Seller Financing - Structure for Early Payoff Considerations

4 Replies

Hey everyone.  Obviously a lot of things to discuss related to Seller Financing (SF).  For the sake of this post, my question relates to early payoff considerations.  I'm currently working on a time-phased purchase of a retiring investor's portfolio.  He's open to the idea of SF over the course of several years to help reduce capital gains versus one year.  Also, and most importantly, it will supplement his current monthly passive income.  

Obviously, "everything is negotiable" in seller financing.  My current plan is to not include a "penalty" against early payoff (if I obtain better terms).  With that said, that time-phased passive income is of great value to him.  If he were to ask about my thoughts on "early" payoff penalties, I'd like to be versed in some options.  Initially, I think the "penalty" would be relative to the amount/time left on the note.  The seller does NOT have SF experience so he will be limited in sharing his proposed options.  

If it helps, consider this hypothetical situation.  This is not the actually deal.   

$100K / 20 Year Mortgage
Home price $100,000.00
Down payment 15.00%
Total amount financed $85,000.00
Payment amount $584.70
Total payments $140,329.80
Interest rate 5.50%
Interest compounding Monthly
Total finance charge $55,329.80
Sum Total to Seller $155,329.80
Seller Net Gain for SF $55,329.80   

So if I wanted to payoff early, what could I present for options if he wants an early payoff penalty? 

Anyone have examples of this situation? 

Best Regards,

Mike

Mike,

It's not clear what you're asking, which is probably why you haven't gotten more traction on this. A few thoughts:

Prepayment penalty cam literally be anything you negotiate. There can be a lock-out period during which you cannot prepay. Then there can  be a variety of terms.

Why are you concerned with this? of seller wants cash flow, he won't worry about prepay. On the other hand, if he is concerned about tax ramifications, then the whole package can be structured to accommodate. 

Not sure what more to say. Can you be more specific with your qiestion?

@Ben Leybovich  

First, thanks for taking the time to reply.  I may have overthought it, which leads to greater confusion with my question.  A few clarifications.

1.  Maybe better stated, I was looking for examples of prepayment penalty.  Your statement about lockout alone helps.  I assumed the penalty (if there's even one) could be "de-escalating" as the note matures.  

2.  I am inquiring about it because the seller is hesitant to seller financing, mostly because he has no experience.  He's an elderly man that thinks in "cash" terms.  So if in trying to provide incentive to him, I wanted to demonstrate the opportunity for continued passive income and added bonus of interest for him carrying the financing.  If he sees that opportunity, I just want to be able to speak to prepayment penalties and not be caught flat-footed in the conversation. Honestly, I doubt it will come up with him, but could arise in legal review.    

Again, I think other than someone providing examples of their prior deals, I think I now have a good grasp of it.  

Thanks again...

Mike

Mike - I don't think a prepayment penalty will push someone over to the side of financing if it is not something they're comfortable with. A prepayment penalty is usually used to protect the yield, but if someone is not comfortable with taking yield as payment, I don't know that you can achieve that comfort with a penalty.

Having said that, a typical most often seen pre-payment structure is a step down. 5% in Y1, 4% in Y2, etc. but you can negotiate literally negotiate anything that works for both sides.

Good luck!

@Ben Leybovich

This is what I was looking for.  It may not seem much of an input from your experience, but it was a good "sanity check" for my thoughts as I approach the negotiation.  

Best Regards,

Mike 

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