Property Owners, we’re going to upgrade you from being the Landlord, to being the BANK. The Banks are making all the money, with out any of the Landlord hassles. Seller financing is one of the best passive income methods in real estate, and a great path to retirement. YOU BE THE BANK! Seller financing, also known as owner financing or seller carryback, is a method of purchasing real estate where the seller acts as the lender and provides financing to the buyer instead of the buyer obtaining a traditional mortgage from a bank or financial institution. In this arrangement, the buyer makes regular payments to the seller, typically including principal and interest, over an agreed-upon period of time. Seller financing is ALWAYS done through a Title company or Real Estate Attorney, it is as official as any Bank Loan and Lien.
Here are some of the advantages for sellers associated with seller financing:
- Increased accessibility: Seller financing offers an alternative option for buyers who don’t want to use banks that may have more upfront loan costs, more red tape and higher interest rates. It provides an opportunity for buyers to secure financing and purchase a property that they might not otherwise purchased if we had to work with a bank.
- Flexible terms: Unlike traditional lenders, sellers have the flexibility to negotiate and customize the terms of the financing arrangement. This can include aspects such as the interest rate, repayment schedule, and the duration of the loan. Buyers and sellers can work together to create terms that suit their individual needs.
- Streamlined process and Faster Sale: Seller financing can streamline the purchasing process by eliminating some of the complexities and delays associated with traditional mortgage loans. Without the involvement of a bank, there may be fewer requirements, fewer fees, and a quicker closing process.
- Potential cost savings: In most cases, seller financing can result in cost savings for both the buyer and the seller. Buyers may avoid certain fees typically associated with obtaining a mortgage, such as origination fees or private mortgage insurance (PMI). Sellers, on the other hand, just like banks, can earn interest on the loan and achieve a higher sale price by offering financing.
- Negotiation power: Seller financing can provide an advantage in negotiations, as it allows buyers to present a more attractive offer to sellers. Since the financing is being provided by the seller, they may be more willing to negotiate on the purchase price or other terms of the agreement.
- Investment opportunity: For sellers, offering financing can be an investment opportunity that generates a steady stream of monthly income through principal and interest payments. It allows them to spread out the tax liability and capital gains taxes over time and potentially achieve a higher overall return on their investment. I’ll discuss tax benefits next:
Concerned about large capital gain tax penalties? Consider these advantages with Seller Financing:
When a seller chooses seller financing for the sale of their property, instead of receiving a lump sum of cash, it can potentially help them save on capital gains tax. Here’s a brief explanation of how this strategy works:
- Installment Sales: By using seller financing, the seller can structure the sale as an installment sale. In an installment sale, the seller receives payments from the buyer over time rather than receiving the entire purchase price upfront. This allows the seller to spread the recognition of the gain over the duration of the installment period.
- Capital Gains Tax: When a property is sold, the seller typically incurs a capital gains tax on the profit they make from the sale. The capital gains tax is calculated based on the difference between the property’s selling price and its adjusted cost basis (original purchase price plus improvements and certain expenses). The tax rate on capital gains can vary depending on factors such as the seller’s income and the holding period of the property.
- Deferring Tax Liability: By opting for seller financing, the seller can defer the recognition of the full gain and the associated tax liability. Instead of paying taxes on the entire gain in the year of sale, the seller pays taxes on the portion of the gain received each year as payments are made by the buyer. This spreading out of the gain over time can potentially help the seller stay in a lower tax bracket, resulting in reduced tax liability.
- Amortization and Interest: In an installment sale, the seller receives principal and interest payments from the buyer. The interest portion of each payment is taxable as ordinary income to the seller. However, the principal portion of the payments is considered a return of the seller’s basis and is not subject to capital gains tax. Over the course of the installment period, as the principal is gradually received, the seller’s taxable gain decreases.
- Consultation with Professionals: It is essential for sellers considering this strategy to consult with tax professionals such as accountants or tax advisors . They can provide guidance on the specific tax implications based on the seller’s individual circumstances and ensure compliance with tax laws.
It’s important to note that tax laws are complex and subject to change so run this by a CPA who specializes in real estate transactions. Sellers should always seek professional tax advice, and carefully consider the implications of seller financing on their specific tax situation before making any decisions.
How is my lending investment(my Money) protected with seller financing?
When using seller financing to sell your property, there are several ways in which your money is protected. Seller financing, also known as owner financing or seller carryback, is a real estate transaction where the seller acts as the lender and provides financing to the buyer. Here are some ways your money is safeguarded, just like banks count on for their protection when lending on real property:
- Down Payment: You can require the buyer to provide a substantial down payment as a percentage of the purchase price. This upfront payment helps ensure the buyer’s commitment and reduces the risk of default. Remember that past the down payment, the more you seller finance, the more interest you make as a seller. Down payment is considerable skin in the game that the buyer would loose, along with payments made, if the buyer stopped paying.
- Mortgage or Deed of Trust: As part of the seller financing agreement, you can create a mortgage or deed of trust on the property. This document serves as a lien on the property, giving you a legal claim to it until the buyer fulfills their payment obligations. Always close with a title company or real estate lawyer and they will have the promissory note written up and filed publicly. The Seller can secure their position as the first lienholder on the property. This means that in the rare event of default or foreclosure, you have the first right to recover your investment from the proceeds of the property’s sale before any other creditors or liens are paid.
- Promissory Note: A promissory note is a legal document that outlines the terms of the loan, including the amount borrowed, interest rate, payment schedule, and consequences of default. By having a well-drafted promissory note, you establish a clear record of the debt and the buyer’s obligations. Always close with a title company or real estate lawyer and they will have the promissory note written up. It’s crucial to define the consequences of default in the promissory note or mortgage agreement. This includes outlining the steps for curing default, such as providing a grace period for missed payments, charging late fees, or initiating foreclosure proceedings if necessary.
- Credit, Background Checks and Due Diligence of Buyer: Before entering into a seller financing arrangement, it’s advisable to conduct a credit and background check on the buyer, also references and business plans may also be appropriate. These extra due diligence steps about the buyer helps evaluate their financial capability and reliability, reducing the risk of potential payment issues. Although due to all the other points in this article, often this due diligence is not performed.
- Property Insurance: You can require the buyer to maintain adequate insurance coverage on the property, naming you as an additional insured or loss payee.
- Escrow and Loan Servicing Companies: Utilizing an escrow or servicing company can help facilitate the payment process and ensure proper management of funds. These companies act as intermediaries, collecting payments from the buyer and disbursing them to you. They will also provide detailed accounting records and monitor payment compliance and while the fee for using this third party service is negotiable, the buyer often pays for it as part of their monthly payment, typical costs are 17$-45$ a month and around a 100$ as an initial set up fee. We typically have the buyer pay for the loan servicing fees but keep in mind many sellers don’t use loan servicing companies and just have the buyer set up a monthly wire going directly into their bank account and they keep track of the simple accounting. Three recommendations for loan servicing companies are Polaris Management at polarismgmt.net, August REI at augustrei.com and Allied Servicing Corporation at allservicing.com
- Title Search and Title Insurance: We ALWAYS close with a Title company or Real Estate Attorney. Conducting a thorough title search before entering into the seller financing agreement helps identify any existing liens or encumbrances on the property. Purchasing title insurance will further protect your investment by providing coverage against any undiscovered title issues that may arise.
By implementing these measures, you can mitigate the risks associated with seller financing and safeguard your investment in the property.
Let’s Talk TERMS
When considering and negotiating loan terms for seller financing, several factors come into play. Terms are negotiable and are a serious consideration in Seller Financing. if the Here are some key loan terms that are often considered and may be negotiable:
- Purchase Price: The agreed-upon purchase price of the property is a fundamental aspect of seller financing. Both parties need to determine a fair and acceptable price for the property, taking into account its market value and any potential contingencies. Typically if a Seller wants a top price for their real estate than a Buyer should seek gracious terms and vice versa, but again, every thing is NEGOTIABLE.
- Down Payment: The down payment is the initial amount paid by the buyer towards the purchase price. It’s typically negotiable and can range from a small percentage to a substantial sum. A larger down payment reduces the loan amount and potentially mitigates the risk for the seller. Sellers make more money on interest allowing a lower down payment. I have been a part of deals where there has been NO DOWN PAYMENT, so keep that in mind when negotiating.
- Interest Rate: The interest rate determines the cost of borrowing for the buyer. It is negotiable between the seller and the buyer, although it should align with prevailing market rates and consider the risk profile of the transaction. Negotiations can determine whether a fixed, adjustable, amortized, or simple interest rate will be used. In an amortized interest loan, each payment is divided between paying off the principal amount borrowed and the interest charged on the remaining balance. Initially, a larger portion of the payment goes towards the interest, while the remaining amount reduces the outstanding principal. As the loan progresses, the interest portion decreases, and the principal portion increases until the loan is fully repaid by the end of the agreed term. Simple interest loan, on the other hand, is a straightforward method of calculating interest based solely on the outstanding principal balance of the loan. In a simple interest loan, the interest is typically calculated on a daily or monthly basis, depending on the agreed-upon terms. Unlike amortization, the principal balance does not decrease over time with simple interest alone. Instead, the buyer must make additional principal payments to reduce the outstanding balance. The repayment term for a simple interest loan is typically shorter compared to an amortized loan since there is no systematic reduction of the principal balance through regular payments. Simple interest loans may be suitable for shorter-term financing arrangements or situations where the buyer plans to refinance or sell the property before the loan term concludes. It can also provide flexibility if the buyer intends to make lump-sum principal payments periodically. Negotiations can also determine whether the payments will be interest-only or include both principal and interest.
- Loan Term: The loan term refers to the duration of the loan. It is negotiable and can vary based on the preferences of both parties. Common loan terms for seller financing range from a few years to several decades. The length of the loan term affects the monthly payment amount and the total interest paid over time.
- Payment Schedule: The payment schedule determines how often the buyer will make payments. Monthly is the most common schedule, paid at the beginning of each month on or before the 5th day of each month. It can be monthly, quarterly, annually, or in any other agreed-upon interval.
- Prepayment Penalty: A prepayment penalty is a fee charged to the buyer if they choose to pay off the loan early. It is negotiable, and the seller and buyer can discuss whether to include such a penalty or waive it altogether. We do not typically have prepayment penalties, but if part of the negotiation was that Seller was promised a certain amount of interest, then a prepayment may be called for.
- Default and Remedies: Negotiations can define the consequences of default, such as missed payments, and the remedies available to the seller. This includes outlining the grace period for missed payments, late fees, foreclosure procedures, and any potential recourse the seller may have in case of default.
- Balloon Payment: A balloon payment is a lump-sum payment that becomes due at a specific point during the loan term. It is negotiable, and the parties can agree on whether to include a balloon payment, its amount, and when it is due. Balloon payments are often used in seller financing to structure shorter-term loans with lower monthly payments.
It’s important for both the seller and the buyer to carefully consider these loan terms and negotiate in a manner that aligns with their respective goals, financial circumstances, and risk tolerance. Getting the paperwork correct at closing from a real estate attorney, Title company, and your Real Property Hero investor who writes up the initial contracts, is a must to ensure that the negotiated loan terms are fair and compliant with relevant laws and regulations.