0% interest on a seller financing deal

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0% interest on a seller financing deal

Addison McCarty
Lynchburg, VA · Member since 2017 · 7 posts · 0 votes

First post to BiggerPockets and my potential first deal as an investor with hopefully many more to come. I would like some advise (contract, clauses, ideas) to make this deal as good as possible for me. I will give the scenario below.

Beautiful 4br 2.5b FSBO owned free and clear (on the market over a year) for 235k (appraises for 238k conservative). Talked with the seller and he is willing to finance the deal at 0% interest with a payment that matches a 20 year schedule (about $850 a month not including taxes/insurance). However, he wants a balloon payment at the end of 7 years. He also wants 30k down (I know, so much for no money down deals...) I want to do a lease option on the house if I close the deal and it could conservatively bring $1250-$1400 a month rent no problem. I also have 3 colleges within 15 min of this house as a back up rental plan.

I don't want to put 30k down which is pretty much all I have to get started in real estate but at the same time, this deal has potential to score big time and would be willing to tie up that cash for a good enough deal. A renter paying 100% equity is hard to pass up. The seller is very motivated but because of the low holding costs, he is not going to be taken advantage of (nor am I in the business of taking advantage).

Can I get your honest opinion!!!! I am self starting my real estate business and would value some expert guidance.

-Addison-

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Russell BrazilBusiness Member
Moderator
Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
9y

0% interest....I'd do this deal in a heartbeat. I wouldn't be looking at a lease option on the backend, just a straight rental though. It doesn't matter if you are just breaking even because your going to build equity up very quickly on a 20 verses a 30 year note. 

Everyone telling you not to buy is only looking at the cash on cash return and that will be low to non existent on the 20 year note...but with 0% interest combined with the 20 year note your internal rate of return is going to be very nice.

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  • Turner Monroe
    Real Estate Investor · Arlington, VA · Member since 2016 · 84 posts · 26 votes
    9y

    This may be a good deal, for someone. But, it sounds like it doesn't meet your goals to me. 

    Here are some questions to ask yourself:

    • Do the numbers, will this property even cashflow with that payment? Yes, you'll potentially get a big check if you keep it for awhile and then sell it (or the market could crash near that balloon payment and you could be underwater). 
    • What exactly do you need to hang on to that 30k for? 
    • What is your goal for that money, and for your investments in general?
    • What would a better deal look like to you?
    • What's your ultimate exit strategy? 
    • Have you considered Rent to Own? That would be a way for you to get back a chuck of the money as a deposit.

    Just things to think about, ultimately the deal has to meet your goals. Figure out what those are, and then offer accordingly. Or get it under contract and wholesale it if you're confident in the deal.

    0Reply
  • Jeff Bridges
    Investor · Hyattsville, MD · Member since 2012 · 822 posts · 441 votes
    9y

    I don't think the cashflow is enough to cover the bare minimum expenses let alone Capex that we dont yet know about. You talk about renter paying 100% equity, but equity doesn't buy you a new roof or HVAC at 5-8k a pop. Lets say you have break even cashflow for 7 years (longshot), then sell, your ROI will be dependent on profit divided by your 30k investment annualized over 7 years.. Are you fine being 30k plus capex replacement expenses in the hole until you sell in 5-7 years (assuming market conditions are favorable to seller). If you refinance, you will be in a much worst spot with even more negative cashflow. Do you want that level of risk? You wont have any cashflow to reinvest with other properties so this wont help you grow your investment portfolio. Its like buying a risky 5-7 year CD with all interest paid at maturity... Try running this through the BP rental calculator... it will show you what type of negative cashflow you are buying with your "equity" and share the screenshot with us to confirm... I think it will help pull you out of this conceptual state and into a more clear reality of the cashflow numbers....

    1Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    This is a poor investment. The rent is far too low based on the value of the property.

    You are going to have deep negative cash flow that only gets worse as equity increases.

    2Reply
  • Jeff Filali
    Rental Property Investor · Broken Arrow, OK · Member since 2016 · 1k+ posts · 1k+ votes
    9y

    Run from this deal.  There's nothing good about it.  Just because someone is willing to finance it doesn't make it a good deal.  Funny that he's asking for a down payment of exactly how much you have available... makes one wonder if he knew how much cash you had.

    2Reply
  • Account Closed
    Fort Worth, TX · Member since 2016 · 62 posts · 15 votes
    9y

    Good post and great question to ask @Turner Monroe

    0Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    9y

    The seller would get stuck with imputed interest liability from the IRS

    1Reply
  • Ujwal Velagapudi
    Investor/Agent/Entrepreneur · Dallas, TX · Member since 2016 · 464 posts · 564 votes
    9y

    I don't think this will cover all your potential maintenance, capex, vacancy, utilities (if applicable), taxes, insurance, management fees, etc. unless you're getting $1500+ in rent. If you really see it has potential, I would consider going to get a traditional loan amortized over 30 years, giving you more wiggle room and will allow you to pocket the extra cash flow to use for your next deal. 

    0Reply
  • Addison McCarty
    OP
    Lynchburg, VA · Member since 2017 · 7 posts · 0 votes
    9y

    Thanks for the feedback,

    I fear I may have not been clear on my language and on the deal so I want to clarify to make sure I am understanding you all correctly. The 30k down payment was an initial offer from the seller, I plan on talking that down quite a bit.  For arguments sake, the price is negotiated to 225k with 25K down.  Seller finances the remaining 200K at 0% interest ($850 a month to pay the note with the amount due in 7 years). I would find a tenant buyer as a rent to own that would lease the house at $1400 a month minimum with an option to buy for 240k with the largest option fee I can find to recoup a big chunk of my down payment. What am I missing in the scenario that will give me the negative cashflow? Cashflow should be close to $400 a month.

    Rental Income (1400 monthly)
    Less: Operating expense(tax, insurance, repairs)
    Less: Mortgage payments (0% interest $850 monthly)
    CashFlow    		$16800
    -  2100
    -10200
    +4500

     House has a brand new high efficiency heat pump and was build less than 12 years ago and a roof that is perfect. My family owns a property inspection business and I know construction and house repairs. This house is pristine and will need very little although I do know that's not a guarantee.

    Thank you all for your time to respond, I appreciate the advice. Let me know if this changes your opinion?

    0Reply
  • Turner Monroe
    Real Estate Investor · Arlington, VA · Member since 2016 · 84 posts · 26 votes
    9y

    People are using "50% rule" and assuming the operating expenses will be around half of the rent. 50% of $1400 = $700 - $850 (mortgage) = -$150. While we don't know what the Operating Expenses are actually going to be, I think you're definitely underestimating them at $175 a month. 

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  • Turner Monroe
    Real Estate Investor · Arlington, VA · Member since 2016 · 84 posts · 26 votes
    9y

    Using the BP calculators, it seems to me like your best case realistic scenario is making about 20% annualized return after selling, assuming you can get a rent to own situation going on, with minimal cost of selling and buying, managing the property yourself, and getting lucky and having no extra expenses or repairs. 

    Is that a high enough return for you to tie up your money for 2-3 years? 

    Remember the potential risks such as higher than expected expenses, something expensive going wrong (roof, leaks, etc.), housing market crashing in those couple of years and not coming back up before the balloon payment, etc.

    Having 0% interest financing is pretty awesome, but run the numbers through the BP rental calculator and see if it works for you. Just don't discount things like vacancy, repairs, etc.

    0Reply
  • Addison McCarty
    OP
    Lynchburg, VA · Member since 2017 · 7 posts · 0 votes
    9y

    Thanks Turner, This was a big help.

    0Reply
  • Bill Hinshaw
    Investor · Murphy, TX · Member since 2011 · 189 posts · 86 votes
    9y

    It could be an ok deal. I would see if you can get him down to $600 monthly payment at 0% interest with a balloon payment after 7 yrs. That puts you ahead of the 50% rule by $100 ($1400 rent - 700 expenses - $600 mortgage). That isn't much, but the 50% rule is a pretty conservative rule. 

    I would also see if I could get him down more on the purchase price. What is the true value of the property? If it sat for a year at 235k, it isn't worth 235k. You really need to be solid on what it is worth.

    Your $2100 operating expense seems really low. You should already know what the taxes and insurance will be. In my market, those 2 things are going to be more than $2100 by themselves. What are they for you? What do want to budget annually for repairs?

    Building equity interest free each month - I like that idea.

    0Reply
  • Addison McCarty
    OP
    Lynchburg, VA · Member since 2017 · 7 posts · 0 votes
    9y

    @Bill Hinshaw Thanks for your time Bill. Taxes are between approximately 1050 give or take a few bucks and insurance will be $736 premium $1786 total. My capex will be lower than normal because its a newer home with no exaggeration a new roof, driveway, hvac, deck, and kitchen. If my exit strategy is in 7 years most of capex wont apply to me although i know that is not a guarantee. Capex will also be lower because I can renovate and fix everything but Hvac myself. But you are right, my operating expense was far too low. I added in vacancy, water, and a little more for capex/repairs that I had missed originally. I overestimated monthly expenses below and I know that rental price is very conservative. Leaves $128 cash flow a month which isn't great but it is close to something I could work with. If I rented to college students, the going rate for a 4 bedroom is 1700 a month which is another option if i want to go that route for a few years before I put a rent to own sign on it.

    You are also correct in saying the price is a bit high but not over appraised value. I would like to see it at 225K. There have been 2-3 similar houses in this neighborhood sell in the past couple months for between 240-250K. It hasn't sold purely because the owners live 5 hours away and are trying to sell in FSBO and the pictures online are still from when his 90 year old parents lived there with ancient furniture and decor. it makes a 2010 house look like its from the 60's.

    Again, I really appreciate your time to give me your two cents.

    Rental Income (1400 monthly)
    Less: Operating expense ($1786 taxes/insurance, 6%vacancy, water, trash, repairs, capex)
    Less: Mortgage payments (0% interest $850 monthly)
    CashFlow    		$16800
    - 5064
    -10200
    +1536
    0Reply
  • Hai Loc
    Specialist · Toronto, Ontario · Member since 2012 · 2k+ posts · 891 votes
    9y
    Terrible purchase price to rent ratio. It's less then 1%.
    0Reply
  • Bill Hinshaw
    Investor · Murphy, TX · Member since 2011 · 189 posts · 86 votes
    9y

    @Hai Loc I agree, BUT...

    For the first 7 years of a conventional 30 yr mortgage, even at super low interest rates, we typically build only a small amount of equity over that time. With this property every dime he pays on the mortgage goes directly to equity.

    I would focus less on the price to rent ratio and focus more on the annualized return after 7 years. Would you invest 25k to get back 96k after 7 years (71k equity plus the original 25k you put in)? And that's ignoring cash flow, which we expect to be pretty small. I would certainly consider it.

    0Reply
  • John Leavelle
    Investor · La Vernia, TX · Member since 2015 · 1k+ posts · 865 votes
    9y

    Howdy @Addison McCarty

    It appears to me you have fallen victim to "Falling in Love with the Property" verse "Falling in love with the numbers!". Numerous experienced investors have advised you this looks like a bad deal. Which I agree with. As mentioned you are not considering all the operating expenses that you should. For example: Pest control, legal, accounting, marketing, snow removal, repairs/maintenance, etc. Not to mention Property Management (Yes your time is worth something, Right?) And even though the property is in "Pristine" condition you still need to put money towards future CapEx. The future is not predictable. You seem to be using an optimistic best case approach to this deal. When it is wiser to stay conservative evaluating deals. If you can make money using worst case then the rest is the cream on the top.

    Good Luck.  :)

    0Reply
  • Addison McCarty
    OP
    Lynchburg, VA · Member since 2017 · 7 posts · 0 votes
    9y

    Thanks John, 

    I am definitely not in love with the property and have no problem walking away. I thought it was worth looking at based on a rare 0% interest financing. I'm a fan of someone letting me use their money for free. A smaller cashflow might in some cases be worth a 16% ROI year after year in equity but I digress. I have reconsidered my numbers and will go back to the drawing board to see if it could work better for me.

    Thanks All

    0Reply
  • Chris Low
    Investor · Redding, CA · Member since 2016 · 180 posts · 102 votes
    9y

    I'd be interested in 0% interest, too, but I wouldn't want all my capital tied up for 2-3 years. I'd work on getting the purchase price down given how long it's been on the market AND reducing the down payment so you can keep your money working for you.

    0Reply
  • Hai Loc
    Specialist · Toronto, Ontario · Member since 2012 · 2k+ posts · 891 votes
    9y
    Bill Hinshaw Not sure if I am reading this correctly. First of all isn't it 30k down and also the agreement of a 20 year amortization. Your going to tie your money up for up to 7 years to bank on your equity and hope that the market at least stays steady with minimal cash flow. I would only consider it if the property is located in a super hot part of town and the vacancy rate is under 5%. This is a totally different scenario if it was 0% down with 0 risk. In Toronto you cannot get over 5k monthly rent on homes that are 1 million. Horrendous rent ratio. People bank on appreciation and equity on these plays with negative cash flow.
    0Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    9y

    0% interest....I'd do this deal in a heartbeat. I wouldn't be looking at a lease option on the backend, just a straight rental though. It doesn't matter if you are just breaking even because your going to build equity up very quickly on a 20 verses a 30 year note. 

    Everyone telling you not to buy is only looking at the cash on cash return and that will be low to non existent on the 20 year note...but with 0% interest combined with the 20 year note your internal rate of return is going to be very nice.

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  • Addison McCarty
    OP
    Lynchburg, VA · Member since 2017 · 7 posts · 0 votes
    9y

    @Russell Brazil I would keep it as a rental for the life of the note however, the seller wants cashed out after 7 years with a balloon payment. Providing I get the price and down payment down to the level I want with obviously positive cash, what would your exit strategy be at the end of 7 years? I could probably get him to a 10 year balloon payment.

    0Reply
  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    9y

    I agree with @Russell Brazil. It's not a great cash on cash, as far as cash flow goes, but the equity build up is great.....$9600/year without any appreciation.  The reselling with a lease option at $240k would take that way though!  In 7 years you've got almost $70k in equity, plus your $30k.

    1Reply
  • James Green
    Wholesaler · Waldorf, MD · Member since 2015 · 459 posts · 245 votes
    9y

    @Addison McCarty another thing to consider since your exit strategy is rent to own. Structure the deal so that the tenant buyer is responsible for all repairs under a certain number, maybe $500.

    Since they are renting to own. I've even heard of where the tenant buyer pays for ALL repairs, but not so sure if that was true,  Term of option not to exceed 18-24 mos, then have them work with a broker/credit repair to prepare them financially to buy the property.

    Downside is if the tenant doesn't exercise the option, & any repairs that may have been needed during the course of their stay was either sub-standard or not done.

    Do you know why he wants 30K? Maybe there is a creative way for you to come up with the money that doesn't drain your nest egg.

    0Reply
  • Addison McCarty
    OP
    Lynchburg, VA · Member since 2017 · 7 posts · 0 votes
    9y

    @James Green This guy is trying to retire and wants a down payment to take care of his expenses in the meantime to pay off his house etc. I am working the deal one aspect at a time. I got him to agree to the 0% interest and now am working on the price/down payment.

    0Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    9y

    I am with @Russell Brazil and @Wayne Brooks  near new house in what is probably an A area for 10% down 0 interest is a smoking deal.. even if it breaks even or you feed it a tad

    IF and its a big IF it can be sold retail in 5 to 7 years for that 240k mark.. its a very nice deal.

    Plus the tenants if you pick right are probably going to be simple to manage not like what you get when you go for lower end CASH flow rentals... like everyone above is talking about.

    Unless you have a legitimate way to scale in the rental business.. owning a few homes and choosing on whether they cash flow 50 to 100 a month more than an other but going down in asset class is foolish.

    buying this Nice property with 0 interest is as the other very experienced folks that chimed in is a home run...

    I would just wonder if the reason the zero interest is because its being sold over market or the retail market there sucks... that would be my concern not if its a deal.. don't listen to those other folks that just mimick and chime in about the 1 % or 50% that's all hog wash.. its about EQUITY 

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