Get Creative with Seller Financing
What is Seller Financing?
Seller financing, or owner financing, is a financing strategy where the seller takes the place of the bank. The conveyance takes place now, and the seller is paid over time in installments, with interest. The buyer will usually execute a mortgage and promissory note at closing, just like they would do with an institutional lender.
When does Seller Financing make sense?
Seller financing can be a perfect fit for the right situation, but it won’t make sense in the majority of deals. First, you have to have a seller who either has no mortgage, or the balance on the mortgage is less than or equal to the buyer’s down payment. There are two reasons this is critical: one, the seller is going to take a mortgage from the buyer, and they will want to make sure that mortgage is in first position to protect their security interest; and two, all mortgages have a “due on sale” clause, which means that conveying the property is a default on any existing mortgages and trigger’s the lender’s right to foreclose.
You also need to have a Seller who is willing to defer their payment over time. Given the choice, the majority of people prefer to have a smaller amount in a lump sum, rather than a slightly larger amount spread over several years. This is especially true if the reason they are selling is to use those funds to purchase another property or asset in the short term. However, there are benefits to the seller deferring payment. The total amount will usually be higher since they will charge whatever interest rate they negotiate with the buyer; also, the tax impact will be spread out over a few years rather than all at once, which could be useful in a larger tax strategy.
You’re going to want to have a special buyer for a seller financed transaction as well. A buyer may turn to seller financing by necessity, if there is some reason conventional financing is unavailable. This could be because of some problem with the buyer’s credit (a foreclosure in their recent past, for instance), or because of a problem with the property that makes it unfinanceable. A buyer may also look for a seller-financed transaction even if they could obtain a conventional mortgage loan, since every aspect of seller financing is negotiable. A savvy buyer may be able to negotiate better terms, or perhaps just custom terms that fit their strategy better than a conventional loan would.
Here is an example of a classic seller-financing transaction. A landlord who owns their rental property outright has become tired of managing the property and tenants. They are getting ready to retire, and want a steady income, which is the reason they bought the investment property to begin with. An investor approaches the landlord, and offers to purchase the property and take over the leases. The buyer’s goal is to purchase three buildings this year, and the landlord’s building fits the profile perfectly. In order to achieve the buyer’s goal, she can only come up with 3% down on each transaction, so traditional financing is out. The buyer offers 3% down if the seller will finance the rest. They agree to an interest rate that is slightly higher than a conventional rate, but lower than hard money. The loan is amortized over 30 years, but with a 10-year balloon, so the seller knows he will be paid in full during his retirement. They close the deal, the buyer signs a promissory note and mortgage in favor of the seller at closing, and five years into the loan the property has appreciated enough that the buyer can refinance with a traditional lender, which she does and pays the seller in full.