direct the funds to the closing agent handling your purchase. Arrange it in advance with both closings, and ask your lender what documents they need to accept the money as your down payment.
Should I sell my note before or after I find a property?
Get it priced before, and sign the sale once the purchase looks firm. Pricing is free and gives you a budget. Signing early risks ending up with cash you no longer need if the purchase falls through.
Will selling my note affect my mortgage application?
It can. If the lender was counting the note's monthly payment as income, a sale removes it. Selling part of the note pauses that income for a period. Tell your loan officer what you plan before you commit.