The freedom to choose terms that meet the needs of both buyer and seller is one of the greatest benefits of seller financing. With a conventional loan your payment is due the first of the month, the interest rate is locked in (or the adjustment is controlled by external factors), and the term doesn’t change. With a seller financed note all these items can be more flexible.
This can be a real benefit in negotiations between buyer and seller as well as increasing the safety of the note. Flexible terms may also help the buyer or seller without cost to the other party. How does this work? Consider these examples.
The payment doesn’t have to stay the same. An elderly seller may not want to commit to a thirty year loan. The buyer may not be able to afford the payments if the loan term is shorter. “Balloons are for Clowns.” is an old rule that says balloon payments are a bad idea. However, if the payments have reasonable increases each year, or at preset intervals the payment can be affordable, yet pay off the loan in an acceptable time period.
Why don’t banks offer these options. Banks want all their mortgages to be identical so they can bundle them up and resell them. Doing loans with non-standard terms would me they have to hold the note themselves and most don’t want to do that.
The interest rate can also change. Conventional loans with adjustable rates were popular. However, with private notes the interest rate changes can be used for purposes other than protection from prime rate increases. Have you noticed how car dealers will offer you a choice of zero percent interest on your car loan or a lower price if you pay interest. That works with home loans too.
If you raise the sales price (loan amount) and lower the interest rate more of the monthly payment will go to principle and less to interest. For the seller that means more capital gains type income and less interest income. Depending on the sellers tax situation this can be significant. For the buyer it means they will have less interest to deduct but they may not need more deductions anyhow. It all depends on the individual situation.
I have only touched the surface of what can be done with seller financing but it should give you an incentive to think creatively if you find yourself negotiating seller financing from either the buyer or the sellers side.
{ 10 comments… read them below or add one }
I am considering selling my home w/owner financing. What are the typical pitfalls of owner financing? How can I protect myself in the event that the buyer defaults ? Do I get to hold onto my title until the payoff? What is the difference in the process of eviction should the buyer default between a bank owned loan and an owner financed loan?
I think the biggest issue is not spending the time and money to get the paperwork prepared properly. Related to that, I think the only difference between how a defaulted bank loan and a defaulted private loan is handled is the bank used tested, attorney drafted, paperwork. The laws the govern the process, notice requirements, etc. are the same.
I am selling my home with owner financing. How do I claim capital gains taxes and when. Can I claim them at the end of the financing?
If you are selling your personal residence I don’t think there are capital gains taxes unless you get over some amount. ( I am not a lawyer and not current on tax law so you need to verify the details.).
Each payment on your note is composed of interest plus a return of capital/profit. Suppose you purchased the house for $250,000 and sold it for $300,000 (net of selling costs). Your profit percentage would be 50,000/300,000 = 16%. Using some made up numbers lets suppose you start getting payments of $3,000 per month. If you made long term loan in the early years most of that $3.000 is interest which you report as interest income from a seller financed mortgage. Lets suppose that of the $3,000 payment $100 was principle ( You can get the exact amounts from an amortization table.) If your transaction is taxable 16% of that $100 principle payment would be taxed as capital gain. The other $84 is just a return of your capital and therefore not taxable.
In other words, you pay capital gains taxes as you actually receive the income.
In my situation I often found it useful to file an automatic extension in the year of the sale and wait until the last possible day to file my return for that year. Lots of my owner financed deals (to VERY marginal buyers) came apart during that time and were much easier to unwind if a sale had not yet been included on my tax return.
Good luck with your sale and if you need to sell the note after it has seasoned for awhile, send me the details so I can work up a purchase quotation for you.
I am owner financing a home. How do I check the buyer’s credit? I tried Equifax but when I finally got through to a live person, I was transferred several times back to the automated service. I appreciate your time.
Laura
I believe that if you go in person to a local credit bureau office they can provide one. You will need a signed release from the buyer before they will do anything.
I am probably about to owner finance my home and am moving out of the country. We are screening our buyers and have one that is going to be able to pay about 6% down. I believe that the couple checks out to be pretty good (long term jobs, stable renters). But should we have a problem, how much harder is it to evict a buyer than a renter?
Keep in mind I am not any attorney, and my experience with evictions and foreclosures is limited to the state of New Mexico. That said, I would expect a foreclosure to to cost at least three times as much and take three times as long as an eviction. The quality of the paperwork you used to sell the house will make a big difference, so make sure you hire an experienced attorney to draft the documents. By experienced I mean someone who actually goes to court once or twice a week to do an eviction.
That said, this is how an experienced investor I know handles things when one of his sales goes sour. When the second payment due date passes without a payment he stops by the house and asks what the problem is. Many times it’s a divorce. In these days it could easily be loss of a job. Usually it is very clear they can no longer afford the house. He points that out and tells the buyers he will refund their entire down payment if they move out by a certain (soon) date. He will advance enough money immediately so they can rent a storage unit for their stuff. If they have damaged the house he subtracts the cost of returning it to the “as sold” condition from the refund. (He normally gets more like 15% down).
To make sure he is back in control of the property he has them give him an option to buy it back from them. That way he can legally sell the house again without being their agent.
It’s a little more complicated that that, but I describe it because he has been able to avoid the expense and ugliness of legal procedures. It gives the buyers some cash for a new start at a time when that is extremely helpful. He gets his property back quickly and can resell it.
Good luck with your sale.
HELLO, I HAD A QUESTION ABOUT A OWNER FINANCED HOME. I HAD BEEN BUYING A HOME OWNER FINANCED SINCE 2007. IN 2009 I FINANCED USING A TRADITIONAL BANK. AND MY QUESTION IS SINCE WE DIDNT GO WITH A BANK THE FIRST TIME, DO YOU THINK I STILL QUALIFY FOR THE FIRST TIME HOME OWNERS TAX CREDIT? THANKS FOR YOUR HELP.
I have no idea. You would need to talk to an accountant or mortgage specialist who is up to date on the latest rules.