The creative-financing boom of the past three years produced an estimated $100 billion worth of custom-crafted home seller mortgages across the country. Now it is stimulating the growth of a sideline industry fraught with consumer problems.
Professional loan brokers, many of them unregulated by any state or federal agency, are buying large volumes of seller-financed "takeback" mortgages in exchange for cash.
They advertise in local newspapers and in business, legal and real-estate publications, offering to purchase first and second deeds of trust or mortgages at competitive rates. They promise a service that's potentially important to anybody who sold a house since 1980 and accepted a portion of the sales price in the form of a deferred-payment note.
The brokers will "cash you out." They'll turn that five-year balloon note of yours into tens of thousands of dollars immediately. Rather than receiving your home-sale profit in monthly dribs and drabs for several years, you can get it now in one lump sum.
The attractions of selling to a loan broker or investor can be powerful, especially for consumers who never really wanted to own a "creative" note in the first place. But if you're in that category and thinking of turning your mortgage into money, you ought to know how easy it is to lose your shirt on the deal.
There is no simple cash price or value for your mortgage. You may get 95 cents on the dollar from one professional note buyer and merely 50 cents from another--all for the same high-quality, well-secured mortgage.
Take the experience of Jo Ann Ewalt of Silver Spring, for example. Ewalt telephoned mortgage brokers active in more than a dozen states to find out what a $70,000 seller-financed first mortgage would bring in today's market.
Ewalt's loan, like many written in the creative-finance boom years, carried a balloon payment after five years, but was amortized (paid off monthly) as if it were a 30-year mortgage. The interest rate was 11 percent, slightly below today's prevailing first-mortgage rates of 12 3/4 to 13 percent.
By normal investment standards, the note was of first-rate quality. The $667-a-month payments always had been mailed on time by the borrowers during the two years since they bought the house. The security on the loan was excellent. The house sold two years ago for $90,500 and is now worth at least $95,000. The couple who bought the property has an annual family income of about $50,000--well beyond the norm for a $70,000 loan.
In short, other than the 11 percent rate, Ewalt's note was what mortgage industry professionals term a "creampuff." But how much could Ewalt raise in cash for her high-quality note? Would you believe anywhere from $38,000 to $63,000?
That's not a typographical error: The range between the highest and lowest quotes was $25,000.
One firm with headquarters in New Jersey and branch offices in 11 states--the Money Store--offered $62,600 in cash for the note. The "discount" of $7,400 from the face value of the loan was designed to pull the effective yield on the mortgage up from 11 percent to 15 percent, according to Money Store executive Bill Segal. By a long shot, that was Ewalt's best bid on the loan.
In conversations with six other multistate loan buyers, Ewalt was offered:
$38,000 in cash, with $500 or $600 more to be subtracted for "settlement costs." The loan broker, U.S. Mortgage Investment Group of Rockville, also warned her to watch out for other brokers whose quotes might seem higher but actually were padded with hidden fees.
$51,000 in cash or a $35,000 loan "at no interest." Ewalt would assign the $27,000 in monthly payments remaining on the note to the broker. The broker would pocket that money permanently. Just before the final balloon payment came due on the loan, the broker would assign the note back to Ewalt. She then would be expected to repay the broker his $35,000 loan in full. Ewalt calculated that the broker's return on this "no-interest loan" would be in the neighborhood of 27 percent a year ($9,000 income a year on $35,000 principal) with hardly any risk involved.
Various other prices and terms, ranging between $51,000 and $54,000.
The wide disparity in quotes offered Ewalt suggests a couple of basic guidelines to follow if you're trying to determine what your seller-financed loan is worth:
Call as many different brokers or investors as possible. Intensive shopping is the only way you'll get the highest price available.
Ask brokers or investors whether they're approved by Federal National Mortgage Association to deal in first and second mortgages. Although Fannie Mae doesn't regulate such brokers, its stamp of approval is a good indication that the lender isn't in business simply to take you to the cleaners.
Don't accept brokers' estimates of discounts and yields over the phone at face value. Three of the brokers Ewalt talked to gave her erroneous estimates of the size of the discounts they were offering for her loan and the percentage yield to themselves. The broker who offered less than $40,000 for her $70,000 loan, for instance, insisted that the discounted yield he'd receive on her note was no higher than 18 percent. He was off by 100 percent.