Good Seller Finance Terms

12 Replies

I'm considering purchasing a pair of duplexes from an older gentleman. He's been renting these properties for 25-30 years and is looking to be done with them. I'm considering a seller-finance offer to help with closing speed and not go through the mortgage process. (though I do have good credit score, decent DTI - but mortgages are a pain these days).

What would be a reasonable starting point for an offer regarding financing?  Price would be around $450K.  If I was getting a conventional mortgage, I'd be putting $112K down (25%), and pay 5.75-6% for a 30yr.

What should I offer him to be both reasonable and competitive?

@Mike McCarthy

I believe you should start with the "555" method: 5% down, 5% interest, 5 year balloon payment.

Of course this is a starting point and you should ask yourself how much you are willing to pay. You should show the seller his benefits for doing seller financing (Tax benefits, the ability to close fast etc)

Thanks @Jo W. . That's exactly what I was looking for - as I don't really know how much I'm willing to pay for the financing as I don't really have any comparison other than what I'd get at a bank.

You mention tax benefits for the seller? He's going to pay 15-20% capital gains tax, but with financing, he'll only see $xx/month income instead, spread over those 5 years. Did I capture that reasonable?

@Mike McCarthy

I'm not a tax expert but for my understanding the IRS considers seller financing to be an installment sales contract, sellers have the opportunity to spread out capital gains taxes over the duration of the installments (5  years in our example) which means that each year he can find other expenses to offset that income. it will be very difficult to find write off on a high amount in one year.

@Mike McCarthy

I never heard of the 555 method, and see absolutely no logic to it. Despite the catchy name, why should everything about your mortgage offer have the number 5 involved? Is there some kind of magic to the number 5 I’m unaware of?

As a 40 year experienced investor who has actually purchased six (not five, six) properties utilizing owner financing, and sold about 20 with owner financing, I suggest you start with something closer to what a competitive offer would be. You don’t want the seller to either be turned off by the idea of owner financing, or consider you a flake, both of which would be likely if you offered 5% down.

I know of no sellers that would be dazzled by the installment sale tax information. Most people realize that if they receive no money they pay no tax. Why people believe they can convince a seller that this is somehow advantageous to receiving income and paying taxes on the income is beyond me. This is like telling someone to not work, because if they receive no income they'll save a lot in taxes. Further, the explanation of if you only receive your profit a little at a time you'll be able to "find" deductions to offset it is counter intuitive- either you have deductions from income or you don't - you don't "find " them . This mis information is the stuff associated with slick real estate pitchmen and laughed at by professional investors.

Unless the seller is desperate to unload AND doesn't need cash, which is usually why someone's desperate, so it's an unlikely scenario, then the seller may become interested in seller financing if the borrower has 20% cash down payment as skin in the game. Why 20%? Because over the years that has been established as the MINIMUM down payment figure for a real estate purchase with only two exceptions: first being for loans with third party guarantees like FHA or private mortgage insurance (if available), second being for lenders willing to accept a higher risk for a much higher interest rate. Like hard money lenders who'll lend 95% but at 14% with 6 points.

So we are at a minimum 20% downpayment. Interest rates at a minimum comparable to investor rates on comparable properties. Most sellers aren't motivated by anything less than 7%. Terms get more interesting, because the higher the interest rate you are willing to pay the longer the term you can ask for. With a 7% rate I'd ask for a 20year amortization and a 10 year balloon. With an 8%+ rate you can ask for a 20 year no balloon as the seller may be able to sell the note at a reasonable discount once it seasons.

My initial offer would be something like 20% down, owner finance balance at 6.5% interest amortized over 20 years with a 10 year balloon. If owner accepts great, if not you’ll need to find out his objection. Is it price, terms, interest rate, or does he just not want to owner finance?

DP, rate, term length are great to hammer out, but the big thing for me (I've done a dozen or so) is actually owning the property.

No Land Contracts! Own it with a mortgage/ deed of trust. Splitting hairs on the rate and balloon mean nothing if you own nothing at the 'buy'.

Thanks for the advice @Don Konipol .  While I realize I can make a completely one-sided offer, I'm looking to make a reasonable offer which would benefit both of us.

Thanks for the details - it's exactly what I was looking for!  I'll let you know how it goes!

My first deal was a 4plex using a seller carry.  $20k down on a $260k purchase price.  6.5% interest amortized over 30 years.  And this was my first deal.  These options exist.  Talk to the owner, get to know them, understand why they're selling.  Offer something you think is fair and you'd be surprised what can happen.  Dan is clearly experienced, but the idea that you have to come to the table with 20% is laughable.  Every owner is on a different path in life and some may be willing to get rid of it with nothing down :)

It would seem to me that price would be part of this discussion as well.  

There is a cash price and there is another price for terms.  You have all bought cars, with 'factory incentives' and various merchandising program that get you 1.9% interest for 72 months or whatever... They offer those incentives in order to protect their price in market place (they call it market price integrity, for those that truly appreciate corporate BS terminology).

So you get a great cash price, or you get better terms.  There has to be some give and take there, you don't get both.

@Spencer Cornelia that is pretty impressive for your first deal, man.  Where'd you find this seller?  Just started writing letters, until you hit on one?

Thanks @Spencer Cornelia  I appreciate the different perspectives. The guy I’m working with isn’t RE savvy, but isn’t stupid either. 

@Mark Sewell I agree, price definitely figures in, but at least I have more experience with that side of the equation. My feeling is the seller is done with the Landlording business as he and his wife are getting older. I don’t think it’s about the cash (as much as any of us don’t need cash). But we’ll see!

@Mike McCarthy I like it!  The landlords are tired of the tenants, but they aren't tired of the cash hitting their mailbox each month.  No doubt they would like to keep that going.  This is a way for them to get there, just what you propose - cash comes in, a fixed amount, and no tenants, and no surprises.  

Do they have to sacrifice a bit of their equity? Well, sure I suppose they do, but not as much as they would need to give away if they accepted a cash offer (from the typical investor with one solution in the toolbox).