Refinance an interest-only seller-financed note?

Question

Hi all,
	
	I'm trying to hash out the details of a deal I have.  The house is worth $95k, the purchase price is $56k.  The seller has agreed to an interest-only loan of $100/month with a 5 year balloon.
	
	My first question: Will this type of loan qualify for a refi with a traditional lender when the time comes?
	
	My second question: Does this arrangement put me at risk of appearing "predatory"?  The seller is very happy, and I backed into the payment based on gross rent - expenses, but that interest rate works out to be incredibly low (.02%).  Are there any risks to myself in moving forward?

Dion DePaoli · Answer

The loan interest rate as Jon has computed is under the Applicable Federal Rate issued by the IRS, which for long term loans is around 3.25% (+/-).  If the payment works, look at lowering the balance to bring the rate in line, otherwise the rate may be imputed on the loan.

Jon Holdman · Answer

First problem is your math is wrong.  $1200 in interest a year on a $56,000 loan is 2.14%, not 0.02%.

Its not a loan that qualifies for a refi.  Property ownership does and you do.  Are you actually buying the property?  Or is this a lease option or land contract?  Do you qualify for a loan?  Credit score, income, cash, etc.  I'm with Eric, who knows where rates will be down the road.  I'd look into refinancing ASAP, which is probably at least a year out.

Kelly Payne · Answer

Thanks Bill Gulley

Eric Black · Answer

Hi Kelly,

The first problem is, you're asking someone to predict what the guidelines will be 5 years from now. My wife has been in the mortgage industry for almost 15 years and she can't predict what the guidelines will be tomorrow! Based on the guidelines as of today you can typically do a cash-out refi on an investment property for 75% LTV on a SFR.

As for question 2, if the seller is okay with your terms then you're not predatory. I can offer to buy the property for $1. It's the seller's decision so if they accept then they can't (or at least shouldn't) turn around and call you predatory.

The only risk I could see is waiting until that 5th year to refi. In my opinion, with the way the government thinks it can spend its way out of debt, there are very few solutions, if any, other than inflation. I am scared of where interest rates will be in 5 years. Yes, .02% is amazing, but you have to average it out over the life of the loans on the property. If you refi in 5 year for 10-30 years and interest rates are 8%, 12% or 15%, how much will the property cost you in the long run?

Dion DePaoli · Answer

As stated above, refinance eligibility is a matter of qualifying for a loan per lenders standards.  That does not include terms of a present loan only the idea that payments were made in timely manners per the note, to a degree, whatever those terms may be.  
	
	The AFR is a tax issue that the seller may face, the rate may be imputed where they have to realize a higher rate of interest than what was actually received.

Bill Gulley · Answer

Translation, the IRS will zap the lender for charging under market interest rates and tax them on interest not received. :)

Terms of a lien are not a lending issue, so long as it's a lawful lien.

I suggest you get a loan servicer. The terms, I/O are okay in a commercial loan, but not a good idea unless you can pay it down for a loan at any time, don't think appreciation will get your LTV there.

Make sure you run it by an attorney and ensure the "use of funds" remains for a commercial purpose. :)

Kelly Payne · Answer

@Dion DePaoli So if the interest rate is lower than the AFR, then it is not eligible for refinance? Or does it only affect taxes?  Thanks for commenting!

Kelly Payne · Answer

Thanks @Matt Devincenzo. That might have been it.  Would check images be enough to verify payment history, or do they need a third-party involved?

Matt Devincenzo · Answer

This may have been less about the structure of the note and more about the servicing or history of it. What may have happened is that the SF loan was done but because it was not serviced the lender couldn't verify the payment history in order to refi it.

Kelly Payne · Answer

@Eric Black Thanks for thoughts.  I have a general idea of the guidelines for refinancing investment properties, but I was specifically asking about seller-financed interest-only loans.  So it seems as long as I meet the LTV requirement, the bank will refinance the kind of loan I'm structuring.
	
	My plan isn't to actually hold this one. The plan is to use this IO loan as short-term financing until I sell it (in 3 years or less).  But I wanted to be sure that if the plan changes I (most likely) could refinance if I needed to.
	
	@Jon Holdman Right. 2.14%. Oops. I was thinking percentages but wrote decimals. Like I mentioned above, I do understand the general requirements for refis.  I have 3 other seller-financed properties.  I'm going to take title to this property, and as far as I know do qualify (with my credit score, debt, income, reserves, etc.).
	
	I had this vague memory of a story of a bank refusing to refinance a seller-financed note because of the payment structure.  That may not be an accurate memory, but I wanted to be sure I asked everyone here before I finalize the loan terms.
	
	Hope that makes sense and sorry for the confusion.

Refinance an interest-only seller-financed note?

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