Owner Financing - Benefits/Pitfalls??

Question

I'm considering owner financing on a house I purchased at the trustee sale in Phoenix for 60K

Using a sales price of $100,000 with $20,000 Down and an interest rate of 10%.  I should get roughly $12,500 back after closing costs.  So I really have only $47,500 of my money in the property.  $60,000-$12,500=$47,500  
I have now created a debt owed to me of $80,000.
When they refinance in 3 years I will make an additional $32,500.  They may refi that much sooner but I am being conservative.  Meanwhile my $47,500 that I have invested is making an interest rate of 16.84%.  We get the higher return because I'm getting paid 10% on the whole $80,000.  Total payments for the 3 years are $24,000, if I do interest only.

Does this look correct. Benefits/Pitfalls??

C L. · Answer

What's the prop worth?

It appears to be a smokin deal for you, but even aside from the licensing requirements, why would a buyer pay 10% interest only in this situation?  Surely if they have 20k as a down payment, they could afford to pay p&i on a loan and would want to.  I wonder if this is a deal you could sell.

I would rent before I would take that deal.  That would be $44k out of pocket in 3 years and if I could not get a loan, then that would be $44k in rent - essentially.  Those people sitting in the property would not be happy campers on the last day of the 36th month.

Make a deal win-win for everybody.

My thoughts.

Marc Faulkner · Answer

Conrad-This looks like a decent deal to me because your buyer has a 20% down payment and you are charging a fair rate for a seller financed deal.  I would make sure that you get a credit report and I would not assume that your buyers will be able to refinance any time soon.  I also would not set up the note interest only as you are not giving the buyer a way to build any equity.  Look for I/Only deals when you are buying so that you can keep your payments low.  Use fully amortizing notes when selling so as to create a win win for both you and the buyer.

Bill Gulley · Answer

Well, the down falls.

Looks to me that you assume you'll sell it for 100K and you bought it for 12 something? Hmmm

Next, it's a non-owner occupied residential property, so to be in compliance with the Safe Act, you'll need to have a Mortgage Originator originate the loan, which will mean you won't be doing an interest only loan.

Don't know where you got the value of the home from, is there any repair needed? Remember, just because you find an idiot to buy something at a grossly inflated price does not mean some judge will find that you have the capitalistic right to do so. If and when they fail to get refinancing because the place is only worth 60K and they have no equity in your contract, you may be deemed to be a preditor and you may be introduced to what is called a "cram down".

In other words, if your deal is not reasonable, you could lose the place and be lucky to break even.

I'd suggest you study the ins and outs of seller financing, and that would not be from some guru type strategy. Better find out if your state has a usury law too.. Good luck

Bill Gulley · Answer

Sounds like Conrad might have a deal where it is not necessary to compute his opportunity costs or insterest expense in order to conceptualize a profit, but 4 hours away?

I know some are doing deals out of state, not only is that in my bag but to me, it's a matter of time before a deal really goes sour. I have purchased properties sight unseen, off an appraisal and after talking to the appraiser, but it was not 4 hours away! That's like me buying a house in St. Louis......no thanks.

IMO, that's too far away to manage a property yourself as a landlord or a private lender. Time for a good mortgage servicer!

Conrad, you wanted down sides to seller financing?  I  am familiar with a seller financed deal closed a few months ago. I know the seller ("R") who sold it as a FSBO who asked me to help out, so to speak, so I have kept an "eye on it" for him. It was owned clear of liens and seller financed to an investor rehab guy, "J".

J  is a younger guy with some construction experience, sharp guy, but he knows it all....one of those.

He got a decent deal as a FSBO. Did about 8K in rehab but took about 2 months to get'r done. Took another 3 months to unload it.   J  sold it  to "S" with 15% down and financed it sub-2 for 3 years, and his loan was extended to match his deal. I told J that his note had to be originated by a mortgage originator or an attorney, I had nothing to do with his note. I looked at the note between R & S but it was done by an attorney.

Come to find out J did not get a building permit and changed the kitchen (requires a plumbing and electrical permit). He also opened up a wall and rehabed the bath. (that's another story)

All went fine and a month or so after the closing and S  enclosed an area under a second story deck on a patio with ext. plywood and put a storm door and window in, guess a neighbor didn't like his work on the house. My friend got a call from the city as they did not pick up any sales to inquire about the addition and he called me for a drive by. I talked to S.

Skipping over many issues, S wants to add his building and applies for the permit. He wanted electrical so the electrical inspector showed up to see if he can do so. FInds the unpermitted work that had been done by J.
 
Inspector basically told S that work needs to be corrected and inspected before any other permit. S now calls me to ask questions and is upset with J and is considering suing him. S doesn't want the house anymore and wants his money back.

Two things I told J along time ago, one was to get the note properly originated and to get a lead test before rehab work under the newly adopted EPA requirements, come to find out neither were done.

That's where we are right now. The city is now after J. S is contacting an attorney and the prosecutor for the violations (EPA). Don't know who his attorney is (will be) but he will know from S to also go to HUD because it was the seller's responsibility to get the loan originated, not the buyer.

Granted, this whole transaction is blowing up because a rehab was done without compliance to the rules by J. He could very well get nailed by EPA, tearing out an interior wall certainly exceeded the area allowed without a lead clearance.

His note is also out of compliance as according to S, it came from a Realtor who listed it for J and it was closed at the Realtor Office by a traveling closing agent where they saved some money.

If S goes through with it, J will certainly be flapping in the wind, IMO.  J will also be in default of his note with R allowing liens being assessed to the property, arising out of any city action or the EPA and failure to keep the property "free of waste" as work was out of compliance.

I bet what will happen is that:

The property will be brought to compliance and inspected by J and without him doing the work.

That J will give the money back to S and probably pay for related and moving expenses.

That J will get a lead inspection and it will probably be free of lead (built in the 60s) but everything has been repainted and clean, so it will probably be good. I have no idea what the EPA will say if they are even informed (could be from the inspector or by an attorney or by S, I have no idea)

Again, this all came about because an investor did not want to follow the rules. And your deal Conrad is not like this deal, not yet, but could be.

The point is that it is the buyer who moves in that can cause problems that brings attention to a transaction. If S had not enclosed the deck area and brought an inspector out there, things might be sliding by with everyone paying as agreed. All S has to do is tear down some plywood, he is not at risk from what he did as he can correct it easily and quickly. J however has a problem. R is not so concerned as he will take the property back, especially since it has been improved.

I'm not really involved. My suggestions to J were casual suggestions. My advice to R was given to him and conveyed to his attorney. I'm not advising or suggesting anything to S.

Whether or not people agree with me when I mention the Safe Act is irrelevant to me, it's a fact of RE investor life now.   Anyone can go back to my previous posts and I think what you will find is that most of the time I mentioned the Safe Act or other requirements, that there is little acknowlegement by anyone and it is ignored as it has been in this thread.

So, Conrad, compliance will likely be a downside to what you have planned.  Not that you can't do it, but I doubt it will go as you anticipate. Good luck

Rob Gillespie · Answer

A lot of variables to discuss, but one of my best deals ever was owner financed. I bought a home at a private auction for 60k. I used private funds at 12% no payments due until the balloon. it needed NOTHING!
I sold it for 170k! 10k down and 1200 per month for 18 months. I got them a new loan and  they cashed me out! 
The funniest part about this is that I had no intentions of buying this home. I went to the auction at the last minute and was the winning bidder without any research at all!
This is just proof of my theory, if you need a calculator to figure a deal, it is too lean!

Conrad Z. · Answer

Thanks for the replies everybody!
I'm not looking to hose anybody, these are actually numbers (2) realtors gave me and being a newbie I felt like I was working for the MOB.

FinanceExaminer. I purchased the house cash at the Maricopa courthouse for 60k and could easily flip for 75k netting 10k after light rehab (the house is in awesome shape) but I was looking for other options instead of just flipping houses like crazy (I live 4hrs away)

MJD - I thought the downpayment was steep myself but lots of these people can come up with this because they have not made a mortgage payment in 12-16 months and finally walked away from a house they were too far underwater on.

I figure with 3 years on the loan term they could fix credit and refi.

The way our government and banks are acting they are porbably just going to forgive everyone for past debts anyway HAHA!

Thanks again for the feedback everyone

C L. · Answer

I was trying to edit my answer when computer froze and had to reboot.  Don't know why it came up like that.

With that much out-of-pocket, I know I wouldn't do that deal w/o having an option to extend the time to refi AND a fixed rate.

Bill Gulley · Answer

Well said! LOL

Hmmm, when I came back, your post was completly blank, no text at all. Empty!  Which is what my comment was based upon and my vote.

After posting, I see you did say something, LOL, but still well said, a smokin deal or close to fraud, have no idea!

Joel Owens · Answer

The pitfalls vary by state.In some states that are judicial having to foreclose  on someone can take a very long time and be very expensive.

They could also trash the place in anger over losing the property.

10% interest only is very high.I can't see someone paying 20,000 and then paying 10% interest with zero pay down on top of that.

Put it out there and see if you can get some bites.

Owner Financing - Benefits/Pitfalls??

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