Owner Financing- More than just the basics

14 Replies

I think I have a general understanding of owner financing. But have some more detailed questions:

-If someone has a small balance on their mortgage payment and there ARV is much higher is it still possible to do owner financing? I know you could pay off the portion but let's say it's higher than what would make sense. For example they owe 70k and the homes ARV is 300k.

-It sounds like part of the appeal for someone to do owner financing is the potential tax benefits. What’s to prevent a investor from coming up with a 10 year payoff plan and then refinancing about 3 years out and paying off the note early? I would assume that this would hurt the original owner since they would be hit with the taxes at that point, correct? However, wouldn’t the owner be penalized with the taxes at the 10 year mark regardless?

Thank you all for your help in helping some better understand the questions above. Thanks!

Originally posted by @Eric Drum:If someone has a small balance on their mortgage payment and there ARV is much higher is it still possible to do owner financing? .

It sounds like part of the appeal for someone to do owner financing is the potential tax benefits. What’s to prevent a investor from coming up with a 10 year payoff plan and then refinancing about 3 years out and paying off the note early?

Research wraps when an existing mortgage exists.  The new SF loan will wrap around and be subordinate to the existing loan, like a 2nd.  Due on sale call risk exists if discovered by the 1st, so have a plan to pay off that first if needed.

There are potential tax benefits if the seller isn't a regular homeowner.  If they are selling their primary residence they will most likely have the sec 121 exclusion available to them.  

Most are ok getting paid off early and will even offer a discount.  Some aren't happy so play it by ear, especially if they have multiple properties and you want to work with them more than once. 

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Everyone has different thoughts, ideas and viewpoint, just like here on BP. Some sellers WANT the cash flow for the next 25 years. I do. That is my retirement money. But if someone refinances, great, I have a lump sum to go and get a new deal or pay off some other debt on other properties.

For some sellers it might be the only way that they can sell the house because of repairs that are needed. They want the cash, but will have to settle for cash flow every month. After several years, I would go to the seller and ask if they want me to refinance and get them cashed out (for a discount of course). So if I owe 160k on a property, I might ask if they would take 130k as a payoff. Just a thought.

@Eric Drum I don't fully get the first question either. To clarify; in the scenario the owner owes $70K and you want to buy the property and they want Market Value of $300K? So the question becomes can you buy the property and they can sell it to you with a $300K lien subject to the first $70K lien? You owe $300K, they owe $70K to fist lien-holder. Yes that can be done, consult a Real Estate attorney. 

As far as taxes they will pay those regardless. The taxes are paid over time as a portion of principal / interest are repaid. 

@Eric Drum. seems to be a bit of confusion/

In answer to your first question, a seller CAN sell a property without paying off an existing lien.  There is absolutely no law to stop a seller from doing this.  As mentioned above the seller can either wrap a seller financed loan AROUND the existing mortgage, or leave the first in place and accept a second mortgage.

However, almost every deed or trust or mortgage contains an acceleration clause.  When a property is sold, and the mortgage is not satisfied, the lender has the right to call the loan.  If the loan is not paid off in full, the lender can foreclose.

Now, whether or not the lender chooses to enforce the acceleration clause has been discussed and argued to death.  In an environment of steady or declining interest rates, lenders are usually happy to continue collecting payments.  Should interest rate rise significantly, we may find a completely different experience.

As per your second question, while many may disagree with me here, I will tell you that based on my 40 years experience in real estate, tax savings as a selling tool to convince a seller to owner finance is the most over hyped and least successful argument anyone present to a seller.

Years ago, when interest rates where high double digits and few people qualified for a mortgage, sellers had little choice but to owner finance or accept a very low price from someone who could buy for all cash.  If the person was teetering on acceptance of an owner financed offer, the buyer would attempt to close the deal by suggesting how much the person selling would save on taxes.  This was often structured as a higher sales price with lower interest to convert some ordinary income to capital gains.  

While this argument might have been effective 30 years ago, the landscape is substantially different today.  In the late 1970s top marginal tax rate was 70%, today its 37%.  Further, inflation was running 12% and pushing people in higher tax brackets each year.  So the value of stretching out the payments was MUCH higher than it is today.  But even in that environment nobody owner financed for tax reasons, the owner financed either to obtain a higher price or because a cash offer was not available.

I have owner financed a number of properties through the years.  The reason I do is either (1) to obtain a higher price or (2) to sell a property that does not qualify for financing or (3) because the only interested buyers are the type that don't qualify for institutional financing, or (4) as temporary financing to quickly complete a sale.  "tax savings" has nothing to do with it.

@Justin Robert Thank you Justin! My first question was based on if the owner really doesn’t own the property 100% and has a small balance on the loan... I didn’t know if there are any strategies are out there that could work. It sounds like a wrap mortgage could be one (I’ll need to dig in more to exactly understand how that works). Does that make more sense?

@Don Konipol Wow, Don great insight and information! You can certainly tell your a pro! To date I have financed all our properties but was interested in owner finance to potentially save some of my liquid cash and free up my ability to get more bank financing (10 loans and then have to put into portfolio etc.) Thank you for your helpful advice!

Originally posted by @Eric Drum:

@Justin Robert Thank you Justin! My first question was based on if the owner really doesn’t own the property 100% and has a small balance on the loan... I didn’t know if there are any strategies are out there that could work. It sounds like a wrap mortgage could be one (I’ll need to dig in more to exactly understand how that works). Does that make more sense?

 This is where you use an option to buy the property.  An option is just that, and only that, and Option to buy the property down the road (the length of the "road" is in the Option Agreement).  Since you are not yet buying the property, the original loans can remain in place.  They will be removed (paid off) when you execute the Option the buy.

...and the "owner" owns the property 100% from the time the sale agreement is signed.  The mortgage doesn't mean the owner owns less of the property...how much they "own" based on the balance owed.  The mortgage is a lien placed on the property...it isn't some type of shared ownership.

Originally posted by @Don Konipol:

@Eric Drum. seems to be a bit of confusion/

In answer to your first question, a seller CAN sell a property without paying off an existing lien.  There is absolutely no law to stop a seller from doing this.  As mentioned above the seller can either wrap a seller financed loan AROUND the existing mortgage, or leave the first in place and accept a second mortgage.

However, almost every deed or trust or mortgage contains an acceleration clause.  When a property is sold, and the mortgage is not satisfied, the lender has the right to call the loan.  If the loan is not paid off in full, the lender can foreclose.

Now, whether or not the lender chooses to enforce the acceleration clause has been discussed and argued to death.  In an environment of steady or declining interest rates, lenders are usually happy to continue collecting payments.  Should interest rate rise significantly, we may find a completely different experience.

As per your second question, while many may disagree with me here, I will tell you that based on my 40 years experience in real estate, tax savings as a selling tool to convince a seller to owner finance is the most over hyped and least successful argument anyone present to a seller.

Years ago, when interest rates where high double digits and few people qualified for a mortgage, sellers had little choice but to owner finance or accept a very low price from someone who could buy for all cash.  If the person was teetering on acceptance of an owner financed offer, the buyer would attempt to close the deal by suggesting how much the person selling would save on taxes.  This was often structured as a higher sales price with lower interest to convert some ordinary income to capital gains.  

While this argument might have been effective 30 years ago, the landscape is substantially different today.  In the late 1970s top marginal tax rate was 70%, today its 37%.  Further, inflation was running 12% and pushing people in higher tax brackets each year.  So the value of stretching out the payments was MUCH higher than it is today.  But even in that environment nobody owner financed for tax reasons, the owner financed either to obtain a higher price or because a cash offer was not available.

I have owner financed a number of properties through the years.  The reason I do is either (1) to obtain a higher price or (2) to sell a property that does not qualify for financing or (3) because the only interested buyers are the type that don't qualify for institutional financing, or (4) as temporary financing to quickly complete a sale.  "tax savings" has nothing to do with it.

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@Joe Villeneuve Thank you Joe! What would protect me if the original “owner” doesn’t make the mortgage payment? I’m assuming when I write up a option agreement with an attorney they would include some type of language like that to help protect me in the contract? Or is that just the risk of doing something like this?

Register your Option Contract.  If the property gets foreclosed on due to non payment by the "owner", the only thing you have at risk is your option consideration money...which should be no more than 5% of the agreed upon price of the property.