What If I Owe Money at the End of a Terms Deal?

In rare cases, you may owe money to the seller at the end of a terms deal. But that doesn't mean you can't profit!

When we do terms deals and when we coach our Associates through deals around the country, we virtually always use the same 3 Paydays™ system. If you don't know, that consists of a down payment (Payday #1), the monthly spread on the home (Payday #2), and then the markup plus the principal paydown at the end of the term (Payday #3).

But in calculating our numbers, we actually need to remove the initial down payment from our profit on Payday #3 in order to get an accurate number for the total profit on the deal (since that was paid when calculating the Paydays we already counted in in Payday #1, so we don’t want to double count it).

But what happens if the down payment is so large that it actually makes Payday #3 negative?

It's a rare occurrence, but it can happen. Let's take a look at one example from an Associate of ours who structured a deal with a massive down payment that effectively cancelled out their Payday #3, making it negative. But they were still able to turn a substantial profit on this deal because they planned accordingly and it’s nothing more than getting your profits up front instead of the end and if over total profit, you set it aside.

A massive down payment

When we do rent to own deals, one of our primary goals is to help the buyer get vested in the house and secure the best mortgage possible at the end of the term. The best way to do this is to start with a large down payment, or as large as possible.

But we're also dealing with people who are unable to purchase a home conventionally. It would be crazy to think that someone in these circumstances can somehow afford to put a 20% (or more) down payment on a home in one go. Nowadays, with COVID and the general market conditions, you may get plenty of people with down payments who need seasoning or down payments who need credit repair—in which case we do collect it all up front. Approximately 50% of the time it’s spread out over term of the rent to own deal.

As such, we often structure down payments (Payday #1) in installments. We'll try to get as much up front as the buyer can reasonably afford, then we'll schedule more payments throughout the next one to two years. Sometimes, we'll schedule these payments around tax season—so they can utilize their tax returns—or around times when they receive bonuses at work.

This deal (handled by one of our Associates) started with a down payment of $159,800 on a $750,000 home. That's around a 23% down payment!

This is, of course, great for everyone involved. Our Associate gets a massive Payday right at the beginning of the term and they can rest easy knowing that the buyer is likely not going anywhere after such a large commitment. The buyer can also rest easy knowing they're locked into the deal and they'll secure a great mortgage at the end of the term.

In this case, the down payment was so large that it turned our Associate's Payday #3 into a negative number. This might be a shock, but it's not a problem if planned correctly. (Clearly, seeing as our Associate still profited well into the six figures on this deal!)

All 3 Paydays™

Let's dive into the numbers to fully understand how this all works. For some context, this was an expired listing that our Associate acquired through a Slybroadcast. This is an automated voicemail system we use to call on expireds, where we ask the seller to call back if they're interested in setting up a terms deal.

They agreed to a sandwich lease purchase with a term of 60 months. However, there is a high likelihood the buyer will be able to close out this deal before 60 months, so all of our calculations below will be based on a 30-month term. If they go longer, that's great for our Associate, and if not, no sweat!

The purchase price on the home was $750,000, although it's important to clarify that we only use this number to calculate the amount of equity owed. In this case, the seller had a mortgage balance of $201,125. When you subtract that from the purchase price, that's $548,875 in equity. For our Associate, that means he's going to pay off the mortgage and give the seller his $548,875 in equity at the end of the term.

(But the mortgage balance will be much lower at the end of the term, which is where we make a significant portion of our profit on these deals!)

You already know that Payday #1 was a whopping $159,800. Payday #2 came out to a spread of $606 per month, which comes to $18,180 over the course of 30 months. That number comes from the monthly payment from the tenant buyer ($4,623) minus the payment to the seller ($4,017).

And finally, there's Payday #3. This is normally our biggest Payday, but not in this case (although it would have been if there was a smaller down payment).

Our Associate sold the house to the tenant buyer for $799,000. That's a markup of $49,000. The principal paydown was also massive—out of that $4,623 payment to the seller, $2,150 was going to paying down the principal. Over 30 months, that's $64,500!

That's $113,500 for the markup and principal paydown, which would be massive in any other deal. But when you remove the down payment, Payday #3 ends up being -$46,300.

Even with that negative Payday #3, the total still comes out to $136,303. That is a significant total and just goes to show that even if one Payday doesn't look great, the total can still be huge.

In this case, our Associate had planned for this well in advance. They knew that Payday #3 would likely be negative based on the large down payment, and that they would effectively "owe" money at the end of the term.

But that's not a problem. All they had to do was hold onto a portion of that initial down payment and their profits from Payday #2 to make sure they could close out the deal at the end of the term. Even if they didn't account for this, they would have had to spend $136,000 over the course of 30 months to end up in the red on this deal—which is no small feat!

(There are much more advanced techniques on how to leverage those funds but that’s for another article, another class, or one-on-one Associate coaching.)

Moral of the story? One "bad" Payday doesn't mean a bad deal. But be sure to calculate the total of All 3 Paydays® from the beginning so there are no surprises. And always save a portion of Paydays #1 and #2 to account for obstacles or hiccups along the way!

Have you ever had a negative Payday on a deal, and were you prepared for it? Feel free to share your experience in the comments below.