Interest Only Seller Financing Questions

[David Cherkowsky]

Hi all,

My agent presented an opportunity to me that would use seller financing and I had a few questions. The seller is looking to sell a house he bought and renovated. Based on a conversation with my agent, the seller is looking to be presented an offer and we would negotiate from there. This would be my second REI; I have another house that was purchased with a conventional loan. I've been reading about seller financing the last few days, and there are a few things that I'm still unclear on.

1. If I presented terms for an interest only payment for a term of 5 years, with a balloon payment due at 5 years, could I refinance during those 5 years into a conventional loan if interest rates drop?  My worry is the 5 years pass and the balloon payment comes due, and now I am stuck with whatever interest rate is available at the time. For example, if in your 3, interest rates drop to 3%, could I refinance then into a traditional loan?

2. After 5 years, I will have only paid interest, the principal will not have changed. Would all traditional loan options be on the table? I plan to house hack, so I assume I could move to a traditional loan at 5% down at that point. Is that correct?

Thank you in advance for your help.

[Greg Scott]

Seller financing is basically a private loan. These are not standardized agency loans.  You need to read ALL of the loan documents to understand the provisions of the loan.  For example, the seller might put in an expensive penalty if you refi early.

Regarding the interest rate risk, I would not buy it today if the deal did not work at today's interest rate.  The reason the GFC happened was there were all these people with mortgages that reset after a few years and they could not support the true mortgage payments. They could not refi out of the loans and they got foreclosed.  Don't let that happen to you.

With that in mind, if you qualify for a FHA 5% down loan, why wouldn't you do that now?

[David Cherkowsky]

Quote from @Greg Scott:

Seller financing is basically a private loan. These are not standardized agency loans.  You need to read ALL of the loan documents to understand the provisions of the loan.  For example, the seller might put in an expensive penalty if you refi early.

Regarding the interest rate risk, I would not buy it today if the deal did not work at today's interest rate.  The reason the GFC happened was there were all these people with mortgages that reset after a few years and they could not support the true mortgage payments. They could not refi out of the loans and they got foreclosed.  Don't let that happen to you.

With that in mind, if you qualify for a FHA 5% down loan, why wouldn't you do that now?

Thanks for the response Greg. I suppose I'm interested in seller financing if we could agree upon a lower interest rate than what I could get through an FHA. I'm thinking something like 10% down, interest only for five years, and 3% interest rate. This seems like a better option than an FHA at ~6.1%. Does that logic seem sound?

[Craig Warner]

Hi David, 

Seller financing may be beneficial only if it requires less then a 15-20% down payment and the seller financing interest rate is less than what we may offer.

With most seller financing I have seen allows a borrower to refinance anytime, so make sure there is no prepayment penalty within the contract.

Yes, you can always refinance out of seller financing, but the property should not be upside down in value compared to the existing mortgage balance.

If you'd like to talk and pick my brain, feel free to get in touch with me.

Thank You

Craig

[David Cherkowsky]

Quote from @Craig Warner:

Hi David, 

Seller financing may be beneficial only if it requires less then a 15-20% down payment and the seller financing interest rate is less than what we may offer.

With most seller financing I have seen allows a borrower to refinance anytime, so make sure there is no prepayment penalty within the contract.

Yes, you can always refinance out of seller financing, but the property should not be upside down in value compared to the existing mortgage balance.

If you'd like to talk and pick my brain, feel free to get in touch with me.

Thank You

Craig

 Hi Craig,

Thank you for the response. I would absolutely like to pick your brain. I'll send you a private message.

[Chris Seveney]

Quote from @David Cherkowsky:

Hi all,

My agent presented an opportunity to me that would use seller financing and I had a few questions. The seller is looking to sell a house he bought and renovated. Based on a conversation with my agent, the seller is looking to be presented an offer and we would negotiate from there. This would be my second REI; I have another house that was purchased with a conventional loan. I've been reading about seller financing the last few days, and there are a few things that I'm still unclear on.

1. If I presented terms for an interest only payment for a term of 5 years, with a balloon payment due at 5 years, could I refinance during those 5 years into a conventional loan if interest rates drop?  My worry is the 5 years pass and the balloon payment comes due, and now I am stuck with whatever interest rate is available at the time. For example, if in your 3, interest rates drop to 3%, could I refinance then into a traditional loan?

2. After 5 years, I will have only paid interest, the principal will not have changed. Would all traditional loan options be on the table? I plan to house hack, so I assume I could move to a traditional loan at 5% down at that point. Is that correct?

Thank you in advance for your help.

The answer is “it depends”. The seller may not be Interested in interest only loan (especially if owner occupied). But the terms will tell you the answers - yes you can refinance but there may be a prepayment penalty

That would be the least of my concerns. The bigger concern would be your ability to refinance and make sure the property appraises for a value that allows you to refinance.

that would be the risk, and if you cannot refinance, the balloon expires, the lender could foreclose on the property
 

[Dan Thomas]

@David Cherkowsky

That doesn't sound like sound logic. Private Money (almost) always costs more. You can certainly offer that rate but it may be laughed off. There is probably little harm in trying and with a very low anchor like that it may help you shave a point or two off. The lender is taking on risk. People who take on risk typically expect to be paid for that risk. If you want a low interest rate, go conventional. If you can't go conventional pay more for private Money.

In my experience (new england) if rates are where they are today I have paid between 9% and 12% for private Money. My goal is ALWAYS to fix the reason for not being able to finance conventionally ASAP and refi into a conventional loan. As mentioned previously you will want to make sure your agreement doesn't have absurd prepayment penalties.

[Michelle Boss]

Along the sentiments of previous replies, your first concern is pretty straightforward to address. Ensure your agreement has no pre-payment penalty.

In my experience, private money loans (which is what this is, as also previously explained in prior responses) typically come at a higher rate ~ 8%-12%.  Owner carry back can have advantages to both seller and buyer. However, ultimately, make sure you have a viable exit if you can come to a mutually beneficial agreement. 

[David Cherkowsky]

Quote from @Chris Seveney:

Quote from @David Cherkowsky:

Hi all,

My agent presented an opportunity to me that would use seller financing and I had a few questions. The seller is looking to sell a house he bought and renovated. Based on a conversation with my agent, the seller is looking to be presented an offer and we would negotiate from there. This would be my second REI; I have another house that was purchased with a conventional loan. I've been reading about seller financing the last few days, and there are a few things that I'm still unclear on.

1. If I presented terms for an interest only payment for a term of 5 years, with a balloon payment due at 5 years, could I refinance during those 5 years into a conventional loan if interest rates drop?  My worry is the 5 years pass and the balloon payment comes due, and now I am stuck with whatever interest rate is available at the time. For example, if in your 3, interest rates drop to 3%, could I refinance then into a traditional loan?

2. After 5 years, I will have only paid interest, the principal will not have changed. Would all traditional loan options be on the table? I plan to house hack, so I assume I could move to a traditional loan at 5% down at that point. Is that correct?

Thank you in advance for your help.

The answer is “it depends”. The seller may not be Interested in interest only loan (especially if owner occupied). But the terms will tell you the answers - yes you can refinance but there may be a prepayment penalty

That would be the least of my concerns. The bigger concern would be your ability to refinance and make sure the property appraises for a value that allows you to refinance.

that would be the risk, and if you cannot refinance, the balloon expires, the lender could foreclose on the property
 

 Thanks Chris. I would imagine I would still get the house inspected and appraised to minimize the risk.

[David Cherkowsky]

Quote from @Dan Thomas:

@David Cherkowsky

That doesn't sound like sound logic. Private Money (almost) always costs more. You can certainly offer that rate but it may be laughed off. There is probably little harm in trying and with a very low anchor like that it may help you shave a point or two off. The lender is taking on risk. People who take on risk typically expect to be paid for that risk. If you want a low interest rate, go conventional. If you can't go conventional pay more for private Money.

In my experience (new england) if rates are where they are today I have paid between 9% and 12% for private Money. My goal is ALWAYS to fix the reason for not being able to finance conventionally ASAP and refi into a conventional loan. As mentioned previously you will want to make sure your agreement doesn't have absurd prepayment penalties.

 Thanks Dan. Agreed, I don't see much benefit in lender financing if it's going to cost me more. I'm planning on bringing an offer and if I get laughed out the door, so be it. Appreciate your replies.

[David Cherkowsky]

Quote from @Michelle Boss:

Along the sentiments of previous replies, your first concern is pretty straightforward to address. Ensure your agreement has no pre-payment penalty.

In my experience, private money loans (which is what this is, as also previously explained in prior responses) typically come at a higher rate ~ 8%-12%.  Owner carry back can have advantages to both seller and buyer. However, ultimately, make sure you have a viable exit if you can come to a mutually beneficial agreement. 

 Thanks Michelle!

[Drago Stanimirovic]

Hi David,

Yes, you can refinance into a conventional loan during the 5-year term if interest rates drop, provided your seller financing agreement allows for early payoff without penalties. This would protect you from being stuck with a higher rate when the balloon payment is due.

After 5 years of interest-only payments, you'd still owe the full principal. If you're house hacking, you could refinance into a conventional loan with as little as 5% down, assuming the property value and your financials qualify at that time.

Make sure the terms allow for early refinancing, and keep an eye on interest rates to refinance when it’s advantageous. If you need help structuring this, I can assist.

Best,

Drago

[Adam Michael Andrews]

Balloons carry a lot of risk for the borrower. You will subject to the lending market at the time near to the balloon expiration.

I would negotiate for the recurring option to extend the loan an additional year at the cost of a 0.75% rate increase. That way you are incentivized to pay him off rather quickly but have some options if either the property or financing market blow up in the meantime.

[Steve Vaughan]

In '22 I sold 19 on contract / with seller financing. Another 8 in 2020. Plus singles here and there since 2007. 

I owned them a long time and were most all debt-free.  Typical tired landlord.

I sold interest-only at a bit under conventional rates (my last one in April for instance was 6% in a 7% world) with low down for tax reasons.  

My last duplex fell out because the buyer was asking for a 4% rate.  Risk-free money markets were paying 5%, so no way.  

I wouldn't get hung up on such a low interest rate or interest only. Straight am doesn't add that much more for you while IO adds a level of complexity and seller convincing that's unnecessary. 

If this seller just renovated, hasn't owned it long and has a mortgage, your chances of obtaining favorable to you proper SF are low anyway. Don't do sub2 a land contract or agree to a wrap.  Too much risk. 

[David Cherkowsky]

Quote from @Steve Vaughan:

In '22 I sold 19 on contract / with seller financing. Another 8 in 2020. Plus singles here and there since 2007. 

I owned them a long time and were most all debt-free.  Typical tired landlord.

I sold interest-only at a bit under conventional rates (my last one in April for instance was 6% in a 7% world) with low down for tax reasons.  

My last duplex fell out because the buyer was asking for a 4% rate.  Risk-free money markets were paying 5%, so no way.  

I wouldn't get hung up on such a low interest rate or interest only. Straight am doesn't add that much more for you while IO adds a level of complexity and seller convincing that's unnecessary. 

If this seller just renovated, hasn't owned it long and has a mortgage, your chances of obtaining favorable to you proper SF are low anyway. Don't do sub2 a land contract or agree to a wrap.  Too much risk. 

Thanks Steve. My understanding is the seller bought with seller financing significantly below market value and has the capital to pay the near due balloon if needed.

The seller is the one who proposed SF due to (I assume) capital gains.

[David Cherkowsky]

Quote from @Adam Michael Andrews:

Balloons carry a lot of risk for the borrower. You will subject to the lending market at the time near to the balloon expiration.

I would negotiate for the recurring option to extend the loan an additional year at the cost of a 0.75% rate increase. That way you are incentivized to pay him off rather quickly but have some options if either the property or financing market blow up in the meantime.

I really like this idea. Thanks Adam.