Owner Financing- More than just the basics

[Eric Drum]

I think I have a general understanding of owner financing. But have some more detailed questions:

-If someone has a small balance on their mortgage payment and there ARV is much higher is it still possible to do owner financing? I know you could pay off the portion but let's say it's higher than what would make sense. For example they owe 70k and the homes ARV is 300k.

-It sounds like part of the appeal for someone to do owner financing is the potential tax benefits. What’s to prevent a investor from coming up with a 10 year payoff plan and then refinancing about 3 years out and paying off the note early? I would assume that this would hurt the original owner since they would be hit with the taxes at that point, correct? However, wouldn’t the owner be penalized with the taxes at the 10 year mark regardless?

Thank you all for your help in helping some better understand the questions above. Thanks!

[Don Konipol]

@Eric Drum. seems to be a bit of confusion/

In answer to your first question, a seller CAN sell a property without paying off an existing lien.  There is absolutely no law to stop a seller from doing this.  As mentioned above the seller can either wrap a seller financed loan AROUND the existing mortgage, or leave the first in place and accept a second mortgage.

However, almost every deed or trust or mortgage contains an acceleration clause.  When a property is sold, and the mortgage is not satisfied, the lender has the right to call the loan.  If the loan is not paid off in full, the lender can foreclose.

Now, whether or not the lender chooses to enforce the acceleration clause has been discussed and argued to death.  In an environment of steady or declining interest rates, lenders are usually happy to continue collecting payments.  Should interest rate rise significantly, we may find a completely different experience.

As per your second question, while many may disagree with me here, I will tell you that based on my 40 years experience in real estate, tax savings as a selling tool to convince a seller to owner finance is the most over hyped and least successful argument anyone present to a seller.

Years ago, when interest rates where high double digits and few people qualified for a mortgage, sellers had little choice but to owner finance or accept a very low price from someone who could buy for all cash.  If the person was teetering on acceptance of an owner financed offer, the buyer would attempt to close the deal by suggesting how much the person selling would save on taxes.  This was often structured as a higher sales price with lower interest to convert some ordinary income to capital gains.  

While this argument might have been effective 30 years ago, the landscape is substantially different today.  In the late 1970s top marginal tax rate was 70%, today its 37%.  Further, inflation was running 12% and pushing people in higher tax brackets each year.  So the value of stretching out the payments was MUCH higher than it is today.  But even in that environment nobody owner financed for tax reasons, the owner financed either to obtain a higher price or because a cash offer was not available.

I have owner financed a number of properties through the years.  The reason I do is either (1) to obtain a higher price or (2) to sell a property that does not qualify for financing or (3) because the only interested buyers are the type that don't qualify for institutional financing, or (4) as temporary financing to quickly complete a sale.  "tax savings" has nothing to do with it.