Structuring a Seller Finance Deal

[Albert Velasquez]

Hi BP FAM, *LONG POST INCOMING*

My family and I have the opportunity to buy a primary residence using seller finance. Here is a link to the three different loan terms I came up with. Let me give some context:

Single-Family-Detached 

Purchase Price: $225,000 

Down Payment: 60k-90k 

ARV: $400,000

Rehab Costs: $87,500 +/- $12,500

My family is not able to qualify for conventional financing which is why we're going this route. I won't go into the details on why, but for the next couple of years we will be unable to get financing the conventional way. However, our finances are in top shape, and we can afford a PITI payment of $5,000 a month. We won't have the chance to invest for the next couple of years anyways, so we don't see a problem with throwing all our money at this deal. We still have a solid emergency fund, so this isn't as risky for us as it might look.

My family's ultimate goal is to do a flip-grade renovation of the home, then do a cash-out refi to pull 90-95% of our equity to use for other investments in the future. My parents and I are going to be meeting with the owner in the next couple of weeks to discuss these terms I came up with. The motivation of the owner is simply to make money. They have no emotional ties to the property. They're firm on the purchase price of 225k. The owner mentioned a 12% interest rate, and that he wanted a down payment of 60k. The owner did also tell us that he did not want to hold the note for a long time which is why we have it amortized over 5 years. My plan was to first present the owner with Loan C in red, and if it's not accepted we can either go with Loan B or Loan A, with Loan A being his initial offer. If we compare Loan C (my initial offer) to Loan A (his initial offer), I increased the down payment from 60k to 90k, and in turn decreased the interest rate by 2 points from 12% to 10%. 

I guess my question for y'all is, what do you guys think of this? Are the terms for Loan C (my offer) fair? My thoughts are that with a 60% LTV the loan is less risky, and gives him more cash up front? Another question is if there is any way I could help the seller lower their tax bill? For example, if I gave the down payment over 5 years instead of a lump sum all at the beginning, would that change the seller's tax bill?

If there are any tips you guys can give me , I'd really appreciate it. Also, if you have any questions about my situation, let me know. 

Thanks BP!

[Nathan Gesner]

@Albert Velasquez one of the benefits of seller financing is that they get steady income and pay less in taxes. If they sold the home outright, the large amount could bump them into a higher tax bracket and they'll be taxed on the entire amount. Then they're stuck with a big chunk of money sitting in a bank account gaining very little interest. Carrying the note gets them a higher interest rate, and they only pay taxes on the amount collected each year which can keep them in a lower tax bracket.

I think your "deal" is bad and here's why:

1. Typical seller financing includes market interest rates, or slightly higher. You're offering 12% which is what a hard-money lender gives for short-term flips. Even 10% interest for ten years is ridiculous.

2. Amortization is typically for a longer term, not just the term of the loan. You could have a mortgage of $165,000 amortized for 20 years at 10% interest and the payment would only be $1,592. At the end of five years, you make a "balloon payment" that pays of the remainder of the balance. The intent is that five years gives you plenty of time to clean up personal finances and qualify for a traditional home loan from a bank, enabling you to pay off the Seller.

3. The market is at a peak. Values today are unhinged from reality. What happens if the market crashes and that $400,000 ARV turns into $300,000? The prices are so out-of-control right now that I wouldn't be surprised if we see a 25% drop in values as things return to normal.

4. What is your experience with flips? Can you stay on budget? What if material costs increase 25%? What if "life" happens and you can't finish the work? Or you find some problems you weren't aware of?

I think the market makes this a terrible time to project your success on a five-year timetable. I think your seller-financing numbers are awful. I have several seller-financed properties with 10-15% down, amortized over 30 years with a balloon payment due in three, and interest rates just 1% above what the banks were offering.