A big cash down payment is what makes a seller-financed note safe: the payor has money to lose if he stops paying. But how do you know the down payment was really made? This case from a note buyer’s files shows how one deal unraveled when the seller couldn’t prove it.
A first deal that looked good on paper
Mandy Goldblatt, a new note broker, was all smiles when she stopped by our office. She had a note for my firm to buy, secured by a first lien on some acreage near Edinburg, in the southern tip of Texas.
“I’ve tried for six months to find a note holder who wants to sell!” she bubbled. “This is my first deal! The seller signed my agreement! When can we close? The seller needs his money fast!”
The security was a five-acre parcel near the Mexican border, bought by Jesus and Maria Garza for $62,000. They paid the sellers, Manuel and Gloria Martinez, $25,000 cash down and signed a note to the Martinezes for $37,000.
| Item | Amount |
|---|---|
| Sale price | $62,000 |
| Cash down payment (claimed) | $25,000 |
| Note carried by the sellers | $37,000 |
It looked good, so I agreed to start our due diligence right away and to close as soon as everything checked out.
The first warning sign: a do-it-yourself closing
I started by reviewing the papers. I quickly saw that no closing agent or real estate agent had been involved in the sale. There were some typos, but nothing serious that couldn’t be corrected. The seller and buyer had negotiated the closing and prepared the papers themselves.
I see warning flags when sellers and buyers close their own deals. Sometimes those deals are just fine, but they’re often full of errors and omissions. I put that in the back of my mind and kept going.
I interviewed the seller, Manuel Martinez. He owned ten acres where he lived, on the main road through McAllen, Texas. He needed money, so he sold five of his acres to the Garzas. He said the five acres had an abandoned taco stand, an underground shelter and a shed. There was also a motorhome on the property, where one of the Garzas’ relatives lived, but it wasn’t part of the security.
Why a notarized statement isn’t proof
I explained to Mr. Martinez that because no third party closed the transaction and no real estate agent earned a commission, I had to insist on proof of the $25,000 down payment. It was certainly a good, secure lien, as long as the Garzas really paid that much cash down.
“No problem,” he said. “I can easily prove the $25,000. I’ll fax it to you now.”
A few minutes later I received a notarized statement, signed by both the Martinezes and the Garzas, saying the Garzas had paid $25,000 cash down. I wondered why Mr. Martinez thought a mere assertion was proof of payment. So I called him back.
“Mr. Martinez, I appreciate the statement, but it’s not enough. I want to be sure the Garzas have $25,000 to lose if they don’t pay their note. A notarization only means these are the real signatures. It doesn’t prove that the facts in the document are true.”
“Jesus Garza paid me the $25,000 cash in front of the notary,” he said. “If she signs an affidavit that she saw the money change hands, will that be good enough?”
“That’s great,” I said. “It’s an acceptable way of proving that a cash down payment is really cash.”
When the stories don’t match
I called the notary, Yolanda Torres, a sweet lady who ran a small accounting and notary business from her home.
“I have to tell the truth, señora. I did not see any money. I just notarized the papers. I can’t sign an affidavit about something I did not witness.”
I told Mr. Martinez what she said. He suddenly remembered that he and Mr. Garza had gone into the next room at the notary’s office to exchange the money. That was very suspicious, so I looked into other details of the note.
The IRS lien
The public records showed a $32,000 IRS lien against the sellers, the Martinezes, filed before the sale to the Garzas. Mandy checked with Mr. Martinez. Yes, the lien was owed, and they planned to pay it off from the note sale. That made sense; many note sellers sell notes to pay the IRS.
But something else didn’t. Why would the Garzas pay $25,000 cash for a property with the seller’s IRS lien still attached? No one wants a seller’s old debts attached to property they paid good money for.
Interviewing the payor
So I called to interview Mr. Garza, and immediately hit a problem: he didn’t speak a word of English, and my high school Spanish was long gone. Luckily, a friend who grew up in Spain agreed to translate, after warning me that Mexican Spanish differs from the Spanish of Spain, much as American English differs from British English.
Mr. Garza was guarded and concerned. We thanked him for his time, asked several questions about the property, then got to the real question: did he pay $25,000 cash to Mr. Martinez when he bought the property?
“Sí.” One hurdle cleared. Then we asked where he was when he paid it. At home, he said. Did he get title insurance? “No.”
That was too many wrong answers. The most troubling: Mr. Martinez said the cash was paid at the notary’s office, and Mr. Garza said it was paid at home.
The deal killer and the warning signs
I told Mandy about the discrepancy. By then I didn’t believe the $25,000 had been paid at all. As a last resort, I suggested getting a copy of Mr. Martinez’s tax return for the previous year. It should show an installment sale of $62,000, with $25,000 down, a $37,000 note carried and interest received on the Garza note.
Mandy checked and came back with another wrong answer: “He hasn’t filed yet.”
I have learned from experience that too many warning signs mean a bad note:
- The seller can’t prove the down payment.
- No disinterested escrow did the paperwork and disbursed the money.
- No real estate agent was involved and no commission was paid.
- No title insurance was issued to the payor or the seller.
- No closing statement was available.
My guess is that Mr. Martinez had trouble selling the five acres and only pretended to sell to Mr. Garza. He made it look like a sale so he’d have a note to sell to pay off the IRS. I told Mandy I had to reject the note.
It’s sad to give bad news to a first-time broker, but Mandy got the message and learned the lesson. She isn’t giving up, and when she finds her next note, she’ll make sure the down payment can be proven.
