We've been looking at looming lender problems that could make seller financing the flavor of choice in the near future, and ways to build in profit spreads when buying and selling. There's yet another aspect to seller financing that has made fortunes for those who understand the secondary market.
The secondary market describes a situation where a lender, who originates a loan, sells it at discount to another lender for cash or for something he wants more than what he's got. This could be more secure paper, such as when he trades a second mortgage for a first mortgage; or it could be higher yield paper that he's prepared to give up some safety in return for yield, such as when he reverses the foregoing deal and trades his first mortgage for a second.
A seller might well be willing to discount and trade a loan that would amortize over 20 years for a loan that pays off in 7 years with higher payments. Who might the parties to this kind of transaction be? One might be an elderly person who needed the income. Who might the party at the other side of this deal be? How 'bout a Roth IRA owned by someone who had several decades before he could begin withdrawing funds from it?
Let me walk you through the process by which one California Company in the 70s made millions of dollars by discounting and re-discounting loans. First, it solicited investors to lend it money at 9% and secured these loans with its corporate stock. It used this money to buy loans from sellers who were selling their houses to owner occupants with seller financing, and who were willing to sell their loans at a discount immediately following the sale. A typical spread between the 9% interest paid for their operating cash, and the interest rate yield was 8%. Next, they used these notes, as collateral at their bank, to borrow even more money with which to repeat the process.
As the credit market tightened, they discovered that they could package their loans into million dollar bundles and sell them to small insurance companies for cash at comparable spreads. They could sell smaller loan packages to long term investors who wanted high yield and passive income. Every loan generated either a spread in the yield, or cash.
This became such a lucrative business that they expanded all over the region with high profile marketing campaigns in which they solicited both investors who wanted to buy loans, and sellers and their brokers who appreciated the fact that they made the house market much more liquid by being willing to buy seller carry back financing that was discounted to produce a reasonable profit for cash.
From time to time the borrower would default and they'd wind up with a house. They kept the more desirable houses as long term rental properties and retailed off the houses they didn't want to keep, carrying back the loans, and discounting them for cash into the investor market to produce reasonable safe yields. This is just one of the business opportunities waiting for someone to come along and seize the opportunity. Is there any reason this couldn't be you?
