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November 24th, 2009 by Dawn Rickabaugh
Deadly Mistake #6: Fail to include a provision for late payments and a due on sale clause in your note.
A couple I talked to recently had a one year old note that they were trying to sell. Not only were the terms of the note difficult to understand, but it failed to include a late payment charge, and didn’t have a due on sale clause.
“But yes!” they insisted, “see right here in the escrow instructions? It definitely states that the late payment fee for missed payments is 6%.”
Well, it’s comforting that you had great intentions, but apparently escrow failed to incorporate your instructions into the note documents, and you didn’t notice! Oops.
HEADS’ UP: escrow companies, title companies, real estate professionals, accountants and attorneys do not necessarily know much about putting together a strong note and calculating the numbers correctly; and unless they regularly buy and sell notes in the secondary market, they may not understand the financial significance of how the transaction is structured. That’s why it’s crucial that you work with a seller financing specialist/note broker when you’re putting your owner financing deal together]
Without a late payment provision, you have no way of covering yourself for financial losses when you have a Payor that regularly pays late.
Without a due on sale clause, the property could be sold and you could be receiving payments from someone you haven’t had the chance to underwrite (determine if they’re a good risk or not). Also, what if interest rates are higher? Wouldn’t you like the chance to improve your return?
Smart tip: Make sure your note includes a late payment fee, and make sure the note and deed contain the due on sale (acceleration or alienation) clause.
You’ll have to check with the guidelines in your state, but usually a 6% late fee with a 10-15 day grace period is acceptable.
Put the due on sale clause in both the note and security instrument (deed of trust or mortgage). It might sound something like this:
“If the trustor shall sell, convey or alienate said property, or any part thereof, or any interest therein, or shall be divested of his title in any manner or way, whether voluntarily or involuntarily, without the written consent of the beneficiary being first had and obtained, beneficiary shall have the right, at its option, to declare any indebtedness or obligations secured hereby, irrespective of the maturity date specified in any note evidencing the same, immediately due and payable.”
Also, if it’s permitted by law, include a prepayment penalty if you’re trying to defer capital gains and don’t want to be paid off early. Generally things are more regulated for residential properties that serve as the Payor’s primary residence. It’s usually easy to enforce a prepayment penalty on investment and commercial properties.
This excerpt is taken from “Seller Financing on Steroids: Pumping Paper for Power, Peace and Profits,” a guide that can be downloaded for free at: www.NoteQueen.com.
Always consult with your CPA, tax attorney and/or financial advisor before selling property or paper.
Dawn Rickabaugh is a RE broker with expertise in seller financing and RE notes (trust deeds). www.NoteQueen.com 626.641.3931