CREATIVE FINANCING - SELLER FINANCING
The Definitive Guide to Using Seller Financing to Buy Real Estate
What is Seller Financing
Seller financing is just what it sounds like: the seller provides the financing. In other words, the owner of the property acts as the bank and, although legal ownership is changed hands, the payment is sent directly to the previous owner rather than a bank.
For example:
I want to purchase a particular rental house but do not want, or lack the ability, to get traditional bank financing. The seller would like $100,000 for the property, but is willing to “carry the contract” – which is investor jargon for someone who agrees to finance a property they own. The owner asks for $5,000 down and a 7% interest rate on the remaining $95,000 amortized over 30 years for a monthly payment of $632.03. I agree to his terms and after doing my due diligence, I close on the property through my local title company. I then look for a tenant who rents the home for $1400 per month and collect the cash flow difference each month.
In the scenario above, the seller gets a good, fixed interest rate on their money, I get to buy the house for just $5,000 down, and I don't have to deal with a bank at all. Seller financing can be another great win-win for all parties involved.
Why Would Sellers Sell Via Seller Financing?
If I gave you the choice of getting $100 today or $1 per month for the next 30 years, which would you take?
Most of you would want the $100 right now, but if you do the math – $1 per month for 30 years is $360, which is more than 3x more than the lump sum! How about now? Did you change your mind? Doubtful. Chances are you still would want the $100.00 because of your current position in life – you would rather have $100 now than $360 spread out over many years. However, others may choose to take the $1 per month, because they don’t need the cash now and would rather have the security of a monthly dollar.
The same principle is true for home sellers. If a home owner owns their home free and clear, many of them would rather just get the cash and move on. However, for a large number of sellers, the value of getting monthly payments outweighs the need for a large check. Let’s take a closer look at why owners would choose to sell via seller financing as opposed to just getting cashed out.
Monthly Income: Perhaps the most common reason sellers would prefer to sell via seller financing is to get monthly income. Just like in the example I used above, with the $100 or $1 per month – there are a lot of individuals who would simply prefer to get steady checks each month instead of one lump sum. This is especially true for older sellers, who need monthly income to survive and pay the bills. A $100,000 chunk of money would only last so long for an older seller, but if that income is financed over 30 years, the money will last them a lot further into retirement.
Better ROI: Many homeowners and investors choose to sell with seller financing because the interest they get from the financing is greater than they will likely get elsewhere. For example, if the homeowner were to sell a home for $100,000, they could put that money into a Certificate of Deposit at the bank to get 1.5% APY… or they could seller finance their home and get 8%. Which is better? Many seasoned real estate investors understand this concept and eventually move their portfolio from a "holding" phase to a "selling phase" where they use seller financing to unload the hassle of being an owner but still collect monthly income by carrying the contract and providing seller financing. At that point, the investor leaves the "landlord" business and enters the "note buying" business.
Spread Out Taxes: Anytime you make money – the government wants it’s share, and when you sell real estate it’s no different. This issue may not be as important for homeowners, because of the IRS rule that allows homeowners to avoid paying taxes on up to $500,000 in profit from selling their primary residence – as long as it meets certain specific criteria. However, investors are not so lucky and are forced to pay taxes when they sell. For example, if an investor spends 30 years paying off a rental property mortgage, and now owns the home free and clear – and decides to sell the property for $100,000 – the investor would need to pay taxes on that $100,000, which could result in a nearly $50,000 tax bill. Additionally, the investor will also need to pay a “recapture of depreciation” tax that could add much more to that tax bill. Therefore, many investors choose to the seller using seller financing rather than getting a lump sum, in order to defer most of those tax payments. You see, the IRS has special tax rules for installment sales, such as using seller financing, so the seller may only need to pay a small portion of that tax bill each year while the loan is being paid off.
Can’t Sell Otherwise: As mentioned in the previous section, many properties simply are not sellable to a typical bank-financed borrower. Offering seller financing can provide a way for the seller to unload a property without needing to do the work to fix it up.
Do You Own Your Property Free and Clear?
Then this creative finance strategy could be for you!
Do You Want Some Additional Monthly Income Without The Worries Of Maintaining The Property
Then this creative financing strategy could be for you!