Seller financing case

10 Replies

Greetings,

I am new to notes and have a property I would like to sell. I am going to describe the "case" and would really appreciate your ideas on the seller financing route. 

The condo 3 bed 2 bath, 1150 sq ft is located in central Phoenix, AZ in a nice gated community. The HOA says the complex is 49% or less owner occupied. So, FHA loans are hard to get. The complex is well maintained. The unit is in a very good condition, has a garage. We paid 115K cash in 2012 and rented it out since than. Rent about $1150-1200 per month. Currently the comps for the same units (they don't get to the market often) 220-235K. We put the condo for sale on MLS for 229K. There is an average traffic but no offers. 40 days on the market so far.

I like the idea of selling but started considering seller-financing option that I have never done yet. My knowledge is limited and I would appreciate your input. 

I made some spreadsheet and ran a few numbers using financial calc... but the more I look at it the more questions arise. My plan A to keep the note (notes) for 2-3 years and than sell to probably an institutional investor. 

My current thoughts down payment 20-30% and the note for the rest 8.5-9% with the balloon after 5 years. Or shall I offer the 1st and the 2nd position?

Are the seller financing of condos with owner occupancy less than 49% difficult?

I am interested to learn about the tax consequences of down/payment/ installement payments. I hope I don't need to pay taxes until I "recover" my initial investment cost (that was 115K) or basis.

I am planning to talk to title company and probably lending attorney to "minimize the damage".

What is the closing costs for seller financing deal in comparison with conventional buy/sell transaction?

Thank you.

I would reach out to someone at First National Acceptance Company, they are one of the largest note buyers in the country and can give you some insight on the criteria and terms they look for when buying seller financed notes.  

@Demjan Van Der Kach Is your primary goal to cash out or to hold paper? If you are more interested in cashing out, you'd be better off waiting for an offer to come in, maybe lower your list price. I don't know what your market's like but, in general, 40 days on the market isn't that long.

Again, not knowing exactly what's going on in your market, I would bet that there are plenty of lenders out there that will finance with less than a 49% owner occupant ratio. FHA will not so you will limit your pool of buyers. I would still check with FHA or have a mortgage broker check for you to make sure that the complex is not FHA approved. Whoever you talked to at the HOA might have had an agenda or may have given you bad info so I would double check.

Offering seller financing may help by increasing your pool of buyers. I've never originated a note like this before but I've read lots of posts over the years cautioning the use of Registered Mortgage Loan Officers (I hope I got that right!) to originate loans for you to ensure that you're in compliance with the CFPB and Dodd Frank when lending to owner occupants. There are exceptions if you're doing a one off but definitely learn more. You can search this BP and find this information.

If you do go the seller financing route, your note will be worth more if you make the effort to make it "institutional grade" and have it serviced. If you have a cookie cutter, two page note, short form deed of trust, and no servicing comments or pay histories to show your buyers, you won't be able to get as much for your note. 

I can tell you now, that someone with 30% down payment is not going to want an 8.5%-9% interest rate on their loan with a balloon in 5 years. I mean, would you?

Creating terms is all about balance. And by balance I mean being realistic & compliant.

It's good that you have some idea of the terms you want, but know that because of CFPB guidelines, your borrower has to show they are capable of making whatever payment/terms you set.

There's lots of factors to consider when financing, so I am only going to touch on one to give you some food for thought.

When I see high rates on seller financing it is usually for 1 of 2 reasons:

  1. The seller wants a higher monthly P&I
  2. The seller plans to offload the loan to an institutional investor later and doesn't want a huge discount

To #1 I say, reduce the term/amortization of the loan. No reason it can't be a 10, 15 or 20 year loan. That'll be more appealing to someone with 20-30% down because the interest rate is lower on the loan, but your P&I is higher.

Regarding #2, I'm curious why you want to offload this loan since this was a cash flow property from the beginning? Also, if it's a chunk of cash that you need, why not take some time to find a passive investor to sell to? (After all, you said you plan to keep it for 2-3 years anyhow). That'll be the smallest discount you can come across in any market, even better than whatever FNAC will offer.

Just my $0.02. This is a good topic, can't wait to see other's input.

@Demjan Van Der Kach if you are planning to sell with carryback to a owner/occupant than a balloon is out of compliance with CFPB regs. Also be sure to have both taxes and insurance escrowed to avoid a high price mortgage loan, or HPML https://files.consumerfinance.gov/f/201603_cfpb_tila-hpml-escrow_compliance-guide.pdf

Bob

Big thanks for the great info.

I am inclined to just sell. My CPA said my taxes on the sale would be only 8K (previous passive losses with my real estate portfolio). 

I just want to understand realistic comparison of reg sale vs reasonable and maybe more attractive seller financing structuring taking into account future short/intermediate term interest rate trends and Time value of money (that I am a fan of learning more).

As a side note, being a health care professional I am amazed and always puzzled by financing and real estate. This condo scenarios with many subscenarios including taxes and different risks makes this decision overwhelmenly complex. It makes me really enjoy learning about real estate, financing, lending et cetera. Reading books is not enough to feel comfortable doing this type of deals and I strongly consider seller-financing to have my feet wet in this real case if it makes sense.

@Andreas Mirza The condo complex is not FHA approved. It was confirmed. Planning to use MLO, meetup with a lending attorney. I hope the seller financing would increase my buyer list options.

@Czarina Harris Yes, Czarina, I would like to be very realistic with my terms. My guess one option would be to find a local real estate agent who is well versed in seller financing and understands local Phoenix market. At the same time I want to find answers on taxes of installment payments with seller financing. As I mentioned before  - just selling - is a great tax deal for me. What are prevalent deal structure in your area on seller financed deals: amount of downpayment and amount of notes, and their terms? 

My goal (considering TVM principles) to get my money back within 5-10 years and for net present value to be better than selling and putting the cash in a conservative portfolio of stocks/bonds - which would be for me: 25% stocks/65% diversified bonds/10% cash or something of that nature yielding 3-4% after tax.

My challenge still.... is the math and comparative analysis with different seller financing structuring. 

At this point I like the idea of shorter term loans with downpayment of at least 20% and 8-8.5%. I would definetely hold the note for few years if the math (that I am going to nail down!:)) makes sence. So, my guess the good math (IRR) with consideration of different risks and reacting to actual changes in the economy and interest rates would determine my future actions. I would like to be flexible with my options holding the note in the future. I would bet on buyer refinancing and sending me a nice check (if interest rates won't skyrocket)...:)

@Bob Malecki thanks Bob. I will keep it in mind. The usury laws in Arizona - 10% cap... well, that is what on the surface at least.

Btw, could you tell me more what you mean by "Also be sure to have both taxes and insurance escrowed to avoid a high price mortgage loan". My guess it is related to owner occupied regulations, ability to pay type of thing??

Love your feedback!

@Bob Malecki thanks for the reference. It was a good piece of knowledge. I don't see the problem to be compliant with TILA HPML Escrow Rule, do you? It actually makes a good papertrail... also this condo probably won't require insurance premium payment. I am going to double - check. I wonder if the buyer will have compliance issues with escrow what can I do in that situation?

Originally posted by @Demjan Van Der Kach :

@Czarina Harris Yes, Czarina, I would like to be very realistic with my terms. My guess one option would be to find a local real estate agent who is well versed in seller financing and understands local Phoenix market. At the same time I want to find answers on taxes of installment payments with seller financing. As I mentioned before  - just selling - is a great tax deal for me. What are prevalent deal structure in your area on seller financed deals: amount of downpayment and amount of notes, and their terms? 

My goal (considering TVM principles) to get my money back within 5-10 years and for net present value to be better than selling and putting the cash in a conservative portfolio of stocks/bonds - which would be for me: 25% stocks/65% diversified bonds/10% cash or something of that nature yielding 3-4% after tax.

My challenge still.... is the math and comparative analysis with different seller financing structuring. 

At this point I like the idea of shorter term loans with downpayment of at least 20% and 8-8.5%. I would definetely hold the note for few years if the math (that I am going to nail down!:)) makes sence. So, my guess the good math (IRR) with consideration of different risks and reacting to actual changes in the economy and interest rates would determine my future actions. I would like to be flexible with my options holding the note in the future. I would bet on buyer refinancing and sending me a nice check (if interest rates won't skyrocket)...:)


In my experience, finding a real estate agent who is well-versed in seller financing poses a challenge. I'm not a CPA so I won't delve into any tax implications for your portfolio regarding seller financing.

As far as what terms are typical for my area, I am in Ohio, where you can buy houses cheap. So most seller financing takes place on properties banks no longer finance, think 75k and below. A typical deal here may look like:

Sales Price 45,000
Principal 43,500
Term 360 months
Rate 8%
P&I 319.19

I'm giving you the terms folks out here set. A lot of these properties are REO from NPLs or tax foreclosure deals. The underwriting isn't sophisticated, but most of the sellers are copy-cat deal makers, so most don't know any better.

I tend to finance this way:

Sales Price 50,000
Principal 45,000
Term 120
Rate 5%
P&I 477.29

Here's why:

  • I want the note to payout as written with very little chance of early payoff
  • Low interest rates look good on paper when you're talking to politicians/Congressional staff on Capitol Hill (which I have done twice now)
  • Borrowers like seeing an "end" to their debt. Easier to wrap their minds around 10 years vs 30 years
  • The P&I makes it worth my time (and servicing fee)
  • And lastly, passive investors will gladly take this deal off my hands for $40k any day of the week

Your situation in AZ is drastically different from my market, so the underwriting will go to suit.

Seller financing in general is on the increase nationwide because of regulations. Banks don't see much profit off a 50k mortgage, anymore, which creates a void. Last I heard, 2017 produced 89,000+ seller financed notes with $7BB+ in UPB.

Hope that helps.

Great info. I wish I could get inexpensive houses here in Phoenix metro... Don't want to have an excuse though... :)

I consider to try 20% down 15 year fixed 6%, no points or 20% down 30 year fixed 7%, no points, the listing price will be bumped to 239K for this seller-financed option. I hope the condo would sell without carry back need... but am willing to try this alternative. Any comments?

I wonder how you guys do your paperwork? does the title, agent and MLO take care of everything for you? Do you involve an attorney in the process? Do you have a custom seller financing package or like to use?

Are the closing costs less when going the seller financed route? Just to be clear - my goal is not to save money if quality and liability would be compromised.

@Demjan Van Der Kach I've only done my own notes using templates but those were between partners or investors that I knew personally. There wasn't a need to have robust documents, just what was needed for a note and deed of trust to secure the investment.

Selling to an owner occupant, I would definitely let the MLO take care of everything. Make sure you've vetted the MLO you intend to use.

In California, we use escrow companies. In AZ, is it the same or do you use title companies or attorneys for closings? If it's not a normal part of AZ transactions, I would avoid using an attorney as they would be unnecessary, might complicate things, and charge you for doing so.

Escrow and title companies should be familiar with seller financing scenarios. It's the same thing they do with buyers and banks on a regular basis. Except this time, you're the bank. The escrow or title company should be able to walk you through what needs to be done.

The closing costs will be slightly more than if it was a cash deal but should be the same as if the buyer came in with a bank loan. It should not be significant.