Owner Financing - Ethics Question

Rental Property Investor · Edmond, OK · Member since 2017 · 30 posts · 31 votes

I have an ethical question related to making an owner financing offer. Here is the offer I am considering making with theoretical numbers to get everyone's feedback on:

The owner would like to sell the property for $115,000. I am considering making an owner financing offer of $90,000 with a 10% interest rate, amortized over 10 years. I would be agreeing to this higher interest rate in order to make the lower purchase price appear appealing. I would then refinance to a lower interest rate in the next 6-12 months. **The owner financing agreement would not include any penalties for early payoff**.

The question: Is it unethical to make the seller accept a lower offer price, by offering a high interest rate, only to refinance quickly, unethical?

Please let me know if my question requires further explanation!

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Dan Kistler

Peru, IN · Member since 2018 · 15 posts · 34 votes

Remind me not to do business with you.

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Leo Poon
Rental Property Investor · Queens, NY · Member since 2018 · 99 posts · 70 votes
7y
Originally posted by @Chase Gibson:

Are all ethical issues removed if you were to add in the contract language similar to this?:
"Buyer has the right to refinance or pay off the mortgage at any time, penalty free, for any reason.
If the seller does not have a lawyer when closing. That could be a lawsuit awaiting to happen. If the seller has a lawyer when closing, then the lawyer will probably point that out to the seller you might refinance in a couple months.
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James Galla
Attorney · Akron, OH · Member since 2016 · 535 posts · 389 votes
7y
Definitely unethical because you seem to be misleading the seller on your intent to carry on with a 10 year term. However, they should do their due diligence in requiring an appraisal and also throwing in early termination fees. If they are sophisticated enough to do an owner finance deal, then they sure as heck shouldn't be basing the value of the property on the prospective interest payments they plan on receiving. They should be looking to have a purchase price equal to the value. Other than that, they are giving you that cut, whether they are consciously aware or not.
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Matt P.
Investor · Columbus, OH · Member since 2015 · 625 posts · 601 votes
7y
@JD Martin Well said JD. If this app would let me format my posts into paragraphs I feel like I could provide a lot more info in my replies without feeling like they are just a wall of text lol.
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Frank S.
Specialist · Chicago, IL · Member since 2015 · 870 posts · 345 votes
7y
Don't do it
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Nicole Heasley Beitenman
Investor · Youngstown, OH · Member since 2017 · 2k+ posts · 2k+ votes
7y
Originally posted by @Chase Gibson:

The seller is open to owner financing due to not having to pay all of the capital gains tax at once, but rather pay it over the life of the loan to me.
I would essentially be leading him to believe that he would be able to pay the taxes over a period of 10 years, and then turn around and force him to pay the taxes in full 6-12 months later when I refinance.
Ahhhh I get it now. Yes, that is unethical. If you plan to refi in 6 months, set up a 36-month term (for security in case there's an issue with the refi), and make it clear to the seller that you want to refi ASAP. You could really screw this guy over by letting him get slammed with a giant tax bill he isn't prepared for.
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Nicole Heasley Beitenman
Investor · Youngstown, OH · Member since 2017 · 2k+ posts · 2k+ votes
7y
It's acceptable when you're using that knowledge to help that person while simultaneously creating an opportunity for yourself.
It's not just about having knowledge. It's also about having resources and desire. If a seller has a house that needs flipped, then there's a reason it fell into disrepair. Perhaps they're an out-of-state investor who just wanted a rent check without the responsibility of maintaining the property. They didn't put aside a repair reserve, they can't rent the property anymore, and they can't sell it. Perhaps they inherited the home from a relative who didn't care for the property; they can't or don't want to deal with it. You could teach these how to flip, but they don't want to or can't afford to.
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Mindy JensenPro Member
BiggerPockets Money Podcast Host · Longmont, CO · Member since 2014 · 7k+ posts · 10k+ votes
7y
Originally posted by @Chase Gibson:

Just to clarify, so that I do not get crucified any further (@Dan Kistler): I HAVE NOT MADE THIS OFFER!
I am bringing it up for discussion because I know negotiation wise it is a great strategy, but I had strong hesitations due to the obvious ethical dilemma. I believe you never hurt yourself by over communicating, so I know how I will move forward with this negotiation.
I guess the true question is: When is it acceptable to use your greater knowledge in a subject to your advantage? For example: If a house flipper wanted to be completely transparent with the person they are buying the house from, they would teach the seller how to flip the house themselves. By not disclosing to the seller how to flip the house themselves, they are withholding valuable information from the seller. Does this happen? No, because the house flipper has a greater knowledge in the subject and uses that to his advantage.
In my original question, my greater knowledge is in contracts and financing property, so is it acceptable to use that knowledge to my advantage? I think for me I want to operate a transparent business and therefore honesty is very important, but I thought this was an interesting discussion to have.
This argument is completely flawed. Flipping a house takes a lot of time, skill and money. Most people don't want to do this. Buying a house at the market price at the time of sale with the intent to put money into it to make it look nicer and then sell for a higher price is completely different than going into a sale with the intent to mislead - in fact actually lying to the seller. A lie by omission is still a lie.
No, it's not acceptable to use your knowledge of contracts and financing property to intentionally mislead a seller.
[email protected]Podcast Guest on Show #261
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Nick Calamia
Realtor · Phoenix, AZ · Member since 2018 · 30 posts · 38 votes
7y
I would advise against this strongly! In the short term it might look attractive to make the quick buck by "pulling a fast one", but for the long term you don't want to set your reputation in your local real estate investing community as the guy who is screwing people over by lying to them to get what you want. Word of mouth spreads faster than you think!
1 Reply
Bob B.
Investor · Jasper GA · Member since 2015 · 1k+ posts · 1k+ votes
7y
@Chase Gibson I wonder what happens down the road, if this is your real name and he googles it and finds this question. It's not easy to make money in this business but you don't need to deceive people to do deals. I think you asked the question because you know it's wrong. Do the right thing.
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Chase Gochnauer
Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes
7y
I would think that if this guy is paying capital gains tax on the sale, he's an investor. If he's an investor, then #1, he's probably saavy enough to know to put in some sort of pre-payment penalty. #2, your assumption that this will "sweeten the pot" for him is flawed. 10% interest is really not that great of a return for an investor.
And to reiterate what others have said, it's misleading, and damaging your name/reputation over an extra 10-15k margin doesn't make sense.
I had a seller sell to me at an extremely low interest rate to incentivize me to hold the contract to save him on capital gains. I'd do the reverse and offer him $100k with a 2% interest rate. That saves you about $3500/yr in interest, over 3 years it saves you $10k. That gets you to your $90k price. He defers capital gains. Win/win.
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Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
7y
"Integrity is doing the right thing, even when no one is watching." - CS Lewis
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Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
7y
@Chase, I think you are getting some good advice hear. What I would say is 'If you have thought about somethinig long enough to ask if it is wrong or unethical, you already have your answer to your question.
More your point of 'trying to get a deal'..... I know several people who have been on both the buying and selling end of owner financed deals. To my knowledge, they have ALL either had a specific clause as to 'no penalty for early refinance' (he got no discount, but was buying a hard to sell property that did not qualify for traditional financing 'as is') or more typically they DO include a prepayment penatly for "__________ " number of years to make up for a discounted price.
In your case, it would take the seller about 3 years of interest payments just to break even on the price discount he would be giving you. A reasonable clause *might* be 'no refinancing for 3 years'.
Dan Dietz
[email protected]608-524-4899
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Chase Gibson
OP
Rental Property Investor · Edmond, OK · Member since 2017 · 30 posts · 31 votes
7y
Originally posted by @Daniel Dietz:
@Chase, I think you are getting some good advice hear. What I would say is 'If you have thought about somethinig long enough to ask if it is wrong or unethical, you already have your answer to your question.
More your point of 'trying to get a deal'..... I know several people who have been on both the buying and selling end of owner financed deals. To my knowledge, they have ALL either had a specific clause as to 'no penalty for early refinance' (he got no discount, but was buying a hard to sell property that did not qualify for traditional financing 'as is') or more typically they DO include a prepayment penatly for "__________ " number of years to make up for a discounted price.
In your case, it would take the seller about 3 years of interest payments just to break even on the price discount he would be giving you. A reasonable clause *might* be 'no refinancing for 3 years'.
Dan Dietz
Dan, This is the kind of response that is incredibly helpful. I appreciate your input and how you presented thoughtful points, as well as, alternative options to consider.
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Mike CumbieBusiness Member
REALTOR® · Brockport, NY · Member since 2015 · 3k+ posts · 4k+ votes
7y
My random thoughts, take for what they are worth:
1) Your going to go through 2 closings in an attempt to salvage money on a 100K property?
2) Most ways to refinance this are going to be at 20% down and not a whole lot better than 10% (unless you are going owner occupied or something which is a whole new can of worms)
3) Your purchase for 90K may be your worst enemy when going to refinance out at 115k in 6 months with no receipts for huge capital improvements.
4) Is there a reason not to take it all into account and make an offer to this guy for where you want to refinance it? If he wants to avoid taking the hit he may take 8% at 105K
4 Reply
Dennis M.
Rental Property Investor · Erie, PA · Member since 2018 · 6k+ posts · 9k+ votes
7y
do unto others as you’d have them do unto you -Jesus
1 Reply
Al Pat
Rental Property Investor · Atlanta, GA · Member since 2016 · 325 posts · 253 votes
7y
Originally posted by @Tom Bertz:

assume you are the seller and the buyer did that to you. Would you think you were dealt with in an ethical manner?
Tom - you beat me to the punch.
For Original Poster (OP), What is legal is NOT always ethical and vice-versa. I always want to run my business on the ground of morality and ethical behavior. OP is NOT solving sellers problem, OP is just making sure he help delay large capital gain for seller for the next 10-12 months until new financing is found (unknown to seller). If I were seller, I will have contingency for the life of the loan (10 years) with reducing pre-penalty option. I wouldn't do this anyway either as a buyer or seller.
1 Reply
Michael J.
Rental Property Investor · Louisville, KY · Member since 2008 · 342 posts · 123 votes
7y
Why not figure out how to make a offer that works for you for the entire term of the note? Seller financing is a great tool to use and you have the added benefit of slow I guess s property and not have a loan with a bank. As far as the original question if the seller tells you he will do owner financing to save in the tax bill over the 10 years I personally would not make the offer and then refi soon. But if the same conversation happened and I did intent on keeping it the 10 years but a few years later my circumstances changed and required me to sell or refinance to keep in my best interest then I would absolutely sell or refinance if I needed to. If I made the offer with no implied agreement or intentions I would not have a problem refinancing later. But honestly a good seller finance deal is good for you.
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James Mackey
Dallas, TX · Member since 2018 · 5 posts · 4 votes
7y
@Chase Gibson I think the terms of that potential offer would make it clear what your intentions are. Having been on both sides of owner-financing for commercial property, if you came at me with that offer I would expect you to be trying to refi before the ink on the transaction is even dry. My experience with owner-financing has been that the leverage is with the seller, not the buyer. Instead of a seller being desperate to move a property, it is the buyer who needs owner-financing because they are unwilling or unable to obtain more traditional financing. I have twice been asked to owner-finance a prospective buyer, and both times the offers came in at higher than asking price.
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Jason Tanner
Member since 2018 · 9 posts · 14 votes
7y
@Chase Gibson A private lender counting on the full amortization would have provisions that the loan could not be prepaid, or if prepaid a pre-payment penalty matching their required yield.
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Mark Dolfini
Specialist · Lafayette, IN · Member since 2018 · 24 posts · 29 votes
7y
If you feel that badly about it, offer him $120,000 on a 0% loan on a 10 year term (or whatever term you can afford and still cash flow). You'll both make out.
1 Reply
Lee Bell
Real Estate Appraiser · Isabella lake, CA · Member since 2018 · 628 posts · 491 votes
7y
Its not ethical, don't be misleading.
Do unto others as you would have them do unto you. Remember that rule? ;>)
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Milena S.
Windsor, Ontario · Member since 2018 · 30 posts · 11 votes
7y
@Chase Gibson So you're essentially telling the owner "if you give me a discounted rate, you'll make your money back anyways through this 10% interest loan I'm getting from you" and then you're going to refinance, screw him over after he gave you a discount for the property, and go on your merry way. Out of curiosity, what if you can't refinance? Unless you're already sure you can obtain some other means of financing the property and you're only telling him this story to get him to lower the price? Frankly, I'm disgusted.
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Simcha Davidman
Rental Property Investor · Baltimore, MD · Member since 2014 · 408 posts · 209 votes
7y
I'm a bit surprised at how many people seem to be passing judgment on the person because he asked the question. We can share our opinions without assassinating his character in our own minds.
Yes, it seems the consensus is that what he proposed is exploitative. But that doesn't mean @Chase Gibson was going to do this - he was asking about it. Maybe he did feel a bit "guilty" and wanted to get a broader opinion to strengthen his resolve.
And even if he was planning on executing this strategy, he still came here asking first - and as far as we know, he is going to change his tactic.
It's so great being in a community where so many people feel cool judging some other guy because they are confident that they would handle (a theoretical) $20k sitting on the sidewalk in front of them differently than OP here.
For all we know, the amounts could be much higher. Don't get me wrong - ethics/morals don't change because the amounts are higher - and I think I know how I would handle this because I know how I handle all questionable situations. But we'd be foolish not to recognize that money is one of the greatest temptations there is.
I applaud Chris for asking and being open to getting shot down!
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Chase Gibson
OP
Rental Property Investor · Edmond, OK · Member since 2017 · 30 posts · 31 votes
7y
Originally posted by @Simcha Davidman:

I'm a bit surprised at how many people seem to be passing judgment on the person because he asked the question. We can share our opinions without assassinating his character in our own minds.
Yes, it seems the consensus is that what he proposed is exploitative. But that doesn't mean @Chase Gibson was going to do this - he was asking about it. Maybe he did feel a bit "guilty" and wanted to get a broader opinion to strengthen his resolve.
And even if he was planning on executing this strategy, he still came here asking first - and as far as we know, he is going to change his tactic.
It's so great being in a community where so many people feel cool judging some other guy because they are confident that they would handle (a theoretical) $20k sitting on the sidewalk in front of them differently than OP here.
For all we know, the amounts could be much higher. Don't get me wrong - ethics/morals don't change because the amounts are higher - and I think I know how I would handle this because I know how I handle all questionable situations. But we'd be foolish not to recognize that money is one of the greatest temptations there is.
I applaud Chris for asking and being open to getting shot down!
Simcha, I could not agree more. I came to BP to ask a question PRIOR to making any decisions. I always thought of this site as a safe place to ask questions without being ridiculed for a decision that I haven't even made yet.
1 Reply
Javier Marchena
Investor · Winter Springs, FL · Member since 2010 · 165 posts · 68 votes
7y
@Chase Gibson
As a seller, I did selling financing for a property. I did not want to be a bank. I did it to help the buyer because his financing did not go thru. I asked similar terms as you mentioned (20% down, 15 years amortization, 5 year balloon, 10% interest). Hoping the buyer will refinance soon.
This was 3 years ago, when interest rates were lower. I was hoping my buyer would refinance soon!! Still waiting.
Not unethical in my opinion.
I would not consider a lower offer with seller financing. I would consider a higher offer with selling financing, or 12% if listing price.
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