If you own a property free and clear of any debt, then you’re in a powerful position when it comes to selling your property. People often give that position away to banks, title companies, and others who look to gain from your asset. If you own real estate property, here is some powerful information you should consider to offer seller financing.
As a property investor I am often blown away that most people will not even consider offering seller financing on property they’re selling. Without hardly any consideration, I get told NO almost immediately when I ask a owner if they would consider seller financing. To be clear, I’m a highly-qualified buyer with a track record of owning and renting real estate, but owners prefer for me to get money from a bank and to give them that cash. By doing this, they’re leaving more money on the table than they have even considered! In this article I’ve included a break down of how much money you are losing, I define the risks, and I offer ways to mitigate that risk. Let’s take a look at the basics of seller financing.
What is Owner Financing?
Since mortgage rates have been low for some time, it’s been advantageous for buyers to seek bank financing because they offer good rates. Owner financing was much more common prior to the 1980s and 1990s, when banks required high down payments and charged higher interest rates. People sought relief from other people, and it worked. Interest rates have declined year over year since 1981 and so have the requirements for credit and down payment. Since then, banks have worked themselves into the vernacular of becoming the “traditional financing” model, one they hope to preserve (for their own sakes).
If you own a property free and clear, you can be the bank to another individual, and we all know what banks do well – make money! Why give away your money so freely? Let’s looks at an example, based off the assumption that you’re going to sell a property for $100,000. In this scenario, let’s look at how much money you walk away with at closing:
Buyer Gets Bank Financing
Down Payment: $10,000
Loan Amount :$90,000
Loan Term: 30 years
Interest Rate: 3.0%
Mortgage Insurance: $50/monthly
Buyers Monthly Payment to Bank: $429.44
Total Amount Buyer Pays Bank: $136,599.71 + $19,000 in Mortgage Insurance
Total Amount Paid to the Realtor (at 6%): $6,000
Total Amount Paid to the Seller: $94,000
And there are other fees such as title search, escrow fees and the list goes on!
If you haven’t lived in the home 2 of the last five years, you will also pay capital gains taxes. Let’s say you bought the home for $50,000 and are selling it now for $100,000. This means you may pay capital gains taxes on $50,000 of AT LEAST 15% (depending on your tax bracket) or $8,500.
Amount you walked away with at closing, after taxes: $85,500.
Amount you walk away with over the course of the contract: $85,500.
Buyer gets Seller Financing
Down Payment: $10,000
Loan Amount: $90,000
Loan Term: 15 years
Interest Rate: 6%
Mortgage Insurance: $0
Buyers Monthly Payment: $759.47
Total Amount Paid to the Realtor (at 6%): $6,000
Total Amount Paid to the Seller: $94,000
Total Amount Buyer Pays Seller: $136,704.81
There are no fees (unless agreed upon between the buyer and the seller). Your capital gains taxes can be deferred, meaning that seller-financing a home is better, from a tax perspective, on the buyer and the seller.
Amount you walked away with at closing, after taxes: $10,000 (down payment)
Amount you walk away with over the course of the contract: $146,704.81.
And you get to pay any capital gains over the course of the contract instead of one large chunk!
What Did You Earn by Giving Away $60,000?
According to the example above, what did you earn by giving away over $60,000? First, you got paid in full, money in the bank. You can take the check given to you at closing and put it in your bank. You can spend it however your please. You got to take your money and run, and you never have to deal with any issues arising with the property. Is that worth $60,000 to you? Let’s take a look at what you really earned, or gave away:
Peace of Mind
You don’t have to worry about the buyer’s check or any of their payments. Whatever issues arise for them over the course of 15 years will not impact you at all. You don’t have to worry about the buyers not being able to afford to pay you, or being late. Lastly, if they fail to pay altogether, the bank will handle the eviction and foreclosure.
Can I tell you a dirty secret? If the buyer doesn’t pay and your foreclose on them, you still own the property. All of the money they have paid them is non-refundable. Unlike a bank, you can choose to fix it up and sell this house again, this time for a lot more money. Let’s examine this scenario:
If they paid you for five years, they will have paid you more than $70,000. Remember they only financed $90,000 for you. Let’s assume they did some damage to your property and you need to invest a few thousand dollars to get it to a state to resell it. This time, you sell it for $125,000 to a buyer, financing it for 15 years. You will again get another down payment to recoup any losses you might’ve had incurred during the foreclosure. Now you know how a bank feels, you’re indeed making more money off this sell than you ever imagined you might. This might come with a few uncomfortable months having an attorney evict original buyer and then hiring contractors to repair damage, but you are still making out like a bandit bank.
Lump Sum Cash
Let’s go back in time and pretend that you sold your property in 2005, and this month in 2020 your buyer made their last payment. The cash equivalent to $100,000 in 2005 is now $135,036.26 in 2021, due to inflation. So not only did the bank make out by giving you a lump sum, they made out by charging the buyer a lot of fees and interest, none of which was a benefit to you. Because you want your money now, are you willing to give away another $30,000 (In addition to the $60,000 you gave away by allowing the bank to leverage your asset)?
If you plan on living 15 or more years from today, you would be giving away more than $90,000 by allowing a bank to leverage your asset! Do you think you’ll need or want $80,000 in 15 years?
Barriers to Seller Financing
So why isn’t everyone seller financing their property? Simple, most home owners need to buy another house, and can’t keep their cash tied up if they want to qualify to buy another home. If you’re an investor or are a selling non-owner occupied home, then you may be able to finance it. So what are the other barriers? Perhaps you don’t know how to draw up an agreement, protect your property, or are concerned you’re going to get scammed or lose money. I help you address these issues below.
Protecting the Buyer and the Seller
Have a good real estate attorney draw up the necessary documents, explain to them your concerns and make sure they address your concerns in the document. You can even pay a title company to dot all the I’s and cross all the T’s. A good attorney will make certain the transaction is lawful in your state and with applicable federal laws, like the Dodd Frank Act. A good lawyer will also include language that will protect you. For example, they will define what qualifies as default, what the process of late payments/fees are, what the terms of foreclosure are and more. He can suggest the proper protocol in your area such as transferring deed to the seller than putting a 1st position lien on the property.
Insurance and Taxes
You can require the seller to pay the insurance and taxes to you and you can pay the insurance company and the taxes on the property yourself. This can be set up fairly easily and protect your property until it’s paid in full.
What If I Change My Mind and Want to Cash Out Later?
Have you ever borrowed from bank 1, only to be informed that bank 2 is now servicing your loan? That’s happened to most Americans, and you can do the same thing! If at some point you decide to cash out, you can sell the note to a lender!
I Don’t Know How to Find Qualified Candidates
You should not sell your home to first person that walks through the door with enough cash for a down payment. If you offer seller financing, you will get lots of interest in the property, and some of it will come from individuals who don’t have the intention on paying you off, and some individuals who intend to pay you off but find out they cannot. To find a qualified buyer, you need to set standards just like banks do (or higher). Make certain they are responsible people by running a background and credit check on each adult who is going to be on the mortgage. Then, call their boss, their employer, call their references and make certain they meet all of your qualifications. Here’s an example of some basic qualifications to screen applicants:
1. Must have verifiable income of AT LEAST 3 times the mortgage payment. You can even make it 4X to give yourself some extra comfort.
2. A credit score of at least 650 and no late payments for the last 3 years.
3. A background report that shows a history of responsibility.
4. Must have been with their current employer for at least 3 years.
These are just a few to get you started, but you are the bank, you set the standards, set them high! Your ad offering seller financing will garner hundreds of responses. Before you make an ad, set up your qualification standards, make an application and application fee. Require the applicant to pay for credit and background reports. Call employers, references and relatives – good applicants do not care if you’re doing your due diligence – a bank will do the same thing to them. If they do mind, you don’t want to sell them your property.
I Don’t Want the Hassle
So you don’t want to pay the taxes and insurance or receive payments? Then you can find a licensed and qualified loan servicer that will do all of that for you, for a fee.
Work Hard to Sell Your Property
I personally look at a lot of houses for sale, and I talk to a lot of property owners. When I mention seller financing, I’m hit with a hard NO almost immediately and almost every single time. I’m always puzzled by property owners who are literally turning down double the money that the bank is going to give them for their home. There are some circumstances that do make sense, but sometimes it simply does not, except that the owner is telling me they don’t want to do the work to earn the money. You worked hard to earn the money to buy that house, why not work hard to sell it to make a lot more money? I’d love to help you answer any more questions you have, please contact us to submit a question or offer feedback to this article.
Set Terms You’re Comfortable With
When it comes to seller financing, you can set just about any terms you want to make you comfortable with the sell of the property. Want to charge and application and fee to get the process going? Banks do this all the time and call it an origination fee! Want to require the buyer to make a balloon payment in 2, 5 or 10 years? Want to make the rate adjustable? Want to be able to inspect the property anually? Just about any term you can think of are open to negotiation between you and the seller.
Legal Disclaimer
I am not an attorney, a CPA, or a real estate professional. I am not qualified to give legal, tax or real estate advice. My advise is based off of research, reason and good, old-fashioned common sense. You should always pay a qualified attorney, CPA and real estate advisor to give you advice that is legal in your state and on the federal level.