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When Seller Financing is Too Much Leverage

by Kevin Kaczmarek on August 3, 2011 · 6 comments

  

It might seem like a great problem to have, too much financing from private sellers. In many instances it is a great problem. You are acquiring properties using other people’s money to grow your portfolio or business. However, there are a few guidelines to follow when buying properties using seller financing.

Begin with the exit strategy:  One of the single best pieces of advice we can use and apply in all aspects of real estate investing: Know your exit strategy from the beginning. If you are buying a property using seller financing, how long will you hold the property? Will you refinance the property? Will you sell it on contract? Maybe a Lease-Option?  Flip the property? You have to use seller financing for your area of expertise in real estate exit strategies.

Avoid Clustering: You will find that once you secure your first property using seller financing the 2nd, 3rd, and 4th properties get easier to secure. Once you get over that hump of the first deal you can start adding properties to your portfolio faster than you could have imagined. With this new found power and talent comes a new challenge. You must avoid too many new properties or debt at one time. When you start out, here’s a good rule of thumb: Only take on the amount of debt you can safely afford to make 6 months worth of financing payments against in case things do not go as planned. Therefore if you can afford to make monthly payments on 5 seller financing properties for six months, that should be your limit per month.

Pay in a 15 Day Spread:  This is neat strategy I have applied to my seller financing deals. As I acquire a property I set my payment date 15 days after my anticipated rent collection date. Therefore if I buy a rental property using seller financing with the tenant paying rent on the 1st of each month, I will negotiate with the seller to allow me to pay on the 15th of the month. That 15 day spread gives me time to collect even late rents to ensure I make my seller financing payments on time. Never put yourself in a cash crunch situation where you have to pay the mortgage with the incoming rent check the same day.

Make Your Contract Assignable: Getting back to the exit strategies in our first key point, there is one aspect to exit strategy that has to be addressed. When buying a property using seller financing, make sure there is an assumable clause in your contract. This will allow you to “wholesale” the property to another investor if the property does not perform as you expected. This does not give you free reign to wholesale your problems away, but this can be used to help in case of a personal credit crunch. You can get yourself out of a bill by wholesaling the contract to another investor who can better handle the debt service.

It is quite easy to miss these details in the excitement and emotion of your first seller financing deal, but if you keep these tips handy and use them diligently as part of your strategy you will build a seller financing system that creates repeat business and repeat profits!

Photo Courtesy: Mariam Shahab

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{ 6 comments… read them below or add one }

Jolene August 3, 2011 at 7:40 am

I like the ‘Pay in a 15 Day Spread’ strategy. In my experience, there is mostly a month when tenants cannot pay on time, and this strategy definitely can protect us against not paying seller financing payments on time.

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Rob August 3, 2011 at 8:07 am

Excellent point about keeping your eye on the exit strategy from Day #1. There is also something to be said about having purely TOO MUCH leverage from a financial perspective. Leverage can certainly mean enhanced profits, but it also means that for every dollar of debt you assume, you are assuming more risk. At some point every investor should ask themselves if they have crossed the threshold of debt comfort, and if those enhanced returns are worth potentially destroying all their equity should even minor events turn against them.

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Drew August 3, 2011 at 4:09 pm

Know your exit strategy from the beginning. This is essential! Being clear of the expectations and goals from the beginning will make the entire process that much easier for everyone involved. Thanks for sharing

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Teyona August 4, 2011 at 1:47 am

Great tips! My favorite is the first one, “the exit strategy”.This is the technique that we should practice first hand. That was a good read.

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Kevin Kaczmarek August 8, 2011 at 10:03 am

Thank you all for the positive feedback on the article!

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Eric September 4, 2011 at 10:04 am

Hello everyone. Sorry guys (Newbie) here but very hungry to learn this amazing niche. May I ask, isn’t it hard to buy as an investor with seller financing when most seller financing deals are people who are investors themselves and/or sellers looking to maximize the price they can sell at??
Also if sellers are selling and able to carry back isnt it beacuse they have equity and/or own the property without a mortgage allowing them to carry back. So if that’s the case can’t they just sell outright and do a straight sale to get the cash they need? Why would they sell at a discount, which I imagine is what (We) the investor wants to create a spread and allow us to have that exit strategy you speak of?

Thanks and I value everyones response.

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