Seller financing: setup, taxes, and contingencies?

19 Replies

Hello all.

I'm exploring a deal on a property that is well suited for seller financing: house paid in full but desperately in need of work (for which the owners don't have the cash to fix themselves) and the owners want way more than it's worth. My goal is to offer the owners something that gets them the price they want, but over the course of 20-30 years. Before I make the offer, I'd like to better understand some of the nitty-gritty so I can calculate my numbers appropriately.

First, how do you go about writing up a seller-financed offer? Is this something you'd need a specific kind of attorney for, or should my realtor be able to handle this? If one needs to go the attorney route, how much does it typical cost to set up such a contract?

Second, how do closing costs factor into an owner-financed deal, and how does realtor commission get calculated?

Third, how are owner-financed deals set up such that the seller is protected against default? Basically I'm wondering people's strategies for giving the seller assurances that I will not default on the loan, or skip out on paying by selling the house and high-tailing it to Mexico ;)

Finally, what are the tax implications of going owner-financed? I know one can typically write off the interest of a mortgage, but I'm not entirely clear on what these payments count as, or if there are ways to declare them as a write-off.

Phew, that's a lot to lay out. To any that have made it this far, you're already a hero. Thank you for any help!

Yes, a competent agent can write the offer with the proposed terms....down payment, interest rate, amortization, etc.  You get title, the seller gets a note and a mtg, just like a bank, which would have to be prepared by an attorney.

The agent gets paid their full commission at closing just like any other sale.

The seller can foreclose on you just like a bank.  With a recorded mtg you’d have to pay the loan off when you sell.

You deduct your interest payments the same as with a bank loan.

@Wayne Brooks Interesting... I guess I was hung up on thinking about it more like a land contract; I didn't consider structuring it exactly like a mortgage. Thank you!

If you're structuring an owner-financed deal as a mortgage, is there any reason you wouldn't jack up the interest rate so you could claim heavy deductions? Is there anything stopping you from something ludicrous like a 50% interest rate on a tiny loan, provided you have some kind of clause that prevents you from paying off the loan early?

@Kyle Bishop Kind of a silly question.....paying more in interest Costs you more, out of your pocket.  If you pay $1,000 extra for something, yes you get a tax deduction for that $1,000, potentially saving say $250 on your taxes.....but you Spent $1,000, saved $250 on taxes, so you still cost yourself an extra $750.

@Wayne Brooks sorry maybe I'm misunderstanding something about mortgages or perhaps I'm explaining poorly.

What I mean is that you could adjust the initial loan amount and interest such that 90% of your monthly payment was interest. If you're paying $1,000 but only a hundred is going towards principal that gives you a huge amount that you can write off, versus a higher loan amount but lower interest where the monthly payment is still $1,000 but much more of that is principal.

Originally posted by @Kyle Bishop :

@Wayne Brooks sorry maybe I'm misunderstanding something about mortgages or perhaps I'm explaining poorly.

What I mean is that you could adjust the initial loan amount and interest such that 90% of your monthly payment was interest. If you're paying $1,000 but only a hundred is going towards principal that gives you a huge amount that you can write off, versus a higher loan amount but lower interest where the monthly payment is still $1,000 but much more of that is principal.

 At that you have bad negotiating skills. Why would you ever pay that high of an interest rate? Its an unethical and the loan would never get paid off. I don't think interest is dollar for dollar when it comes to writing it off with taxes.

@Keyonte Summers if you're setting it up as a typical mortgage then it's a fixed length... the interest % has nothing to do with your payoff date.

100k loan at 4%, standard 30-year term:
- Monthly P+I payment: ~$465
- $57,495.61 paid in interest after 30 years
- 20k down payment

28k loan at 20%, standard 30-year term:
- Monthly P+I payment: ~$465
- $126,394.82 paid in interest after 30 years
- 2.8k down payment + give them 17.2k cash (maybe this isn't legal, and that's why this strategy doesn't work?)

The seller receives the same for either, and the buyer pays the same for either, but the buyer has a higher interest write-off on the latter.

"Its an unethical": To the buyer or to the government? I'm not advocating for doing anything here, just trying to understand why this isn't more common.

"At that you have bad negotiating skills": That seems pretty uncalled for... though if I'm doing something wrong I certainly want to be called out for it.

@Kyle Bishop the seller may get the same amount but you have a very different equity stake at the of the loan in each case. It’s a dumb idea to take option two. The tax benefits do not offset the increased costs.

@Kyle Bishop Your numbers are confusing, you’re paying the same over time in the two scenarios, but.....any way you slice it it’s a horrible idea, you’re just not understanding the scenarios.

For one thing, if you paid the house off in one year....

Scenario 1 the seller gets about $124,000

Scenario 2 the seller gets about $25,000 total

Why would a seller do that?

@Wayne Brooks I'd hope they wouldn't do that! I mentioned in a previous comment about adding some kind of clause preventing early payment. Regardless, it seems like this is too complex for me to ask about over the forums. I'll chat with a realtor to see what I'm missing.

@Storm S. If your monthly payments are the same and the loan is fixed term, there wouldn't be any extra cost, but like mentioned, I'm probably missing something about loaning laws here and will talk to someone in-person.

@Kyle Bishop

Two things:

1) I know what you're suggesting..and what you're suggesting is going to be an issue because every state has a cap for interest rates on promissory notes and if you don't want to be breaking any usury laws I'd stay clear of doing that.

2) Lets just say it's under the usury limit. You have to realize that to get your interest expense written off; something else has to give. In this case, the seller would have to pay extra tax for the interest you're trying to inflate while simultaneously decreasing principal. So if I was the seller, why would I want to pay more tax just so the buyer could get more write-offs..the whole point of seller financing was to save on taxes/maximize the net of sale by arbitrage of inflation and interest rate for a form of passive income.

Hope that makes sense.

I understand what you are thinking, but in the long run it does not make much difference in the 'real world', on average.

My example I *think* is more what the range might be on what you are thinking. Right now I am dealing on buying some rentals that the owner ONLY wants to sell with 'seller financing' to spread out capital gains tax and to have an ongoing stream on income. He owns them free and clear. I will give an example of what we have been talking about so far.

4 Plex worth about 320K. I presented 3 options;

1) 300K @ 5.7% /30 Years with 10 year ballon if desired by him. $1556 month.
2) 320K @ 5% /30 years ...........same...............
3) 350K @ 4.15% /30 years ........... same.............

It comes down to what his cap ex tax rate is vs in ordinary income tax rate. He needs to talk to his accountant. I am *guessing* that in his case it will be only a few thousand different in taxes over 30 years IF he kept it that long. Where this *could* come into play in a bigger way is with someone that does NOT have much taxable income and they *might* be able to stay in the 0% capital tax bracket. For *most* sellers it is close to a wash, I think.


Great thread. I am currently discussing a potential owner financing deal myself. In my case the seller still has a mortgage on the property. We have agreed on the sells price, but now working on the terms. This entire owner financing thing is totally new to me as well. I was advised to make the monthly payments into some-sort of escrow and have that pay the mortgage. Then the seller will get paid what's leftover. 

Following this discussion. I'm seeing tons of owner financed properties listed on the MLS. No bank loans or cash purchases..just owner financed loans with these properties about 10k over market rate. I've got a couple properties paid off that I wouldn't mind doing that with. I don't know if it's worth it or how to go about it. They are older properties that are slowly falling apart. I wouldn't mind being the bank and let someone else take care of all the maintenance problems.

Originally posted by @John Morgan :

Following this discussion. I'm seeing tons of owner financed properties listed on the MLS. No bank loans or cash purchases..just owner financed loans with these properties about 10k over market rate. I've got a couple properties paid off that I wouldn't mind doing that with. I don't know if it's worth it or how to go about it. They are older properties that are slowly falling apart. I wouldn't mind being the bank and let someone else take care of all the maintenance problems.

 Keep in mind that if your buyer default on your note, you’ll have to go through the foreclosure process.

If you do it lease-to-own, it will be just an eviction but the title will stay on you.

If the house is old and falling apart but the buyer can't get even FHA loan (which almost anyone can now), the chances are huge, that buyer won't have money for repairs, leave alone roof or foundation.

I’d rather sell the house like that (maybe cheaper or with a tenant) than doing land contract, seller financing etc

@Jay Weathersby That's super interesting... I think this is where the "due on sale" clause can potentially bite you (though from the podcast it sounds like it typically isn't a problem). I guess the sky's the limit as far as flexibility with that kind of loan... I wonder about taking a mortgage off someone's hands through seller financing without even having to provide a down payment!

I never understood why people would do lease-to-own when the owner could just rent without the "own", but that makes perfect sense that its easier to deal with someone higher risk through a lease. Really cool to learn about these alternative methods of financing!

@Daniel Dietz , I would be interested to know if you are/will put any money down? And how does earnest money play into this?

I am currently working on my first owner financing offer and appreciate the advice/experience.

@Dale Byram this is only my second one, so I am not real experienced, but just dipping my toes in :-)

My first was the house I am living in for about 6 years now. I bought it from a Flipper that I did work for (I am in construction) who had 2 for sale, working on two, and but in bids on 3 more and got all three! Too much for him to do at once. There was lots of trust there so he wholesaled it to me. He paid 75K, sold it to me for 85K and the ARV was about 140K but needed about 25K in work. He carried the note for 1 year at 6% interest only. He borrows his fund at 3% so he made a spread and 10K.

This set of properties I am going to talk over terms with him today. I think he will definitely want something down. I would not want to do more than 20%, and am hoping to negotiate more like 10%. I think he would only want as much as he needs to cover his 'depreciation recapture tax', which he is going to talk to his accountant about. That way he does not need to come up with cash out of pocket but can also stretch his capital gains out as much as possible.

To make this work in my SOLO401K I need him to do at LEAST a 10 year ballon, and would prefer if he just want to carry it 20-30 years.

We have not talked about Earnest Money yet. Some other properties that we bought directly but NOT seller financed we put down $1000 per property once the offer was accepted with the condition that we get financing and an acceptable inspection. We had 30 days to get those done.


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