Help me understand seller financing criteria

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Help me understand seller financing criteria

Jon C.
Real Estate Investor · Phoenix, AZ · Member since 2008 · 74 posts · 14 votes

I think I understand the basics of seller financing methods. I know people use "subject-to" a lot but I believe that is one type of seller financing. But there is also lease option and I've heard Agreement for Sale or something similar.

I am interested in wholesaling these deals and wanted to clarify when seller financing is a good strategy.

An example of a deal as I understand it:

House worth 100k. Owner owes 90k at 6%, with payments of $600. Rents in area are $1000. Owner wants $2000 to leave.

I get the property under contract for $92k. I market it for 98k with 10k down. At closing, my buyer brings 10k. 2k of that goes to seller, approx 1k goes for closing, and 7k for me.

It seems to me, for something like this to work, there are a couple things that need to be in place. Please tell me if this is correct:

1. Seller has little to no equity but NOT upside down.
2. Home is in good condition.
3. Mortgage payment less than rental comps(unsure of exact formula)

Am I missing something with all of this?

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    15y

    For one, I think title insurance alone will cost you more than a grand, so $1000 for closing costs seems very low.

    For another, why would an investor pay you $98K for a house with a market value of $100K? That's way too thin.

    And, its a subject to deal. Though some would consider that a form of owner financing, its not nearly as good as an owner carried note on a free-and-clear property. If the numbers were right (i.e., (rent/2)-$100 > P&I payment) and you're willing to take the risk of a subject to deal, this seems like a good way to acquire some rental properties with minimal cash out of pocket. If you're wanting to wholesale, you need to find better deals than this, IMHO. A $100K property at $98K, even with the subject-to financing, is a pretty thin deal.

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    15y
    I would disagree Jon, a sub2 deal is often better because all the risk, essentially8, is on the seller and current responsibly party to the note. As a sub2 buyer, you "promise" to make the payments and keep it current, but the ultimate responsibility still lies on the seller which make a sub2 deal quite attractive to a buyer. Add in the fact that the sub2 may have a nice conventional note at under 6%, most owner carried notes will be higher than that as sellers will want better returns than 6% on their money.

    I agree with the balance of Jon's comments though, this deal would not be attractive to almost all investors. Why would an investor wnt to pay full retail price for a home? The answer is, they wouldn't which means you will need to find deals with lots less owed than the value in order to have enough room for you and your end buyer.

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  • Jon C.
    OP
    Real Estate Investor · Phoenix, AZ · Member since 2008 · 74 posts · 14 votes
    15y
    Originally posted by Will Barnard:

    I agree with the balance of Jon's comments though, this deal would not be attractive to almost all investors. Why would an investor wnt to pay full retail price for a home? The answer is, they wouldn't which means you will need to find deals with lots less owed than the value in order to have enough room for you and your end buyer.

    The numbers I put up were roughly the numbers I was told as an example of this type of deal, with a 5 year term. And apparently it sold to a buyhold investor. This was from an experienced wholesaler.

    I have been previously told that subject to deals were good for properties with little equity. You're telling me I need a lot more equity. If the property had that equity, wouldn't a traditional purchase be better? I guess I wonder at what point a subject-to is better than a traditional sale. That's why I want to know what sort of criteria is needed for subject-to rather than traditional sale.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    15y

    A subject to deal gives the buyer the ability to acquire a property without having to qualify for a loan or to get a loan in their own name. As Will points out, all the risk of a default remains with the seller. So, yes, there's a good argument that a deal with minimal equity is acceptable.

    Now, I don't agree with the idea there is no risk to the buyer. Yes, the buyer cans choose to just walk away if the deal goes south. Personally, I think that would be a pretty poor choice, since you're going to wreck someone else's credit. Further, I think there is a real possibility of interest rates going up in the future. When I first started looking at houses, in the early 80's in Houston, OO rates were 16%. Yep, higher than hard money is now. Inflation was rampant. Could that happen again? Not a high probably, but a possibility. Will 6% loans on properties sold subject to get called? You bet. That's specifically why the due on sale clause was created. I don't think it will take anything near 16% before lenders start looking for this sort of situation. If the buyer's put out a $10K down payment, and no doubt some rehab money, too, then there's a very real risk of that money being completely lost.

    Just because one particular buyer bought one particular property at a high price doesn't mean every buyer will. Lots of RE investor buy properties right off the MLS. You have to know your buyers. If you know what your buyer's want, and can find it, they will (or, at least should) buy it.

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