Seller financed or 30-Yr: Which would you choose?

Question

Hi All! Looking for some insight in a unique situation I've been presented with. Which do you like:

Option 1: Purchase a $210,000 (tax value) home needing a $60k renovation in a great neighborhood w/ conventional 30-year mortgage + the option to purchase the 2 adjacent lots. 10% ROI after cash out refinance to hold as rental.

-or-

Option 2: Purchase the house and the lots for $370,000 (tax value) with Seller Financing and $40k down at 2% interest (blended P&I payments) for 10 years amortized over 30 years. Lots might support a duplex and triplex or SFR and duplex. I would still like to renovate the house and cash out refinance and hold as rental for similar returns, but I'm still learning about this...

Andrew R. · Answer

Hi, I think I'd agree with @Will Fraser. From a cashflow perspective Option 1 would almost certainly be the better choice.Would the cost of the land under the option agreement be the same as the purchase price in Option 2? I'd personally say that even with a (reasonable) premium on the purchase price the option-agreement would be favourable unless you had a plan to develop the unused land immediately. It may help your thinking to do a cashflow analysis for 5/12/20 years to model the various scenarios.

Ryan Howell · Answer

@Sam Morgan - technically yes, but I don't see why you couldn't right one check every month.

Sam Morgan · Answer

@Ryan Howell that sounds lie a really great idea. Would I be paying three separate mortgage payments each month? The seller might not be fond of having it spread out like that. This might be a great way to negotiate. Thanks for the idea!

Ryan Howell · Answer

@Sam Morgan - Exactly. Instead of filing 1 deed of trust (mortgage) for the seller's note and putting the lien on 3 parcels, break it up into 3 separate liens....for example sake - $200k on the house, $100k on one lot, $70k on the other lot. Knowing the $200k is short term, you can maybe pay higher interest rate to make it desirable, etc. By having them individual, you have flexibility to refinance and pay off the seller's note on the house and keep the others. I would recommend you have your attorney draft the promissory notes so you have the verbiage you need for what you intend to do.

Sam Morgan · Answer

Hi @Ryan Howell and as always thanks for your input @Will Fraser Can you elaborate on this a bit? Ideally, I'd like to rehab the house and then cash out refinance to recapture some of my capital, but I thought I couldn't do that with Seller Financing. What you are proposing sounds intriguing, but I'm not sure I get it. Essentially, have 3 separate loans thru the seller? Then after rehabbing later this year (or 1 year later for seasoning), go and refinance just the house to pay off that separate deed and continue with the owners terms on the lots?

Ryan Howell · Answer

@Sam Morgan - Can you do a hybrid of both? Perhaps you can "break up" the seller financing into three seperate seller financing options - 3 deeds of trusts breaking up the total $370k between them. This would allow you to refinance the house individually and continue paying on the notes for the lots?

Will Fraser · Answer

Sounds like an appetizing deal, Sam!

Sam Morgan · Answer

@Will Fraser and @Andrew R. thanks for your input. With option 1, the option to purchase the lots will expire quickly after closing, within a month. Not much time for due diligence. Apparently, there are other interested buyers. I think I could turn around and sell the lots for a profit if need be. I'm leaning towards the seller financed package - Option 2- since I could almost certainly have the monthly debt service covered by renting out the SFR upstairs (it has 2 separate living areas, but may need to be converted into duplex which could be very costly, and maybe impossible), and I think I could find private lending to help fund building projects on the lots. The seller financing allows me to purchase everything now at tax value, with ability to cover the debt service, making this a longer term play with the returns gaining momentum down the road in yeas 3, 4 and 5.

Will Fraser · Answer

Nice work on finding this deal @Sam Morgan!Personally I'd roll with Option 1 and explore the options for the lots while I have an Option to purchase them. You'll have your hands full with the home and the work needed right now and if you have an Option to Purchase the lots then you could pull that lever if needed when needed instead of jumping the gun and obligating yourself to more work than you know that you WANT to do at this point.If you had a definite plan for the lots I'd have a different answer here, but in light of the lots being an open-ended possibility I'd lock them up with an Option and execute if/when needed.