Long-Term Seller Finance - Pros and Cons

6 Replies

Hello BP - Happy post-Thanksgiving forum browsing.

I have a potential seller finance deal on the line and I'm looking for your thoughts.

This is a 2-unit property in Denver Metro that I'm trying to structure a deal on. The owner is around 65 years old and she doesn't want to use a realtor, doesn't want to be a landlord anymore, is free and clear on the property, and wants to finance the property for her retirement income.  Kind of the ideal motivated seller that I've been in search of. 

The monthly payment is the big deal for her and she wants that payment for as long as I'm willing to keep her around as the financing. In the terms, I would certainly give myself the option of refinancing her out of the deal - but I want to weigh the pros and cons of a long term seller financed deal.

I'm seeing the pros of a long term seller-finance like low down payment potential, locking in a low interest rate long term, and not having the pressure of refinancing if the market turns.

My questions are - what are some other pros of a long term seller finance deal, and maybe more importantly - what are the potential cons that I'm missing?

I'm also looking for some advice with creative structuring. Does anyone have some creative ways to finance a deal like this?  Just looking to make this deal attractive to the seller, and work in my favor as well. I was looking through the forums and didn't see much out there specific to long-term seller finance deals. Thanks in advance for any insight. Much appreciated.

@Tom Horan I am not really sure what you are asking. You have most things covered. In your shoes I would ask the seller what she wants in terms of income and work backwards from that. She should know that she can't expect more income from the property than the rents coming in would support. Don't forget to remind her there are expenses (taxes, insurance, repairs - new carpet etc) and vacancies so rents can't equal the payment. Once you agree on the payment, then you work on the terms of the loan. I would have no problem doing a 30 year fixed. Make sure it is assumable so that if you want to sell it, someone can assume the loan from you and still make payments to her. That should be an easy sell. The other sticky item is the down payment. I would approach that from the standpoint of the more I put down, the lower the monthly payment would be since it reduces the amount financed. Each time I have done owner financing, I have gotten 100% financed. Your mileage may vary. Don't be shy to ask for what works best for you. If they say no, then figure out a solution.

Personally, I don't see cons to owner financing. Perhaps they don't send you a 1098 for your interest payment. 

Most of the cons on seller financing are for the seller. They have the brain damage of a foreclosure if you don't make payments. There is also the tax liability of recaptured depreciation. That is why most sophisticated sellers want some down payment so they have money to make their tax payment. 

Personally I have found the owner carry to be advantageous for both parties when the seller doesn't need or want the lump sum of funds. By spreading out the principal payments they spread out their tax burden and if they pass before the loan is paid off, there are no capital gains owed by the heirs (it's passed to them on the stepped up basis). Another advantage of owner carry is that often you get a chance to pay of the heirs at a discount. Instead of them collecting the loan payment for x more years you offer to pay them a lump sum at say 80% of outstanding balance. Everyone smiles at that point. Fixer Jay DeCima discusses this in his book on "Investing in Fixer-Uppers"

@Tom Horan It looks like @Bill S. covered things pretty well above.

It is kind of ironic how many landlords, particularly older ones, are adverse to doing 'owner financing' or similar when it can *maybe* solve some of their problems. 

We had a friend who was well into retirement years, their early 80s, and he and his wife still had about 20 units - it was their 'retirement thing' when they both retired early from their professional careers. They still did almost all of their own painting between tenants, their own PM etc.... They had all units owned free and clear AND nice pensions too boot. Unfortunately she passed away rather suddenly and all of the property stuff was no longer enjoyable to him and he wanted to sell a lot of them. He did not need the cash in any way - just wanted out of the work of it all.

We struck up a deal to buy 4 duplexes an 1 fourplex from him. We tried to entice him to do owner financing, but after some thought he declined. One thing that was NOT an issue for him, but *could* (probably) be an issue for many sellers was the Capital Gains Recapture Tax. In his case, since his spouse had just passed, all of that gets 'stepped up basis' to the current values. That means he would NOT need a large down-payment to cover that. Many if not most sellers might need funds to cover that. 

We offered to put 10% down to 'have skin in the  game' and 5% interest for 5 years up to as many years as he would like. Being a friend, we know his investing habits and knew he would likely just put it in a CD at 1% or so. He decided not too mostly due to not wanting his kids to have to deal with payments over time etc... once he passed. In MY mind a payment stream for 5-30 years to your heirs would be a nice legacy to leave, but we are all different. 

The funny part is at the closing table he jokingly said "I wish there was something I could do with these fund to earn a decent return". ;-).

More to the point of what specifics of what to be aware of are I know I have read on here that there are different ways to title/deed/etc.... things that can make it more beneficial to the seller or buyer if things come down to a foreclosure - learn those. You can either use it to protect yourself, or to reassure her that she is protected. The assumable clause mentioned above is GREAT advice in the case we have rising interest rates. It could make it a much more attractive property when it comes time to sell.

Good Luck, Dan Dietz

@Bill S.

Thanks so much for putting some time into my post - and I apologize for the somewhat vague nature of my questions. I guess I'm just trying to make sure I'm covering all of my bases and not overlooking something obvious.

The first part of your post - I think I have covered pretty well. I know the amount the seller is looking for in a monthly payment - and I've been very upfront with my expenses as well. She seems to be on board - now we just need to negotiate some of the terms and numbers.

I appreciate the comment about the stepped up advantage and also the potential discounted buyout from her heirs. Her goal is to pass the payments on to her daughter after she passes. I think this will be a big pro for her knowing that the capital gains will be minimized over the course of the loan and not passed on to her daughter after she passes.

If you think of any other red flags that a new investor may overlook - I am all ears. 

Thank you again for your time!

@Daniel Dietz - Great to hear your experience with Seller-Financing. It makes a ton of sense to me - and I'm hoping I'm on the right track with this deal. 

The seller has a tax background - so I feel like she's pretty in tune with the tax benefits. It's been an easy "sell" so far in conversation but still some negotiation to get through for sure.

@Bill S. - Great advice about the assumable clause as well. It'd be great to have that rate locked in across sales and could definitely be another pro for this seller. 

Thanks again to both of you.

understand her tax implications. an installment contract may be best. what about heirs? basis? low interest high price may work. 121 sale? by helping her best you can win too. generally always borrow long and lend short.

@Tom Horan if she is 'tax savoy' as you say you might want to search past post here for discussions of 'price vs interest rate' for lack of a better term.

Meaning this; on a 100K loan @ 20 years @ 5% you get about $660 month, and a total of 100K principal & 60K of interest. You would have the same payment on a 120K loan @ 20 years @ 3% and a total of 120K principal and 40K of interest. 

She would know pretty quick which would be more tax advantageous for her and her heirs down the road.

Dan Dietz

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