How can I buy a house with seller financing?

Question

Hey guys,

Found a guy through a mailer that doesn't want to "give the house away" (i.e., this is not a wholesale prospect), but he might consider an owner-financed option. He owns the property outright and collects rent but lives an hour away and it's a pain for him to come in for repairs and such.  FMV is around 140k and rents for $1000 --could be raised to $1,100 easily. I mentioned the possibility of a market value purchase with principal only payments for 5 years with a balloon after 5. At that point I'd have 20% equity to refi without a down payment, and I'd own a cash flowing rental.

Anyone done anything like this? I know the numbers on this house are far from what people see in Indiana/Michigan/Ohio, but bear with me on these Pacific NW numbers!! What should I know about this type of transaction? How is the deed transferred and all that? Would this deal pencil to you, or rather, what would make this deal work?

Also, is this too risky? I'm assuming the market will increase over the next 5 years, but...

Tom S. · Answer

Good luck Tyler!  Feel free to post more questions as needed.

- Tom

Tyler Blackwell · Answer

Rob K, taxes, insurance, and w/s/g are probably in the range of $300, so I really can't see this one working with rents at $1,000. I let the guy know that it wouldn't work for what he's asking (both price and interest) at the current rent rate. I think there may have been $100 at the end of every month to sock away for any repairs or to clean up messes, but that's pretty tight. Too tight it turns out.

I'm going to keep looking for deals!

Rob K. · Answer

Five years go by very fast. Think back to what you were doing five years ago and how fast it went by.

I'm one of the people in Michigan that enjoys 30% returns, so I'm having a hard time seeing how you will make a profit on this.

How much are the taxes and insurance? Will there be any left over each month after you make the payment? What happens if there are repairs or vacancy? You stated that the rent could be raised from $1,000 to $1,100 "easily". Would the same tenant stay if you raised the rent 10%? What if he moves out and the house sits empty for two months? If the numbers are thin enough, that could wipe out your profit for the next five years.

I would go over all of the numbers very carefully.

Tyler Blackwell · Answer

Thanks for the advice fellas.

Brandon Turner, thanks for the comments and the add...I'll be in contact with you and maybe we can work some deals in Grays Harbor! Actually, are there any cash buyers out there?

I tend to agree with you on the balloon payment as well. It would be scary to have invested so much in the deal and after 5 years the property doesn't appraise well enough to refi without a substantial down payment.
 
Tom S., I may bug you later for more advice, but you're right, he does want interest. Do you typically amortize your interest much like a bank would do? I feel like that would be a poor way to build equity right off the bat, since most of the payment to the seller would be interest, but what has been your experience?

My purchase price idea was more like $135k-140k, but instead of paying interest on a month basis and to reduce prinipal, I was thinking of bumping the purchase price and asking for 0% interest.

I'm very green in this area of seller financing, so I'm very happy to have the seasoned veteran comments :) Thanks guys!

Altin Velaj · Answer

I second Tom S. Appraisal is important .

Tom S. · Answer

Hi Tyler,

I've done some purchases of seller financed homes and here are my thoughts.  This assumes you want to buy in that area and those are your numbers for FMV and rent.

- You can certainly start the negotiation with no down payment and no interest, but I think to make it more enticing, the seller is going to want a combination of both.

- I don't think the 5 year balloon is a good idea either.  If the seller insists, you can also write it as a 5 year balloon with the option to extend it another 3-5 years (it's all negotiable!).

- Get the property appraised.  Make sure you're not overpaying.

- Even if you can get in as a no money down deal, make sure you have cash reserves!  You need to be ready for the triple whammy of tenant not paying, trashing the place, and having to pay to evict.

- The title co or closing attorney will handle the paperwork of the note, transfer of deed etc.

Let us know how it goes!

- Tom

Brandon Turner · Answer

Hey Tyler -

My suggestion: move down the coast a little :)  Elma, Monte, Aberdeen has some killer deals. The rent isn't as high and quality of tenants a little rougher, but we definitely have those "Indiana, Michigan, Ohio" numbers :)  I live in Monte. :)  Another benefit : NO ONE out here is doing mailers that I know of. I don't even think there is a single wholesaler in Grays Harbor.

Anyways - my other thoughts: I don't like the idea of a balloon payment. In the slim chance you can't get a bank loan - you could have a serious problem on your hands in 5 years.  It's not as major since its not gonna be on your credit- but still, principle!

I also assume the market will increase over the next 5 years, especially in your area, but there are no guarantees. I'd say when investing - the deal needs to pencil out assuming the property never increases in value. If it does -it's just icing on the cake.

Thoughts?