First owner finance deal

[Paul A Christy]

Hi everyone, I found an owner willing to be the bank for me for 95% (only 5%down ) in a simple loan of 4.25 percent interest for 5 (maybe even 7 years) but then the balloon pops and I owe him the entire asking price. As is I would probably cash flow around 1-2 hundred on day one but it’s under market rent by 5 to 7 hundred a month (tenets are month to month ) and he has 4 garages that I could rent out there as well. Property is in good shape and in an EXCELLENT town. But my concern is when I have to refinance that it will not have gained 20 percent equity since I think it’s about 25-35 k over market rate (lessthan 5 percent of total)  or worse it will go down in value putting me in a pickle.. any advice please??

[Caleb Brown]

5 years is a long time and anything could happen. If it's a 100K price point(for an example), you'd need it to appraise at 135K or more to pay him off. That's only 7K in appreciation so 7% per year. If the current market is doing way more than that you should be in okay shape. What would you the balloon payment be for? Have you asked an agent to run comps and see where the current market is doing in terms on appreciation? Would this be your first deal? 5% down at 4.25% interest is cheap and 1% lower than going to a bank for a loan. Figure out how to make this property work if it pencils out :)

[Paul A Christy]

Thank you so much for the response! Not my first deal, not including my house it’s my 4th. However I’m usually a value add guy and this one is in such good shape. It’s just that it’s in such a great area, and finding a 5 percent down deal looks great to me because I’m used to 25 percent, and the interest is cheap. But the payment would strictly be going toward interest and I’m left with the entire principle when the 5-7 years is up. It’s cash flow neutral now, but can definitely be raise 500-700 a month. I’m thinking for 36k plus closing I can secure an asset, hopefully it goes up 10 percent, I paid 5 percent, and I would save the cash flow for the other 10 percent so I can refinance into a traditional fixed rate. My realtor friend who has his own brokerage said it looks like a good deal and that even in a bad case I could sell it in that area and be okay.

Any thoughts ?

[Curt Smith]

I agree with Caleb EXCEPT I'm risk adversed and will only do deals that have the odds highly stacked in my favor. I'd only do 10 yr balloons. You have to know how banks/appraisers work re a REFI. If a commercial loan, they go of the T12, trailing 12 mo rent, which means you need to have your expenses dropped and rent increased by no later then yr 3 to 3.5 yr to execute a REFI by yr 4 to 4.5. Y9ou can't risk running out the clock all the way to month 11 in yr 5 of a 5 yr balloon. Even if you currently think the property needs little capex, after owning, attempting to rent raise, you will see your much nicer compitiion and figure you need to do a bunch of upgrades. This takes time and cash cash and only then the rent raises after the curent tenants move out or you push them out, then vacancy and no income while you bleed cash doing remodels.

Not raining on this deal.  Just shinning a flashlight on problem areas and realistic logistics of raising rents and only then getting a bank to give you a higher appraisal.  IE the "income method" for value goes off trailing performance, typically last full 12 mo.  So the deal has to be kicking on all 8 cyclinders 12-24 mo prior.

Negotiate a 10 yr balloon!  is my suggestion.   And/or get a price reduction.    This is the knife hiding in seller financed deals, agreeing to paying toooo much on the basis of not having to qualify for bank financing, then being in a trap.  Few can do the math to find the trap in the deal.  Best of luck.

[Caleb Brown]

Quote from @Curt Smith:

I agree with Caleb EXCEPT I'm risk adversed and will only do deals that have the odds highly stacked in my favor. I'd only do 10 yr balloons. You have to know how banks/appraisers work re a REFI. If a commercial loan, they go of the T12, trailing 12 mo rent, which means you need to have your expenses dropped and rent increased by no later then yr 3 to 3.5 yr to execute a REFI by yr 4 to 4.5. Y9ou can't risk running out the clock all the way to month 11 in yr 5 of a 5 yr balloon. Even if you currently think the property needs little capex, after owning, attempting to rent raise, you will see your much nicer compitiion and figure you need to do a bunch of upgrades. This takes time and cash cash and only then the rent raises after the curent tenants move out or you push them out, then vacancy and no income while you bleed cash doing remodels.

Not raining on this deal.  Just shinning a flashlight on problem areas and realistic logistics of raising rents and only then getting a bank to give you a higher appraisal.  IE the "income method" for value goes off trailing performance, typically last full 12 mo.  So the deal has to be kicking on all 8 cyclinders 12-24 mo prior.

Negotiate a 10 yr balloon!  is my suggestion.   And/or get a price reduction.    This is the knife hiding in seller financed deals, agreeing to paying toooo much on the basis of not having to qualify for bank financing, then being in a trap.  Few can do the math to find the trap in the deal.  Best of luck.

 Agreed on that. Everything is negotiable. Maybe raise the down payment or interest rate to get more time. 

[Igor Avratiner]

With owner financing, you and the seller are going to have a relationship for a long time and the success of each party is connected with the success of the other. If the terms of the loan put either party in a bad spot it could wind up hurting both parties involved. If you feel like the balloon opens you up to significant liquidity risk you should openly discuss that with the seller up front and try to collaborate on new terms that remove that risk. 

Just because the seller is offering you financing and you don't have to go to a bank, that doesn't automatically make it a good deal or one you should do. On the other hand, problems always come up anyway and you will have to solve them so if the location is excellent or there are other compensating factors don't allow fear to stop you from doing the deal. I heard the term "Preparation over prediction" so be prepared for several scenarios when it comes to the balloon and do the deal.