Seller financed down payment
canton, OH · Member since 2012 · 25 posts · 9 votes
ok, here is a theoretical idea. I am new to this so don't take this as advice, more of a question. Could you and the seller form an LLC with the seller maintaining 20% ownership in the property. Then the seller is not a debtor, but has an equity position. Then after getting the loan and financing, the seller could be bought out at a predetermined buy out price (maybe after the property is capped out and refinanced.
Could this be a potentially legit strategy?
The seller has a property in a business entity? If not, he can put it in one. He'd be refinancing. He most likely will have a personal guarantee on that loan. Then you can buy into that business entity, being in that entity you can manage the property. An agreement to purchase the LLC shares can be adopted in the operating agreement. The seller can go on vacation, but will be on that loan until it is paid off unless a lender agrees to release them and take the new member as the sole borrower, not likely. Also, you can manage that LLC, be paid, earn your way in over time, but if you remove that seller from the LLC entirely as the owner of that property and the loan is made to the LLC and that "seller" a beneficial interest has been transferred and the lender may call your loan due, the "seller" needs to be in the LLC, but doesn't have to be active.
Refinancing is a different animal than buying, the LTV for a cash out refi will be lower, 70/60 maybe 50% with a bank, if they will do it at all. I suggest you not do your LLC purchase the day after the refi either, give it some time to cure so that your long range plan is not tied immediately to yesterday's loan. A member retiring is fine, moving out of management is fine, but you did represent to the lender that you were managing and active in that entity, they are giving "you" the loan.
Now, before folks get "creative" need to know what is legal, not guess and know what alternatives there are using inside the box techniques. Mentioned was the 10% down, 15% carry back by a seller and 75% from a lender, that is customary as a "purchase money" transaction.
When you mix bank financing or any agency that carries any federal loan guarantee you are subject to mortgage fraud issues. Mortgage or bank fraud is different from civil or criminal customary fraud matters where intent for some financial gain might be required. With bank fraud , any statement or omission which misleads an insured lender in considering relevant facts concerning any loan or business transaction is evidence of intent, the lender does not have to suffer an actual loss. Not disclosing liabilities or contingent liabilities or expected liabilities known to be made in connection with a transaction or after that transaction has closed what was created from or in connection with that transaction can constitute fraud.
There is no way around it, on a loan application you are to provide your assets and liabilities. Any liability known to be incurred arising from the transaction is a contingent liability which is also asked. Next, point blank, the question, "is any part of the down payment borrowed", is on the standard 1003 application. A down payment can be borrowed in certain cases, but it must be disclosed and approved. Under IRS Code, all real estate transactions must have an accounting of all funding and expenses, single family residential are accounted for with a HUD-1, you can use the HUD-1 for commercial requirements but it's not required to be used. Not showing borrowed funds is not a proper accounting of a real estate transaction, so, you're in violation again. That will go to seller financed transactions where any lien is made in connection with that property.
Doing seller financing, you're not subject to banking regulations but to civil and criminal aspects of fraud, showing or telling a seller something that is not true can still be fraud in that transaction where that seller relies on the financial information given to determine if they should extend credit. The transaction still needs to be properly accounted for with seller financing. Why not just have the seller do 100% financing and they may take additional collateral?
I prefer seeing an installment sale of a business entity, that can be structured hundreds of ways, it's not a real estate transactions but may have tax transaction matters and such are not made of public record until shown with the Secretary of State as officers/directors/members or owners. :)
Key is does your seller understand he doesn't get 1st position on the lien. Not many sellers would take a 2nd position unless secured by something else. Even if you get a bank to say OK to 2 liens and educated seller may not be ok sitting in second.
as @Tom S. said, use a local lender. It will be recourse, but will allow you to get 10% and possibly 15% seller carry back. The debt service still will need to be at 1.2. You could also raise the purchase price and have the seller provide for the closing expenses and a reserve fund.
The only way I've done the seller financing of a second mortgage is with small local banks where it's a commercial and portfolio loan. And I had a good relationship and history with the bank. And good credit.
In addition, I had to have the downpayment up front from my own funds. When we closed and the second mortgage was done, I was then reimbursed my downpayment funds (not all of them - it was 25% down and then the seller did 15%, so I was effectively in for 10% down). All of this had to be fully disclosed and approved by the 1st mortgage lender.
It can be done, but I believe commercial loans and portfolio lenders are the key.
Good luck!
- Tom
@Prasad J. I usually just add some language to my regular contract. We have a blank field that says "Other financing conditions" and I usually add something like this:
"Seller to provide financing via 2nd position mortgage loan, to buyer, for the sum of $20,000 (or 20% of the sale price), at an interest rate not to exceed 6% per annum, interest and principal, amortorized over 15 year period, payable in monthly installments with a balloon payment due in 3 or 5 years."
I usually work out these seller financed deals with sellers who are also investors. A more sophisticated seller may require a personal guarantee if you are buying in an LLC. If that is the case or even if I just want to give my seller a more comfortable feeling about it I'll add something like this: "Buyer also appearing herein to sign individually and as insolido obligor of the aforementioned debt."
You can set any terms you and the seller can agree on, but that is usually how it goes for my seller finance deals.
See you at the top!
This is a variation on a question asked a couple of times in this thread. Would it be possible to do a joint venture with a seller who owns a commercial building ? My thought is after the seller contributes the property to the entity, I would refi the building and be the individual guarantor of the new mortgage. If I could do a 75% refi (with cash out) I would give the seller excess cash and his 25% left in the deal would be his equity. I would be doing this to get around having to put up the 25% down payment. At sometime in the future I would cash out my joint equity partner. I have read about the second mortgage ideas with the seller holding a second mortgage of 15% and lowering my down payment to 10%.
I am looking for a strategy that can be replicated many times. The buildings where I am looking to employ this strategy are typically difficult to sell so it gives me some leverage with a seller. I like the idea of the joint venture because I can offer the joint venture partner a % of the cash flow (perhaps 25%) vs. an interest rate that is an absolute amount. I can see a couple potential issues that could be drawbacks.
1. Would the contribution of the building in the entity make the seller realize a gain on the total sale even though he gets only 75% of his cash now. This obviously would not happen if he held a mortgage.
2. Could I get a 75% cash out refinance?
Are there other considerations that I haven’t thought of?
Thanks in advance.
Bob
@Aaron Thomas I would certainly think that is a good possibility. You just need to get on the phone and call all the small local banks in your area. One will bite on the opportunity to fund it.
Bumping this post. I also have a seller potentially willing to carry the 25% down payment. Would it be possible to do a 100% seller financed deal then refinance with a lender for 75% LTV 6 months later and pay the seller the 75% cash you get from the bank? At that point you would have a 25% 1st position with the seller and a 75% 2nd position with the lender?
@Andrew Flora Nope because I can't imagine there is a bank out there that would take the 2nd position on a 75% LTV. Banks will usually only take 2nd on something like a HELOC on a primary residence or a credit line against the equity in a property. The mortgage with the seller could be "refinanced" at that time, cancelling the original mortgage, re-filing the new mortgage and shuffling them from 1st to 2nd and allowing the bank to take over 1st position if the seller were willing to be 2nd. And this all depends on the bank as most of the smaller portfolio lenders can have terms that vary from one bank to the next. You just have to call around.
Does this property need rehab? If not, then no cash input is required and my preference would be to find a bank wiling to do the 75 or 80% and allow the seller to fund the 20-25% down payment with a seller 2nd. These banks exist, you just have to call around. You need to buy low enough to still cashflow under 100% financing, assuming this is intended to be a rental.
Good luck with it, let us know how it goes!
@Andrew Flora I've posted on this in other threads and above - this can be done but for me only with commercial lenders. In addition, I had to have the 25% down first, we closed, then executed the seller financed 2nd, and that essentially reimbursed me on my downpayment. Luckily I was able to get the 25% down through a 401k loan, so it only cost me a $100 admin fee to do it.
So it can be done. As Bob mentions above, you have to call around. Good luck!
Can you do something along the lines of getting 75% financing from the bank and work out a deal with the seller where you finance the down with them? So you as the buyer would be financing 75% with the bank and 25% with the seller.
@Josh Heinen Hi Josh - see my post above:
" this can be done but for me only with commercial lenders. In addition, I had to have the 25% down first, we closed, then executed the seller financed 2nd, and that essentially reimbursed me on my downpayment. Luckily I was able to get the 25% down through a 401k loan, so it only cost me a $100 admin fee to do it. "
Hope that helps!
Thanks Tom, is it an option if you dont have the 25% first? Exaggerating with for the purpose of this topic, what if I have zero dollars, can I seller finance the down payment and then use a bank for the other 75%, making monthly payments to both parties each month
@Josh Heinen yes you absolutely can do what it is you are asking. You just have to find the right bank who will allow it. This is exactly how I got my start because I had no money and was determined to figure out how to get into this with other people's money including seller financing. I posted about it several years ago and broke down in some detail how I made it happen and some of how it was structured. I have come to find out since then that there are numerous small portfolio lending banks in my city that are happy to allow a 25% or even 20% seller financed 2nd mortgage to cover your 20% down portion, all happened at the same closing.
https://www.biggerpockets.com/forums/50/topics/188852-how-to-structure-my-creative-finance-to-purchase-a-duplex?page=1#p1275590
Hey @Brandon Johnson, great job on getting to 33+ properties. What lender do you use in your area that allows seller-financed 2nd position? Thanks!