How Seller Financing Really Works
[This is part 3 of 7 in a series about creative financing]
My last two articles have introduced the concept of creative financing:
- 6 Reasons I Prefer Creative Financing to Bank Financing
- My Creative Financing Toolbox (And Why You Need It Too).
In this article and short video I want to explain one of my favorite investment tools - seller carry-back financing.
Seller financing isn't something new. In fact, it's likely much older than money, banks, or regular loans (interesting article Financial Times - "Debt: it's back to the future").
In 3,000 BC in Mesopotamia people kept records of who owed what to whom. These debts weren't like our bank loans today. Instead they were just credit that one person gave to another when exchanging goods (i.e. seller financing).
For example, let's say an ancient goat-herder had ONE extra goat, but instead he needed THREE bushels of grain.
A neighbor had THREE bushels of grain, but he wanted TWO goats.
They made a trade:
ONE goat + ONE "I-owe-you-a-goat" = THREE bushels of grain.
The owner of the grain seller financed his product. The down payment was one goat, and the buyer still owed him another goat at a later date.
Seller financing of real estate is really no different.
If a seller is asking $100,000 for her house but a buyer doesn't have $100,000 cash, she could agree to take $20,000 down and extend credit for the $80,000 remaining balance. Interestingly, like the grain farmer, she doesn't even have to take money. She could take cars, gold, boats, trailers, or anything else that has value to her.
Seller carry-back financing, also called an installment sale, can be very creative, fun, and profitable. In times when banks don't lend as much money or when bank money is too expensive (i.e. the early 1980's), seller financing can be the only way to get a deal done.
Particularly for income property, I love seller financing because it allows me to ensure I have cash flow and profitability on a purchase. With bank financing, the bank dictates the terms and I must take it or leave it. If those terms don't allow me to make cash flow or a profit on a particular selling price asked by a seller, I might have to put a lot more money down or just walk away.
But, if the seller is willing to provide financing, we can customize the terms (down payment, interest rate, payment, length of financing, etc) so that I make cash flow and a profit and so that the seller gets his price.
If you want to start using seller financing for your investment purchases, you should first understand exactly how it works and how it differs from bank financing.
I made a video to explain seller financing using drawings and diagrams. Let me know what you think:
YouTube: Seller Carry-Back Financing Explained
In my next article about creative financing techniques to buy real estate, I’ll explain how I use self-directed IRA accounts as private lenders for my deals.
Until then …