Today, we’re going to give you a quick introduction to a new tool you can add to your real estate investing toolbox: seller financing!
WHAT IS IT?
In the conventional way of buying real estate, the buyer and seller sign a purchase agreement or “contract” which spells out that the buyer will pay the seller via cash or will obtain funds from a 3rd party lender. Upon closing of the deal, the seller receives funds for the purchase price of the home in full, minus closing costs, and the deed is transferred to the buyer. If a mortgage is used, the 3rd party lender then puts a lien, or claim, on the property, until the mortgage is paid off by the buyer.
Howver, in this method, the seller is acting as the lender. No 3rd party lender is used. Upon closing of the purchase agreement, the ownership in the house still transfers to you, then the seller then puts a lien on the property until you pay them off in full. This actually makes intuitive sense to most people, where only a buyer and seller are involved, but because home prices have gotten so high, mortgages from banks and other 3rd party lenders have become commonplace so the seller can leave the transaction upon closing with cash in hand.
The caveat to seller financing is that the seller of the real estate must own the property outright. Meaning, the seller may not owe a lender anything on the house if they wish to finance the property to you.
WHY USE SELLER FINANCING?
So why would we want to use this method? It makes sense for a buyer of course, because they don’t have to come up with a large amount of cash (10-20% downpayment) upfront like a bank or traditional lender may require. It often occurs with low or no money down due from the buyer.
In the seller’s case, they can get a higher purchase price for their home. To offset the higher down payment normally required, a seller can sell the house for a larger amount than the market may give them and then amortize the higher amount into the financed loan. The seller is also acting as the lender so they receive the interest on the loan that they are making to you, as opposed to you paying the interest to a 3rd party lender.
- Down Payment
You’ll need to discuss with the person selling how much money they will require upfront to purchase the property. Some sellers will want 10% down, some may not require any money upfront, but this means your monthly payment will be higher.
- Interest Rate
Next, you’ll need to discuss what interest rate the seller would like to receive on the “loan” that they are making to you.
- Loan Due Date
Finally, how long until the seller expects to receive the full amount for their property? 2 years? 5 years? 10 years? This often depends on the seller’s age and financial goals.
That’s basically it! To make things much smoother and make sure your seller financing agreement is agreeable to both parties, you may want to have a real estate professional or attorney write up a contract between both parties.
AN UNDERUTILIZED ADVANTAGE
Before we wrap up, let me address the stigma around this method and other unconventional ways of buying and selling real estate. Yes, house flippers and ultra-savvy investors use seller financing to structure their deals and yes, seller financing can turn out ugly if you’re not smart about it.
But, it is is a completely legitimate way to buy and sell real estate if you do it smart, have contracts in place, and obey the terms of the deal. Just like conventional financing, if you don’t make your payments or don’t obey the terms of the loan, something bad is going to happen. That should be no surprise in either seller financing or traditional financing.
Thanks for reading this week’s blog. If you want more info on real estate purchasing strategies, set up a call with one of our investment counselors here at Rent to Retirement and we’ll help you discover the most optimal way to acquire real estate and scale your portfolio that best fits your goals!