Owner financing: interest due on sale!

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

I wouldn't do it. This is basically a simple interest loan with a prepayment penalty. One of the best aspects of a seller finance loan is the ability to sell the property, and keep the note intact.

4 Reply

Ned CareyPro Member

Moderator

Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes

3y

@Meredith Mihm If I understand this correctly it makes no sense.

is he saying that the payments he recives will be 50% interest and 50% principal each payent from the beginning? That would mean the iterest rates changes every payment for that to mathmatically work out.

Even if you could structure it so the unpaid interest simply acrues uncompounded until the property is sold, The seller would be screwing himself. My guess is he or you misunderstand how interest acrues and is applied to amortizing mortages.

The fact that the mortgage needs to be paid off when you sell the property is a 100% normal occurance. While @Joe Villeneuve is correct, it is a real benefit if it dosen't need to be paid on sale, few mortgages are structured that way.

But, if sold, the total amount owed with interest (initially 197K after down payment) would be due.

Huh? By your numbers he is loaning you $100k You would only owe %100k minus whatever principal you have paid down with your monthly payments.

3 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Quote from @Ned Carey:

@Meredith Mihm If I understand this correctly it makes no sense.

is he saying that the payments he recives will be 50% interest and 50% principal each payent from the beginning? That would mean the iterest rates changes every payment for that to mathmatically work out.

Even if you could structure it so the unpaid interest simply acrues uncompounded until the property is sold, The seller would be screwing himself. My guess is he or you misunderstand how interest acrues and is applied to amortizing mortages.

The fact that the mortgage needs to be paid off when you sell the property is a 100% normal occurance. While @Joe Villeneuve is correct, it is a real benefit if it dosen't need to be paid on sale, few mortgages are structured that way.

But, if sold, the total amount owed with interest (initially 197K after down payment) would be due.

Huh? By your numbers he is loaning you $100k You would only owe %100k minus whatever principal you have paid down with your monthly

What he is saying is that he would structure it so that, if I sold it, I'd have to pay him not only the remaining principal, but the remaining interest that I would have paid over the entire life of the loan.

I might not have worded that very well.

I don't understand why he wants to amortize it that way, but I'm not as concerned about that as I am about owing 30 years of interest no matter what!

4 Reply

Ned CareyPro Member

Moderator

Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes

3y

@Meredith Mihm I thought it might be something like that. i am not a lawyer but my guess is this is wrong in lots of ways. He is proably breaking usery laws for charging so m uch interst if you pay early. Next my guess is he would owe taxes on that interest as it is earned the day the loan is made. He might be shocked to find out he needs to pay taxes today on the $97K in interest that he won't receive for 30 years.

Clearly this is a non starter, however I would have him prepare a formal proposal and run it by an accountant and or attorney. Once he reaslizes what he want's isn't possible maybe he will make a deal that makes sense.

2 Reply

Chris SeveneyBusiness Member

Moderator

Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes

3y

Quote from @Meredith Mihm:

Help-- should I do this? I just negotiated an owner financing deal that I am happy with. I like the down payment and the monthly payment. The property is distressed, and I will be getting it for a good price. He wants to amortize it 50/50 interest and principal for the life of the loan (30 years), I'm not sure exactly why, but tax reasons.

The potential problem is that he will only do it if, when sold, we owe him the entire amount WITH interest. So if we had to sell it in the first few years, it might be hard to break even. I don't plan to sell, but this makes me a little bit uncomfortable. Other than that, the deal is a very good deal. Should I do it?

Details:

4 plex-- income $3000/mo, Purchase price 140K, 40K down at 6ish% interest, amortized over 30 years (so no more than $700/mo payment)

(Expenses: tax $225/mo

Insurance: $150/mo

sewer: $200/mo

lawn/snow: $50/mo

capex/repair/vacancy: $700/mo

(So almost 1000/mo cash flow)

But, if sold, the total amount owed with interest (initially 197K after down payment) would be due.

I would have to put in at least 30-40K to correct deferred maintenance, but ARV should be 250K-300K.

Am I missing anything? This is a good deal, right?

So he wants a prepayment penalty / guaranteed payout. I would say absolutely NO to this.

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Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

3y

I think what he is trying to do is accrue his interest.. so he does not have to pay tax on it if you accrue it I believe you only pay tax when you physically receive it. I could be wrong but I know i do virtually all my lending on accrual basis and we dont pay tax until we get paid off.

if you payoff real early that's a massive pre penalty if you owe all that accrued interest Very few people would go for this deal i bet.. Only way i would do that is if you had very little money in it and if he would not accept a reasonable payoff you just hand him the keys.

Pre payment penalties are common in commercial notes like this would be .. your not occupying it right ?

so he pays no tax on accrued interest you get no write off for it.. ( confirm with CPA) Usury is his problem not yours.. same with legality of prepay penalty etc.

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Account Closed

Investor · Scottsdale Austin Tuktoyaktuk · Member since 2021 · 4k+ posts · 4k+ votes

3y

Quote from @Meredith Mihm:

Help-- should I do this? I just negotiated an owner financing deal that I am happy with. I like the down payment and the monthly payment. The property is distressed, and I will be getting it for a good price. He wants to amortize it 50/50 interest and principal for the life of the loan (30 years), I'm not sure exactly why, but tax reasons.

The potential problem is that he will only do it if, when sold, we owe him the entire amount WITH interest. So if we had to sell it in the first few years, it might be hard to break even. I don't plan to sell, but this makes me a little bit uncomfortable. Other than that, the deal is a very good deal. Should I do it?

Details:

4 plex-- income $3000/mo, Purchase price 140K, 40K down at 6ish% interest, amortized over 30 years (so no more than $700/mo payment)

(Expenses: tax $225/mo

Insurance: $150/mo

sewer: $200/mo

lawn/snow: $50/mo

capex/repair/vacancy: $700/mo

(So almost 1000/mo cash flow)

But, if sold, the total amount owed with interest (initially 197K after down payment) would be due.

I would have to put in at least 30-40K to correct deferred maintenance, but ARV should be 250K-300K.

Am I missing anything? This is a good deal, right?

@Meredith Mihm I applaud you for taking the step and getting this far. You just got excellent advice from 4 of the most experienced investors. Analyze WHY they don't like the deal, learn from it and move on to a deal that actually makes sense. If you, or anyone else that comes across this, doesn't understand the nuances of why this is such a bad deal, ask your questions and I'm sure someone will explain.

4 Reply

Wayne Brooks

Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes

3y

@Meredith Mihm “Interest paid that would have would have been paid for the life of the loan, no matter when it is paid off”……he is delusional and no one would likely dumb enough to do that. Straight up amortization over 30 years, with Maybe a small prepayment penalty before 5-10 years.

3 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

3y

Quote from @Ned Carey:

@Meredith Mihm If I understand this correctly it makes no sense.

is he saying that the payments he recives will be 50% interest and 50% principal each payent from the beginning? That would mean the iterest rates changes every payment for that to mathmatically work out.

Even if you could structure it so the unpaid interest simply acrues uncompounded until the property is sold, The seller would be screwing himself. My guess is he or you misunderstand how interest acrues and is applied to amortizing mortages.

The fact that the mortgage needs to be paid off when you sell the property is a 100% normal occurance. While @Joe Villeneuve is correct, it is a real benefit if it dosen't need to be paid on sale, few mortgages are structured that way.

But, if sold, the total amount owed with interest (initially 197K after down payment) would be due.

Huh? By your numbers he is loaning you $100k You would only owe %100k minus whatever principal you have paid down with your monthly payments.

She didn't say the mortgage had to be paid off (which is normal) shed said the interest had to be.

2 Reply

V.G JasonPro Member

Investor · Member since 2022 · 3k+ posts · 3k+ votes

3y

Hard no, homie.

4 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Quote from @Ned Carey:

@Meredith Mihm I thought it might be something like that. i am not a lawyer but my guess is this is wrong in lots of ways. He is proably breaking usery laws for charging so m uch interst if you pay early. Next my guess is he would owe taxes on that interest as it is earned the day the loan is made. He might be shocked to find out he needs to pay taxes today on the $97K in interest that he won't receive for 30 years.

Clearly this is a non starter, however I would have him prepare a formal proposal and run it by an accountant and or attorney. Once he reaslizes what he want's isn't possible maybe he will make a deal that makes sense.

Thank you, Ned. There's a chance, albeit small that he actually doesn't really understand the way that his previous deals have been structured (by his attorney/accountants), and it makes more sense on paper than the way that I'm understanding/explaining it, so having a formal proposal is a good idea before I rule it out completely.

0 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Quote from @Wayne Brooks:

@Meredith Mihm “Interest paid that would have would have been paid for the life of the loan, no matter when it is paid off”……he is delusional and no one would likely dumb enough to do that. Straight up amortization over 30 years, with Maybe a small prepayment penalty before 5-10 years.

Ha, well I was close to dumb enough! The monthly payment would be about 30% less than with a bank loan, which makes it cash flow nicely. I did, at least understand that it would be a big problem if I wanted to sell it in the first few years. Where I went wrong was that, in the amortization calculator, I didn't think about the fact that the "total payment" 215,838 was NOT including the 40K down payment. If that had been true, it would have still taken 4 years to get the total amount owed down to the amount I was willing to owe the bank initially. But with such a low monthly payment, it seemed worth considering. Anyway, I see now that I was about 6 years off. At least I'm learning a lot from this mistake.

1 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Quote from @Jay Hinrichs:

I think what he is trying to do is accrue his interest.. so he does not have to pay tax on it if you accrue it I believe you only pay tax when you physically receive it. I could be wrong but I know i do virtually all my lending on accrual basis and we dont pay tax until we get paid off.

if you payoff real early that's a massive pre penalty if you owe all that accrued interest Very few people would go for this deal i bet.. Only way i would do that is if you had very little money in it and if he would not accept a reasonable payoff you just hand him the keys.

Pre payment penalties are common in commercial notes like this would be .. your not occupying it right ?

so he pays no tax on accrued interest you get no write off for it.. ( confirm with CPA) Usury is his problem not yours.. same with legality of prepay penalty etc.

Jay, thank you for this insight, and for not thinking me a fool! To give him the benefit of the doubt, he was referencing larger commercial deals when he explained how this works, so maybe that's where he was coming from. And yes, I actually would have been occupying one of the units. I'll bet you're right about accruing interest.

0 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Quote from @Account Closed:

Quote from @Meredith Mihm:

Help-- should I do this? I just negotiated an owner financing deal that I am happy with. I like the down payment and the monthly payment. The property is distressed, and I will be getting it for a good price. He wants to amortize it 50/50 interest and principal for the life of the loan (30 years), I'm not sure exactly why, but tax reasons.

The potential problem is that he will only do it if, when sold, we owe him the entire amount WITH interest. So if we had to sell it in the first few years, it might be hard to break even. I don't plan to sell, but this makes me a little bit uncomfortable. Other than that, the deal is a very good deal. Should I do it?

Details:

4 plex-- income $3000/mo, Purchase price 140K, 40K down at 6ish% interest, amortized over 30 years (so no more than $700/mo payment)

(Expenses: tax $225/mo

Insurance: $150/mo

sewer: $200/mo

lawn/snow: $50/mo

capex/repair/vacancy: $700/mo

(So almost 1000/mo cash flow)

But, if sold, the total amount owed with interest (initially 197K after down payment) would be due.

I would have to put in at least 30-40K to correct deferred maintenance, but ARV should be 250K-300K.

Am I missing anything? This is a good deal, right?

@Meredith Mihm I applaud you for taking the step and getting this far. You just got excellent advice from 4 of the most experienced investors. Analyze WHY they don't like the deal, learn from it and move on to a deal that actually makes sense. If you, or anyone else that comes across this, doesn't understand the nuances of why this is such a bad deal, ask your questions and I'm sure someone will explain.

Thanks for your gentle words, Mike. I realize now that my big mistake was that I didn't think about the fact that the total payments made (215K) DIDN'T include the down payment. That made the math uncomfortable, but not awful, in light of the cash flow. The truth is much uglier.

It's wonderful to have a place to come and ask rookie questions without being laughed off of the forum.

2 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Adding some more information, in case anyone is in the same boat. I'll talk to an attorney tomorrow. But google tells me that, although there are Dodd-Frank regulations on prepayment penalties:

For mortgage transactions, a “creditor” is defined in the regulation as a person who extends credit secured by a dwelling more than five times in a calendar year. Under this definition, the vast majority of people engaging in owner carry financing will not fall under the scope of these rules. As long as you extend such credit 5 or fewer times per year, the prepayment limitations will not apply to your owner carry financing. However, if you do make six or more loans in a year, these limitations will apply to your transactions, and assessment of a prepayment penalty in excess of the limits described above would be considered a violation of the regulation.

0 Reply

Matt Greer

Real Estate Agent · Mesa, AZ · Member since 2017 · 237 posts · 170 votes

3y

I wouldn’t touch it. You’re essentially locking yourself in to high interest and have no ability to liquidate in Order to to protect yourself from possible future financial turmoil since the payoff would be outrageous.

1 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

3y

Quote from @Meredith Mihm:

Adding some more information, in case anyone is in the same boat. I'll talk to an attorney tomorrow. But google tells me that, although there are Dodd-Frank regulations on prepayment penalties:

For mortgage transactions, a “creditor” is defined in the regulation as a person who extends credit secured by a dwelling more than five times in a calendar year. Under this definition, the vast majority of people engaging in owner carry financing will not fall under the scope of these rules. As long as you extend such credit 5 or fewer times per year, the prepayment limitations will not apply to your owner carry financing. However, if you do make six or more loans in a year, these limitations will apply to your transactions, and assessment of a prepayment penalty in excess of the limits described above would be considered a violation of the regulation.

There ya go sounds like its legal to have a pre pay for a one off owner carry.. U should be able to negotiate this to a win win.. if not I guess it would be a pass unless you think you are going to keep it forever.

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2 Reply

Wayne Brooks

Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes

3y

@Meredith Mihm You may, or may not, be able to talk sense to him. And this is Not how commercial loans work….a prepayment penalty, yes….payment of the interest that Would be due over the life of the loan, no. Try to see what he is trying to accomplish.
The “half of each payment is principal and half interest” is an odd request. Typically, in the first 5 years at 6% your principal portion would average about 15% of the payment. Maybe he is trying to classify more of the payments as principal, as opposed to interest, to pay less tax in the beginning. But the payout at the end when paid off is nuts….tell him that part is an absolute no go, see if you can work something out from there. Prepayment penalties on a sliding scale used to be common…5% in year 1, 4% in year 2, and so on.

2 Reply

Ned CareyPro Member

Moderator

Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes

3y

@Meredith Mihm you mention the Dood Frank law. There are MANY state and federal lows in addition to Dodd Frank that would likely apply here.

0 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Quote from @Ned Carey:

@Meredith Mihm you mention the Dood Frank law. There are MANY state and federal lows in addition to Dodd Frank that would likely apply here.

Okay, thanks-- waiting to hear from my real estate attorney!

0 Reply

Ned CareyPro Member

Moderator

Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes

3y

@Meredith Mihm one thing that is a common misconception is that interest is "Front loanded" on mortgages. It is as if people think lenders chose to get more interest up front and accept principal later. NO that is not the case. This is a big misunderstanding. You may understand this but for other reading along.

Lets say you have a 100k loan at 6% for 30 years. That would be apayment of $599.55

The interest owed after one month is $500 but your payment is 599.55. The extra $99.55 is applied to the principal. Now you only owe 99,900.45.

The interest on the new lower principal amount is only $499.50. So the second month of the loan you pay off the extra 100.05. Now you only owe $99,800.40

And so it goes. Ever so slowly you pay down the loan. More interest is paid early in the loan becasue the loan is bigger. As it gets paid down there is less interest due andmore goes to the principal.

So how can he collect 50% interest and 50% principal on every payment? it just doesn't work that way. I don't know how to even calculate that but it is possible this actually be a big advantage to you. That is why you would need to see the specifics of loan docs and how it is written

1 Reply

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

3y

Quote from @Ned Carey:

@Meredith Mihm one thing that is a common misconception is that interest is "Front loanded" on mortgages. It is as if people think lenders chose to get more interest up front and accept principal later. NO that is not the case. This is a big misunderstanding. You may understand this but for other reading along.

Lets say you have a 100k loan at 6% for 30 years. That would be apayment of $599.55

The interest owed after one month is $500 but your payment is 599.55. The extra $99.55 is applied to the principal. Now you only owe 99,900.45.

The interest on the new lower principal amount is only $499.50. So the second month of the loan you pay off the extra 100.05. Now you only owe $99,800.40

And so it goes. Ever so slowly you pay down the loan. More interest is paid early in the loan becasue the loan is bigger. As it gets paid down there is less interest due andmore goes to the principal.

So how can he collect 50% interest and 50% principal on every payment? it just doesn't work that way. I don't know how to even calculate that but it is possible this actually be a big advantage to you. That is why you would need to see the specifics of loan docs and how it is written

Ned when you spell it out that way the last half of the loan could be interest free if its that front loaded in interest.. but this is just going into the Tulles on this one..

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David Dachtera

Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes

3y

@Meredith Mihm,

It sounds like the seller may be trying to take advantage of you or doesn't full understand how loan repayment works.

A $100K loan over 30 years - depending on the interest rate - is going to have total interest paid somewhere around $120K. Your 50/50 P/I payment would be about the same as an amortized P&I payment at a fixed interest rate. So, no real benefit there unless the equity build up is somehow figured into the repayment plan. As another poster pointed out, the interest rate changes per payment.

I'd have to say no myself, but see what your attorney and accountant have to say.

My $0.02 ...

1 Reply

Nicholas L.Pro Member

Flipper/Rehabber · Pittsburgh · Member since 2018 · 6k+ posts · 5k+ votes

3y

@Meredith Mihm

i have a peripheral question for you that i'm curious on

you mentioned 30-40K of rehab. in my view that means this isn't a good seller finance deal. how would you recoup that - wouldn't it just sit?

1 Reply

Meredith Mihm

OP

Rental Property Investor · Winona MN · Member since 2019 · 80 posts · 42 votes

3y

Quote from @Nicholas L.:

@Meredith Mihm

i have a peripheral question for you that i'm curious on

you mentioned 30-40K of rehab. in my view that means this isn't a good seller finance deal. how would you recoup that - wouldn't it just sit?

Now that you mention it, it would take 8 years of cash flow to recoup the down payment and rehab costs. I guess I've just let myself get emotionally attached to this place. That, plus the monthly cash flow looked good. I do think I could potentially refinance after rehab, but would sacrifice a good deal of the cash flow to take money out.

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Owner financing: interest due on sale!

Owner financing: interest due on sale!

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