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.
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What about selling your house, seller financed to your child with no interest loan. How do I keep from not losing my exemption on capital gains if he refinances later on down the road.
I think selling to a relative with a no interest loan would be asking for trouble. If you are trying to help a child the better method would be to make the loan at market rates and then gift them as you see fit to make up for it. If you get paid you own the taxes. I don’t know any way around that.
A family member purchased a new home for cash as an investment. They also purchased this so that we could then buy the home form them with no interest.
We pay all fees, Taxes, Homeowner’s Association, Insurance and a set amount each month for payment.
The only thing is we have nothing showing that we are purchasing the home, no paperwork to file homestead. No breaks for car insurance and so on.
I am not complaining, because there is no interest involved which saves us a huge amount, but we would like some sort of paper showing that we are purchasing the home.
Could you suggest something that would show us as the buyer and be recognized legally?
You are right to be concerned. If something were to happen to the seller(s) there would be serious potential for legal ugliness.
I know several investors who do not want the details of their real estate transactions in the public records for everyone to see. Instead of recording the deed, note and mortgage, they record a Memorandum of Understanding. This is a document, signed by both the seller(s) and the buyer(s), that states that a contractual agreement exists between the parties. When recorded with the county clerk this clouds the title. In your case it would mean that if the property were sold to someone else or if a new mortgage was placed on it the title company closing the transaction would want documentation from you before they would issue title insurance.
In addition, I would suggest the same attorney that drafts the Agreement prepare proper sale documents and hold them in trust. That would protect your position and help prevent future legal problems.
Great article. Thanks for th helpful info!
I’m about to put an offer in on a owner financed property. The addendum was going to read as follows….
“Contingent upon owner financing and a clear title. Buyers will pay 10% of purchase price at the closing. Buyers will assume a 7%, interest only loan, for a one year term. The Buyers may extend the interest only loan, for no more than one year. If the buyers exercise this extension, an additional 1% shall be added to the interest only loan.”
What else should I add? Will this cover me?
Will there be any payments on the interest only loan or will the interest just accumulate? Usually assumption language would say “assume and agree to pay…” Is there language in the agreement to make sure the assumed loan holder actually receives the money paid? In other words, is the money going through a neutral third party like an escrow or title company? In the event you fail to pay are you on the hook for the whole loan, or are your losses limited to your down payment and any payments made? Does the note become due and payable immediately if you sell the property? If this is not bare land, who carries what insurance and how is any insurance payout handled? I just had $13,000 of hail damage to my roof. The insurance check went to the seller who then paid the roofer. It would have been ugly if the seller wouldn’t or couldn’t have done that.
I know nothing about your income or how you plan to pay for this but I can guarantee you will not believe how fast two years can go by. I am buying my own place on a zero equity wrap. When we set it up the seller asked if we should set it up to balloon in ten years. That would be this year. Can you imagine shopping for a new loan this year with the way the markets are? Fortunately, I passed on that.
Have I scared you into retaining an attorney yet? Seriously, owner financing is one of those things where if it is worth doing it is worth doing right – even if you can’t “Afford” it.
I hope it works out for you.
Paul
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