How do I structure seller financing?

Question

I am going to start a new marketing campaign to reach my goal of buying 2 properties for buy and hold.

Here is my criteria: Town house, built pre-1996, last market sale date 1996.

I am hoping to find original owners that have not made any upgrades or improvements to their town home since buying it 20 or more years ago. Clearly, if there is some distress then that helps! ( smoking in the house, cats, messy/hoarder, etc.)

I am looking to buy these as-is, direct from seller.

My plan is to have two offers:

1. Cash, if thats what they need (70% formula- which would then turn into wholetail/fix-n-flip).

2. Seller financing. I would offer to pay close to market price for the townhouse if they are willing to finance it at favorable terms. That would be a low interest rate(0-3%) and a long amortization schedule(10-15 years). Hopefully, it would help them provide a stream of reliable income and being able to get rid of the property without going through the traditional sales process with realtor. It would help me because with a low interest rate, most of my payments would knock down principal and provide cash flow.

Have any of you done seller finance for the long term and with low interest rates?

Brian Gibbons · Answer

Check this article on "imputed interest"

Tax Rules on Imputed Interestby Eric Bank,  Imputed interest is taxable, just like real interest.Your business might incur imputed interest in several ways, including installment sales, below-market loans and original issue discounts, or OIDs. Imputed interest, often called phantom interest, arises from interest that is considered to be paid even though no actual payment occurred. Your business must pay taxes on the imputed interest it earns.Applicable Federal RatesThe Internal Revenue Service won’t stop you from making interest-free installment sales or below-market loans, but it will tax you as if you collected interest at applicable federal rates, or AFRs. The IRS publishes new AFRs each month. If your business charges less interest than the appropriate AFR, it will have to compute and pay taxes on the difference, which is imputed interest. The IRS publishes different AFRs reflecting the different types of arrangements that create the imputed interest.Installment SalesAn installment sale is one in which customer payments extend into future years. You may agree to an installment sale without charging your customer interest, but you’ll have to pay taxes on the imputed interest that you should have charged -- that is, the AFR. You only incur imputed interest if the installment sale payments are less than the present value of the sum of principle and AFR interest amounts. If your installment contract has inadequate stated interest, it must use the AFR rates for Section 483. Use Section 1274 rates if you make the sale by giving your customer a loan at a bargain interest rate.

http://smallbusiness.chron.com/tax-rules-imputed-i...

Jeff Rappaport · Answer

@Charlie John,

I like your ideas of structuring owner finance for properties.  I do it on every lead that comes in.  I usually give the seller several owner finance options to choose from.  I may offer more that what the property is worth with a low interest rate (usually the lowest federal rate) over the course of 3-7 years.  The obvious reason is to structure it so there can still be a cash flow and of course the principle pay down.  I try to structure these with little money down but usually am flexible as long as the seller does not want 10% or more down.  I know I can flip these all day long!  The less I put down the more I can get from another investor.

I will also offer a more traditional owner finance with a larger down payment and a higher interest rate (4-5%) over a longer term but with a lower price.  These are properties I am always looking to flip to another investor.  This would be more of the traditional owner financing scenario.

I may offer an interest only option.  I will offer less for the purchase price and show the seller that he/she will get more over time.  I will structure these from 5-12 years with a smaller down payment.

If there is any debt owed on the property I will use many of the same options as above but structure is as contract for deed where the deed is held in escrow and will not trigger the due on sale clause of the underlying loans.  I will also look at taking property "subject to the mortgage" and structuring something around the existing debt.

Keep in mind that even when you can't structure something to fit your personal buy and hold needs that there is a potential exit strategy to still wholesale that financing to another buyer and get paid fairly handsomely.

I am curious why you are only focusing on townhomes.  I do it on houses, multi family, commercial etc.  If you keep at it you will find that you can become very creative with these offers and if you listen very intently, you will find out the seller's hot buttons.  Once you accomplish that you become a problem solver.  A very highly paid problem solver!  Good luck!

Jonathan Godes · Answer

Maybe some CPA's can weigh in on this, but I believe if you get an interest rate that is significantly below "going rate" the seller would have gift taxes they would be liable for. At least that is what I have been told before.

On the practical side, why would anyone lock themselves into a 3% interest return when the fed is raising interest rates quarterly? I could see MAYBE doing a 5 year balloon on a 20 year AM schedule, but very few people will take that interest rate risk.

You can have a low payment with a "normal" interest rate of 6%, but it would require a 30 year traditional residential loan and you wouldn't be paying down the principle as quick as you would like. Or you could do an interest only loan and aggressively pay the thing down and try to beat the adjusting rate (HELOCs are good for this strategy).

How do I structure seller financing?

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