Ideas for seller financing with current mortgage in place?

Question

I've got a potential duplex deal where seller owes about $115k at 2.5% and is tired of the headache. They just want it gone, and are open to me making payments to them. The initial price they threw out was $240K, which is probably fair. I feel I've developed a solid relationship with seller, and I want to help them out, but need to find common ground where we both win. I've never done any sort of creative finance before. I would obviously like to keep the [email protected]%, but curious as how to structure terms for the remaining $125K back to the seller. How would you structure, or do you have any good resources (Posts, podcasts, videos, books) that would help paint a clearer picture?

Current knowns:

Rent: $1050 each side (at least $200 under market rent)

Taxes $4,500/yr

Insurance: $1,500/yr

Tenants pay all utilities, mow and snow

One idea I have is to offer full price of $240k payable to the seller over a 30yr period at 2.5%. That way my payment to them is almost double what I anticipate they are paying on their current mortgage. After my conservative estimates, it barely cash flows for me, but I could bump rents fairly easily to help that. Seller made a comment that this duplex was her 401(k), so by me making ~$950/mo payments to her for 30 years might do the trick? I would have to figure out the details of ensuring sellers are paying the bank, or maybe I make the bank payments and send the remainder to the seller.

Any guidance would be greatly appreciated!!

Kyle N. · Answer

@Mitch Messer and @Tom S.I think the reason they're talking to me and entertaining the low down payment and low interest rate is because I used their original asking price. She even told me that the price was negotiable, but I kept that $240k number. I also met with sellers over the weekend and showed them my buying spreadsheet and showed them all of the variables that we could change/adjust. I also told them that if they wanted to sell with a realtor, that would be quicker and they would get a lump sum of cash after paying off their existing note. I also explained realtor fees, closing costs, and capital gains tax. I try to live by the Zig Ziglar quote of "You can have anything you want, If you first help enough people get what they want" I'm not even sure I want this deal, but I'm excited over how much I've learned from this chat and by taking action to get to this spot. It can only get better from here! Thanks Everyone!!

Mitch Messer · Answer

Hey @Kyle N., you say "[t]he initial price they threw out was $240K, which is probably fair." How are they and you defining "fair?" This is a investment property, so the value is a function of its ability to consistently generate income. With Gross Income of $25,200 currently, and Operating Expenses (insurance+taxes+vacancy+maintenance+management) of about $12,720 (1500+4500+2100+2100+2520), you're looking at Net Operating Income (NOI) of $12,480. If you were to buy this with $240K cash, and assuming ZERO repair costs (which is most unlikely), you'd be looking at a cash-on-cash return of 5.2%! That's pretty awful... Even with sweet 2.5% subject-to financing, I think you're massively overpaying for this asset at $240K! What am I missing?

Mitch Messer · Answer

Hey @Kyle N., first let's be extra careful with the terms. The $928.53 note payment to the seller would be Debt Service, not Operating Expense, so wouldn't affect the NOI but rather the Cash Flow. Also, Cash-on-Cash return uses Cash Flow rather than NOI.That said, I do get your point that the low interest rate on the financing would definitely help with the CoC. I just don't know if that'll be enough... Here are two things to consider:1. Has the seller agreed to only accept $5K down to close this deal? That seems extremely low (just 2% of the $240K purchase price). If I were the seller, I'd ask for more down just in case I had to foreclose and take the property back.2. You're ignoring Renovation Expense and Capital Expenditures. Properties owned by sellers who are "tired of the headache" often have a ton of deferred maintenance that will fall to you to address, either upfront or down the road. Your current CoC calculations don't take this into account.I LOVE the fact that you are running your numbers and considering the alternatives beforehand! So few investors do.Just keep in mind the great advice being offered in the thread to NOT be seduced by attractive financing.

Chris Seveney · Answer

Have you run comps on this property? You will be running a negative cash flow on this property and this does not look like a good deal at all. Sometimes people have blinders on when they are excited someone will do a sub2 deal with existing financing being very low in place, but if the purchase price does not make sense, then you have ZERO exit strategy on this asset if you overpay. Your only exit strategy is to come out of pocket to cover the shortfall which most people do not have those types of funds.

Kyle N. · Answer

@Mitch Messer, I appreciate the feedback and the thought provoking you've inspired in me! However, I'm looking at the deal a little differently, but please let me know if you agree. I agree with your numbers, but what if we take your operating expenses of $12,720 and add to it a monthly mortgage pmt back to the seller of $928.53 ($235k@2.5;30yrs;$5k down) for a total of $23,860 per year operating expenses. Gross income of $25,200 - $23,860 expenses = $1,340 NOI$1,340 (I agree-not much) NOI on $5k down = 26.8% COC That's pretty not awful, and those are as-is numbers. Current rents are at least $300 below market on both sides, so if I only bump rents $100 each side brings in another $2,400 of income, which translates to nearly 75% COC as soon as I take over. If I bump rents on both sided $100/year for 3 years, my year 3 income goes from $1,340 to $8,540, or 170% COC per year. Please...someone show me what I'm missing! Or if anyone has ideas on how to execute.

Jay Hinrichs · Answer

you bet if you like it go for it.. just be realistic on length of contract very few folks are going to give you a 30 year mortgage. they look at their personal expiration date and figure that they will never get paid off before they expire.

Jay Hinrichs · Answer

this is a prime candidate for your seller to do a wrap.. they take the mortgage at 240k at whatever interest you set.. and U pay ment that payment out of that payment they pay on the first. and they make the delta. I suspect 30 years is not going to fly with almost 99% of sellers.. so be prepared for a 5 to 10 year balloon payment to pay them off.as others have stated dont let the low interest tail wag the dog.. also running % profits is great but look at the gross proceeds its still very low amounts of money that only benefit you if you have a lot of these going on its hardly life changing.. Just sayin..

John Cardinale · Answer

I’m pretty sure the only safe way to do this to get the property in your name, which is definitely your main priority, is to do a sale subject to the existing mortgage, and then an owner finance with seller holding 2nd position mortgage. Try doing a little reading on “subject to” transactions.

Tom S. · Answer

@Kyle N. Just curious, why wouldn't the seller just list this property on the MLS for $240k? Even after commissions and closing cots they would be getting their money soon, which they could invest in a safe CD at 5%, instead of the 2.5% over 30 years you're offering? Be prepared if the seller's attorney handing the paperwork advises them this scenario, and what your response may be. Personally I wouldn't want to deal with all of the unknowns of the transaction, versus just listing it on the open market.

Kyle N. · Answer

@Jay Hinrichs, I totally agree that this is not a life changing deal by the numbers, but it could be a life changing deal as it's my first creative finance deal. I'm kind of learning as I go and only expect to get better as I progress. Thanks for the insight!