Anyone have experience in Owner Financing?

Question

We have tenants looking to buy a house, and we were considering selling them our rental with a lower interest rate than current market rates.

Does anyone have experience doing this? What are the risk? How would you go about this?

Olivia Grabka · Answer

@Sean Haley

Seller financing is great, you avoid fees and typically get a low down payment.

Key items:

1. Property should be conveyed

2. A note should be recorded with loan terms

3. Mortgage reporting for tax purposes:  make sure the owner understands that you will report the payments and that they need to issue a 1098

Chris Seveney · Answer

@Sean Haley

Out of curiosity why would you sell a home at lower interest rates than market rate?

Think about what the payment is, and what that payment got you 20 years ago compared to today - because in 20 years it’s gonna be worse and they have a low rate they will never refinance and you will basically have an upside down investment with the risk they could default.

Nicholas L. · Answer

@Sean Haley

it IS selling the home.  the new owners own the home.  you have a mortgage on it.  if they stopped paying you would foreclose (depending on state laws.)

i have bought on seller finance, and i think it's a great option for sellers / investors looking to end / exit their careers.  they don't need / want to invest anymore and so they like the passive income - even more passive than collecting rent.  but if they're beginning, though (like you are?) it seems like you could do a lot more with the cash up front than the cash over time.

just something to think about.

Andrew Kiel · Answer

@Sean Haley - There are volumes of books and other information out there about seller financing.  I've purchased and sold many properties this way and feel it's a wonderful tool, but with risks.

In the most simple form, you sell the house to your tenant and get a note in return.  The risk is that you may have to foreclose on the property if they fail to make the payments.  That's probably the most important question you need to ask yourself - are you willing and prepared for that outcome?  In this case, since they are already in the property, you probably have a fair understanding of how they keep the house and what their payment history is.  However, even in the best of circumstances things like death, divorce, and disability can quickly change that.  I would also recommend that they have sufficient 'skin in the game' IE additional down payment above and beyond just having lived there a while.  It's far less likely you'll foreclose on someone who puts 20-25% down than 0-5%.

Seek out someone with experience to help you, a real estate agent, title agent, and/or attorney are great places to start.  Just beware, most of these 'experts' are not experts on seller financing.

Also, you may want to consider using a note servicer (in my area many title companies offer this service).  They will be the intermediary to collect the funds, get you paid, and send the notices (and handle the foreclosure) if needed.

Steve K. · Answer

I don't see why you would give them a better interest rate than a traditional bank. Typically when a borrower is less credit-worthy, they pay more to borrow. The reasoning for that is they would be considered higher risk. The risk is if they stop making payments, then you would need to foreclose and that could take a long time and cost a lot of money. They may be living there for free during the foreclosure/eviction process, and you'd still need to cover your expenses on the property out of pocket, and foreclosures can take many months or even years, and the property may come back to you in much worse condition than it is now. I've done a few seller-financed deals and they have all been a point or so above prevailing interest rates. As a seller I'd want a higher down payment, a higher interest rate, etc. something for taking on the risk of lending to a sub-prime borrower.

Chris Seveney · Answer

What are your returns selling cash (net returns) and putting the money in th markets at 8% year vs. what rate you are charging over the next 20 years. Remember also that the interest on the loan is taxed at ordinary income rates.

So for example lets say you have 100k and were making 8% in the markets - 8k per year and say you are in top bracket, you will pay $1600 in taxes per year or netting 6400.

Now lets say you did a loan and were at 5% you are earning $5k per year (actually less because principal is being paid down and some of money goes into essentially a 0% checking account). But for ease say 5k at 37% taxes you are netting $3,150/yr.

Thats over $3k per year... Just food for thought

Sean Haley · Answer

I agree, and I do have funds dedicated to the traditional market. The thought behind this was a note would have less volatility than the market, while juicing returns compared to a core rental. Then possibly selling an equity position in the debt stack to get a promote

Sean Haley · Answer

No liens on the property. I don't see it as selling the home because I would own the lien on the property, albeit I wont benefit from the sale perse. The cash yield from the loan would be greater than the yield from renting the property, even with area appreciation. Tenants are building credit to purchase a home. Thought we could both benefit, they get a slightly lower rate than market with 15% down, and we would get better returns as lien holders.

Nicholas L. · Answer

@Sean Haley

does it have a mortgage on it?

why do you want to sell?

Anyone have experience in Owner Financing?

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