Seller’s Risks with Owner Financing
1. The buyers may not pay. This is the only risk novice buyers
and sellers really think about. Participants in a owner financed
transaction need to realize they are going into the banking business
in a small way. Everyone knows banks have large buildings
and make a lot of money. They sort of forget banks also take some
heavy losses. However, banks get to play the odds. They
try to make more loans on which they profit than loans on which they
take a loss. For the seller trying to unload his house the news
on the day the monthly payment is due is either all good or all bad. Sellers
frequently insist on terms that actually increase the chances the loan
will get into trouble.
2. The sellers may need their cash faster than the contract pays. This
can be a subtle trap.The sale is done and some time later something happens
in the sellers life which causes them to need a chunk of cash. The obvious source of funds would seem to be selling the contract for cash. After all, the buyer has been paying every month and the interest rate on the
note is well over what banks are paying on CD’s.
A few calls to the note brokers advertising in the paper will spoil
that illusion. In the United States home ownership is reguarded
as a sacred right and governmental systems are in place to make sure
cheap money for home buyers is always available. The government
backs the bonds that get issued to provide the money so loans can be
made at the lowest possible rates. When you try to sell a privately
held note the buyers of the note will expect much higher rates. The
way they do this is to discount the value of the note.
Note discount calculations are complicated and depend on a lot of factors. However,
even a short term note, with market interest rate, and a good payment
history may be discounted by 25% or more. One of the difficult
parts of being a note broker is educating consumers about the true value
of their note on the open market. Successful note brokers typically
do that by proposing terms which help the note seller feel like they
are getting more for their note than they really are. This works
because few people really understand the mathematics of notes.
3. There may be unintended tax consequences. As
long as the seller continues to hold the note and reports the interest
as income the tax situation remains simple. For the buyer the interest
is deductible and the tax results are obvious. The tax situation
is more complex if the note gets sold to a third party at a discount. It
will also be more complicated if seller financing was used in the sale
of an income property. In that case the sellers “basis” in
the property comes into play and the allocation of the money from the
payments is more complex.
4. There may be title/ownership issues. Title
issues are rare in the residential home market. Subdivisions have
to on the books for years so there are few boundary issues. Title
insurance is a almost always used so potential problems are found and
corrected early. With land and income property title related problems are more likely. Owners
get sued, make bad business decisions, fail to pay their taxes, get divorced
and do other things that result in clouds on the title. Even with
residential property, sellers may “forget” to mention they
deeded an interest in their home to their kids who then will have to
sign the deed as part of the sale. Even though it is expensive,
I would strongly suggest title insurance.
5. Poorly drawn paperwork puts sellers at risk
of not being able to enforce the contract. Serious problems
will require a trip to court to resolve. THis is expensive and
takes a long time. In the
meantime the buyer may live the the property for months without making
payments. The seller is stuck making payments on the underlying
loan(s) to protect his equity without any income. I have known
sellers who would drive buy “their” property and watch it being
destroyed without being able to do anything about it. In court
the only thing which will really matter is the paperwork. Things
that were said or promised are not considered. This is the time
when the seller may realize the generic document they got at the stationary
store really doesn’t protect their interests well. In other words,
the parties to a seller financed sale should do everything with the idea
that they may eventually be in court and the documents they are signing
will determine what happens.
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Great site. I own a small lot with a single wide mobile home on a nice lake in central NC. The lot is very small, but good water view, new pier, etc. Am thinking about selling it – a little too far to drive for periodic maintenance and renting it is getting old. I spoke to a realtor the other day who indicated that lenders are reluctant to lend for mobile home purchases because of their depreciation. She suggested I consider owner financing. Am open to the idea, but want to make sure it makes sense – financially, taxes, etc. Thoughts? Considerations?
Thanks.
My understanding is that financing for used mobile homes is impossible to find, so I suspect owner financing is your only choice. It sounds like you have been renting it for some time so you don’t need all the warnings I would usually give about how easy mobile homes are to damage, etc.
It should qualify for an installment sale so you will have a choice of taking all your capital gain in the year of the sale (assuming you sell at a profit) or spreading it over the life of the note as an installment sale. If you have some capital losses somewhere, such as stocks, you might be able to time sales so gains and losses net out.
I would suggest the use of an escrow company to hold all the papers so that if something happens to you or the buyers the transaction doesn’t get messed up. As a landlord you already know what to do to avoid problems with unpaid utility bills, and you will want the contract to include language that makes taxes, insurance, etc. clear and gives you the right to step in if needed.
There is an old saying in owner financing circles that “balloons are for clowns”. Balloons on mortgages lead to problems. If you need/want to keep the payments smaller but don’t want to sign up for a 30 year loan you can always require the interest rate or payment amount to increase every so often. This will really shorten up the length of the loan without the financial stress of a balloon payment.
Good luck with the sale.
I am selling stock in a company that holds 2 commercial properties using seller financing. The loan will be for 2 years at 7.5% interest. The buyer is a prominent business person in the same town where the company and properties are located. My attorney is drawing up the loan, and the company’s attorney the sale documents. However, I am still looking for any advice available. Do you have any experience or suggestions related to my situation?
I am to far from the transaction to suggest anything specific and your are apparently well represented from a legal standpoint.
I saw a Warren Buffett quote to the effect of “You can’t tell who is swimming naked until the tide goes out.” The economic tide has certainly gone out these days. Are you certain the “prominent business person” has the ability to repay the loan?
Have a 5 bed/3 bedroom completely renovated property 1.5 miles Emory University in Atlanta (located in Druid Hills within the Lavista, Clairmont, and N. Druid Hills triangle). Owner financed a sell for $439 a couple of years ago with 25K down. The 25K down went to transaction and broker fees. The remaining balance of 414K was carried at an attractive rate of 5% at the time (Sep 2007) – roughly $2000 a month (which includes insurance). The owner just informed me before Christmas that he will have to walk away mid-Feb. I asked as sign of good will to restore the house into pre-sale condition and make payments until June. The original terms of the contract were that he would get owner financing within 12 months of the original sale, but his credit and job situation did not get better fast enough. He also indicated he would refinance, once his house in Jacksonville (that was in a trust) sold; then a year ago he indicated that his father put 50K into Jacksonvile house and if it sold the money would go back to the trust and he wouldnt get a dime; now he indicates he will be leaving Atlanta and move into the Jacksonsville house b/c he doesn’t have to pay rent (he was laid off a month ago and has a 4th baby on the way).
I honestly don’t want to take the house back because it has been a bad luck/cancer/money pit since 1999 due to bad contractors and tenants. What are my options? Can I sue the owner for breach of contract? If so, on what grounds? What is my likelihood of success? Like I said earlier, I am owed 414K, but I would gladly walk away quickly with a 395-400k cash in hand. The property appraised for 435K Sep 2009. The recent zillow estimate is 414k. Please advise. Thanks in advance for your help. Happy Holidays. God Bless All.
I assume from your comments there is no debt on the property beside your note.
The buyer has no job & probably no significant assets. If you take him to court and obtain a judgment, there is nothing to collect. So, even if you “win”, you loose. I think your time/money would be better spent working with the buyer to get the house back in a timely manner and in as good a condition as possible. You will want your attorney to draft the paperwork necessary to give you clear title.
I can appreciate your desire to be rid of the property once and for all, but these days investments which return more than one or two percent are hard to find. I know nothing about your real estate market, but would have to ask if your estimate of value is realistic in today’s economic climate.
If you calculate the return you can expect from investing the net cash from a quick sale at a current investment rate you know where you will be if you dump the property. Can you design an owner financed sale that will attract a strong buyer and give you a better return?
My wife and I have owned our home for 8 years. We purchased it for $170,000.00 and have made improvements of $60,000.00 over the past 4 years. The homes value is around $210,000.00 and we owe the mortgage company an even $100,000.00 right now. We have a buyer for the sale/purchase price of $200,000.oo with $150,000.00 cash down, and wants us to carry a $50,000.00 first mortgage on a balloon (interest only payments) basis, due in 1-2 years. She’s going through a divorce and is getting the down through the divorce settlement. Has a good job and job history, but has poor credit. What would you suggest for terms, interest rate, and clauses to forclose if the balloon note is not paid in full on time? How should title be held, and recorded? Any special clauses in the agreeement suggested. Thanks.
I think the foreclosure provisions will be the standard ones included by the local attorney with real estate experience you have draft the papers. That will all be standard boilerplate and is well understood. I would have all the payments made through an escrow company so there can be no question about what was paid and when.
With a $50,000 first on a $200,000 asset you will be in a really strong position. You choices depend on your situation.
Do you need the 2nd $50,000, or will you just have to find someplace to invest it? Right now 5% on a well secured investment would look pretty good and you might hope she keeps paying the interest for a long time. If you really need the money stricter terms might be to your advantage. “Balloons are for clowns” is an old real estate adage which I think has some merit. For me personally, I would try to avoid them and keep the terms as forgiving as possible.
If you got the house back would you be happy because you could sell it again and make more money or would you be upset with all the hassle because you had hoped to be done with it forever. Your answer sets the parameters for terms, subject to my comments about balloons above.
I have a owner financed home that the people have been living there for 3 years they did not pay there taxes for 2008 and have not paid there taxes for 2009. When can I forclose on the property.
That will depend on the law in your community and the exact language of your documents. I would suggest contacting an experienced local real estate attorney and going over the details with them. By experienced, I mean someone who does real estate work all the time, not the nephew of a friend who just got out of law school.
Use the meeting to develop a list of your options and their probable costs. Be sure to include non-litigation solutions! By that I mean can you talk to them directly, if there is no hope they can catch up would it be cheaper to offer them a thousand bucks to move out? That sort of thing.
Is the property worth more than what you owe on any underlying note plus the taxes due? In some parts of the country values have come down so far the answer might be no. If that is the case consider hoping they keep making payments but let the property go.
We live in changing times and many of the old “rules” don’t work anymore.
Good Luck
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