Interest-free seller financing

Kansas City, Missouri
Private Lending & Conventional Mortgage Advice
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Interest-free seller financing

Na Christian
Member since 2024 · 2 posts · 2 votes

My goal: create an interest-free loan which is appealing to a potential homebuyer, yet doesn't make too big of a discount on my end.

For example: If I sold my $300,000 house with 20% down ($60,000) over 30 years, at 6.7% interest rate: $1548.67 principal and interest per month
1548.67 x 12 x 30 = $557,521.20

What I would do would offer a lower monthly payment and no usury, but it would effectively be like a prepayment penalty.

Arbitrarily, let's say 20% off the monthly payment, or $309.73 less per month: $1238.94 monthly payment.

House would be sold at $446,018.40, which is $111,502.8 less than the total paid with a normal mortgage, but $116,018 more than the market price. This is 20% off, or 80% of the original total cost, if you include interest. Down payment would still be $60,000.

Of course if buyer defaults on the loan I would still foreclose, and I would require home insurance/property tax in escrow like the banks do.

Do you think this would work?

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  • Scott TrenchPro Member
    Rental Property Investor · Denver, CO · Member since 2014 · 2k+ posts · 6k+ votes
    2y

    Here are reasons why I wouldn't do this as a buyer:

    - I bring you $60K, and now have negative $80K in equity. Ridiculous. I will not lose the forest (the fact that I would be buying a property that is deeply negative equity) for the trees (the fact that it might "Cash flow"). 

    - I understand basic tax principles. If you give me a loan at 0% interest, then everything up to the Applicable Federal Rate (AFR) is considered a taxable gift. As of May 2024, that rate needs to be 4.55% or higher. That's $20,293 per year in "income" I will have to declare. 

    - Depending on appreciation, I will be underwater for at least a decade in this "deal". While I am capable of holding onto a property like this, I fear for the newbies who have very real risks of not being able to hold onto the property long enough to get out from underwater.

    Because the buyer of this property is likely to be inexperienced and not know or think through all of the items discussed here, this strategy may put you in a ridiculous position of power for at least the next decade over the buyer. 

    I hope that novice investors on BiggerPockets stay far away from this type of deal. 

    But, sadly, I think that if you posted this for sale out in the real estate investing world, saying you are open to seller finance at 0% interest, you might have an incredible amount of interest, and be able to take advantage of many newbies who have no idea what they are doing. 

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  • Manny VasquezBusiness Member
    Real Estate Agent · Orange County · Member since 2022 · 318 posts · 293 votes
    2y

    Great analysis @Scott Trench!  To add a 4th point if you will, more like point "3a" (it's kinda closely tied to your 3rd point), if the Buyer ever wanted to sell, the Buyer would be "locked in" to that deal for at least a decade or until the house was "above water".   Due to the negative equity in the deal, if the Buyer ever wanted to sell, for whatever reason, the Buyer would have to either "short sell" or wait until the house appraised for more than the proposed sales price of $446,018.40.  I don't believe anyone would want to purchase a home with negative equity nor would it make sense to be "locked in" into any deal under those terms. 

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  • Na Christian
    OP
    Member since 2024 · 2 posts · 2 votes
    2y

    Thanks for the quick reply. My goal is to come up with a way to avoid interest payments as a buyer and/or a seller while still providing or receiving financing. It seems like the American system (tax code, AFR, etc.) is set up to reinforce usury. There are some potential buyers who avoid interest-bearing mortgages, for religious or other reasons.

    I suppose a prepayment penalty could be setup which would result in basically the same thing as I propose, in other words, a normal mortgage with a lower interest rate/market price/down payment, with a very large pre-payment penalty (starting as equal to the amount of interest owed over 30 years) that would slowly go down as the mortgage amortized. In short, it would negate any advantage to making any early payments, with this advantage to the lender balanced by providing a noticeably lower monthly payment than the $1548.67 to the borrower. Do you know what laws there are about pre-payment penalties, especially regarding seller financing?

    It's counterintuitive to me that the $20,293 would be taxable income because the house could still be foreclosed on if the borrower defaulted.

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