How Much Higher Would You Pay For Seller Financing?
Investor · Tampa, FL · Member since 2010 · 377 posts · 56 votes
How Much Higher Would You Pay For Seller Financing?
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Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes
15yIt isn't about paying more for seller financing. It is about paying more on price in order to get better terms. I certainly don't like your 10 year balloon. I would consider that if I had zero interest, which I do get.
Also, why are you paying 5%? If he got cash and put it in the bank how much would he get? If he got 1% and you paid him 2% to carry paper that is 100% more than he would get in a savings account! 5% is what banks get for loaning money. He isn't loaning you any money at all so why even pay interest?
I have and will pay interest, but I certainly negotiate for not paying until the street lights come on. If I do pay interest, I won't pay more than what banks charge. I did a deal recently and the seller took back $100K at 4% on a $110K purchase price.
If the seller is going to get full price, he should be giving you favorable terms; low monthly payments, low / zero down payment, long pay back period, etc.
The real reason I like seller financing (I prefer to call it seller terms) and don't focus on price/terms up front so much is that the deal isn't done until that note is paid back in full. I like to call in about 12 months and make the offer of some cash for a little discount. I have gotten as much as 50% off a note for making small cash offers. After they do it once, that start thinking of you as an ATM and will call and make offers to you. That is where the real deals are made!
34 Replies
- Full-Time Investor · Charlotte, NC · Member since 2009 · 2k+ posts · 1k+ votes15y
i would decide my minimum profit goal if it was a flip, and go by the 50% rule to make sure i cashflow if it was a rental...i would be willing to pay anything that falls in that range and meets those requirements....sure, i'd pay more, but i'd still make sure i wasn't getting a losing deal..i bought a few sub2's last summer that i regret..don't get too excited by the financing
- Investor · Tampa, FL · Member since 2010 · 377 posts · 56 votes15y
Thanks Bryan. So what I'm understanding from you is that you WOULD pay more, just as long as your 50% rule plays with it well and you cash flow. Thanks for your input.
- Full-Time Investor · Charlotte, NC · Member since 2009 · 2k+ posts · 1k+ votes15y
i would...bc i get to keep and invest the money that i didn't have to use and those returns should offset a slightly higher purchase price (remember the purchase price still should work for your profit goals)...just my opinion...i don't mind paying a few bucks more for it being financed..just like, if i am paying cash, i'm expecting a large discount..works both ways :)
- Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes15y
It isn't about paying more for seller financing. It is about paying more on price in order to get better terms. I certainly don't like your 10 year balloon. I would consider that if I had zero interest, which I do get.
Also, why are you paying 5%? If he got cash and put it in the bank how much would he get? If he got 1% and you paid him 2% to carry paper that is 100% more than he would get in a savings account! 5% is what banks get for loaning money. He isn't loaning you any money at all so why even pay interest?
I have and will pay interest, but I certainly negotiate for not paying until the street lights come on. If I do pay interest, I won't pay more than what banks charge. I did a deal recently and the seller took back $100K at 4% on a $110K purchase price.
If the seller is going to get full price, he should be giving you favorable terms; low monthly payments, low / zero down payment, long pay back period, etc.
The real reason I like seller financing (I prefer to call it seller terms) and don't focus on price/terms up front so much is that the deal isn't done until that note is paid back in full. I like to call in about 12 months and make the offer of some cash for a little discount. I have gotten as much as 50% off a note for making small cash offers. After they do it once, that start thinking of you as an ATM and will call and make offers to you. That is where the real deals are made!
- Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes15y
Originally posted by Aaron Mazzrillo:
Also, why are you paying 5%? If he got cash and put it in the bank how much would he get? If he got 1% and you paid him 2% to carry paper that is 100% more than he would get in a savings account! 5% is what banks get for loaning money. He isn't loaning you any money at all so why even pay interest?From the Seller's perspective, there are a couple good reasons to charge interest:
1. From a tax perspective, it will decrease the year one tax burden and spread it over a longer period (which may decrease the overall tax burden depending on the Seller's marginal rate). If there is no interest paid, the entire gain from the sale is taxed immediately, even before any payments are received; if interest is involved, the interest payments are taxed only at the time of payment;
2. From a balloon standpoint, using interest allows the Seller to keep the purchase price down (while making the same return), which in turn provides the Buyer a better opportunity to refi, as it's more likely to appraise. Given a fixed monthly payment, it's easier to refi a lower principal amount than a higher principal amount.
- Investor · Tampa, FL · Member since 2010 · 377 posts · 56 votes15y
Hey Aaron,
Thanks for your post. Paying more to get better terms, understood. How many years do you usually negotiate your balloon for? I said 5% b/c honestly I never thought about just offering 2% so good point. Good call on the 12 month pay off. I'll try it!
- Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes15y
Hi Tony!
I love owner financing and agree with Bryan that there should be a price/term trade-off. I also find Aaron's hard negotiating on rates interesting. Myself, I'd probably jump on the 5% if you can get him down to the 90K. A 10yr balloon doesn't bother me as I would probably have the place paid off by then based on your CF analysis. I'd want that loan to be assumable. If he is really stuck on his number, perhaps you want to go back to him with a lower interest rate (ala Aaron) or longer balloon. or both The problem is that you won't have an "I can get out tomorrow" purchase price. This used to be very important to me.
I've also done the discounted pre-pay; usually when I plan to sell! Good luck!
- Investor · Tampa, FL · Member since 2010 · 377 posts · 56 votes15y
J Scott - if there is no interest paid but I still make the seller $500 per month payments thats all principal, he would still get taxed on the entire sales price amount in year 1?
Cheryl - based on the cf analysis how would you have the property paid off by then? Also, why isn't the "i can get out tomorrow" price important to you anymore in todays market?
Thank you both.
- Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes15y
Tony,
90K @ 5%, amortized over ten yrs is about $900 per month. You say rent is $1,200. I don't know what taxes and ins are. If you only have 10k into the deal, these numbers look good to me. Everything depends on tenant selection and turnover. You indicated "move-in" condition, but I don't know the life of the hvac, roof, etc.
I'm fine with a property that will pay off in ten yrs with only a 10% down. This is hard to find in the DC area.
As far as "get out tomorrow", my financial situation is alot better than it was 25yrs ago. I'm more interested in getting good tenants to buy houses for me. I don't need the cashflow - but want places to be paid for in 10-12yrs max.
Investor's can't usually get 5% financing w/no points, lender fee's, etc. If the property fits my criteria, I'd be very interested.
- Investor · Tampa, FL · Member since 2010 · 377 posts · 56 votes15y
Cheryl - sorry for leaving out the details, but its actually 90k amortized over 30 years, due in 10. Is your position still the same about this scenario?
- Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes15y
Tony,
Amortized over 30 doesn't really matter to me. It is good for you if you need/want the CF. I just like owner financing. No points/lender fee's, loan app, appraisal, etc. I'd make sure it's assumable - that will be your "out" if you need to sell. Another investor can step in. I think owner financing is terrific. We had a similar lending environment in the early-mid 90's. Owner fin. won't show up on your credit report and the terms you laid out are very good in my opinion.
I'm not the best investor. I've hit some home runs, but the rest is just "bread and butter". I'll accept a decent deal rather than knock myself out for the "best" deal. I don't like to work too hard or too much. Having 20 tenants buying (or having bought) properties for me is fine. I've also done some pretty good flips. I've had over 100 transactions. This is a retirement plan for me (us). I plan to sell and take back mortgages.
- Investor · Tampa, FL · Member since 2010 · 377 posts · 56 votes15y
Cheryl,
I like your approach. It's conservative and realistic. You're right, not a home run approach, but it gets the job done. Your retirement plan is terrific as well. Thanks for your advice.
- Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes15y
Originally posted by J Scott:
From the Seller's perspective, there are a couple good reasons to charge interest:
1. From a tax perspective, it will decrease the year one tax burden and spread it over a longer period (which may decrease the overall tax burden depending on the Seller's marginal rate). If there is no interest paid, the entire gain from the sale is taxed immediately, even before any payments are received; if interest is involved, the interest payments are taxed only at the time of payment;
2. From a balloon standpoint, using interest allows the Seller to keep the purchase price down (while making the same return), which in turn provides the Buyer a better opportunity to refi, as it's more likely to appraise. Given a fixed monthly payment, it's easier to refi a lower principal amount than a higher principal amount.
Tony is interested in buying the property, not pretending to provide tax advice. Besides, what you state above doesn't even make any sense. I would greatly appreciate it if you would do your research before you attempt to discredit my posts by quoting me and putting some nonsense underneath. Please run what you state above by your CPA and ask them if they understand it, because I don't get it, my CPA doesn't get it, and neither does her partner. And all three of us DO invest in real estate.
- Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes15y
My BS Meter is going off again!
Tony, never pay more than a fair market price for a property, even if you get seller finanicng.
Paying 10K more on the deal is like going to a bank and paying 9 points!I think what Bryan was saying is that if the deal worksand it is truley a deal, cash flowing for him, he is not particular about price. You're not particular about price until something happens and your heirs can't refi because it's underwater on your financing.
Seller financed principal received from the gain is taxed as it is received. Interest is taxed as interest income to your seller. If there is no interest, he will pay taxes on the gain as it is received, and the IRS will hit him for the imputed tax rate, google it, so the seller basically gets screwed.
Aaron says he is a marketing expert, sounds like it to me.
Anytime you hear any "investor" claim that they do unorthodox financing or deals, it's time to hold on to your wallet! I have done transactions where there was technically no interest, in fact a few hundred, but they were structed in a non-profit housing entity (I had 2 and was affiliated with 2 others).
My definition of marketeer is one who practices the art of deception in order to make a sale! Also known as Guru 101.
There are plenty of advantages for someone to provide seller financing, you don't have to do anything else to get a good deal than be able to seel the seller on the benefits as opposed to taking cash.
Not all properties are suitable for seller financing. If the price is not right and something happens down the road and you don't have the equity you counted on, you lose!
Lastly Aaron, IMO, your approach with Jason was a littleover the top for someone of your experience as you posted in your profile and especially with 45 posts! Jason rarely makes a mistake here on BP, but he did lose me with the tax issue. So, if you think you will be impressing anyone with whiz bang seller financing deals here, you're going to have a rough road to hoe my friend. Keep in mind too, that what we do in one state may not be applicable in all states.
Tony, I'll give you a deep discount on my PM replies (LOL)! Good luck...
- Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes15y
I agree with Bryan. I would be sure that the property can cash flow. I also would consider paying full market price which sounds like it is 90K, but I wouldn't consider paying more than market.
I also agree that when seller financing I would be looking for favorable terms. Seems to me that 5% is a favorable interest rate.
- Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes15y
Originally posted by Financexaminer:
Lastly Aaron, IMO, your approach with Jason was a littleover the top for someone of your experience as you posted in your profile and especially with 45 posts! Jason rarely makes a mistake here on BP, but he did lose me with the tax issue.Thanks Bill...
Though the reason I lost you was that I was absolutely, completely incorrect in what I said...and I apologize for the bad info...
I misinterpreted how my CPA did my taxes on a bunch of seller financed mobile homes last year (which can't be sold as an installment sale), and that led me to making the very incorrect statement about getting fully taxed in the year of the sale.
Again, sorry about the bad info and thanks for the correction!
- Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes14y
Originally posted by Aaron Mazzrillo:
The real reason I like seller financing (I prefer to call it seller terms) and don't focus on price/terms up front so much is that the deal isn't done until that note is paid back in full. I like to call in about 12 months and make the offer of some cash for a little discount. I have gotten as much as 50% off a note for making small cash offers. After they do it once, that start thinking of you as an ATM and will call and make offers to you. That is where the real deals are made!Sorry to dig posts out of the grave, but I haven't seen this discussed before in my readings and wanted to understand more...
What exactly is the mechanism for this, can you provide an example?
Lets say you owe $100k over the next 10 years when you approach the seller. You say I'll offer you $20k cash now for half the note? Are you essentially buying 5 years (same payment, but now for 5 years vs 10) or are you reducing the principle balance by $50k ($50k over 10 years)??
Seems like an intriguing idea... I can see sellers liking that big cash hit versus slow monthly payments. After they've gotten past the idea of getting 100% cash on sell day, a 5 figure payout is probably a nice little yearly bonus to them.
- Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes14y
Originally posted by Danny Day:
Whats the 50% rule everyone is talking about?On average, expenses on a rental property will average 45 to 50% of your gross rents. These expenses include insurance, property tax, property management, vacancy, repairs, etc etc etc... everything short of servicing your mortgage.
If you're renting for $1,500 a month, you can safely expect to have $750 a month (over a long term average) to service your debt and pocket as free cash flow.
- Investor · Columbia, SC · Member since 2010 · 30 posts · 6 votes14y
Originally posted by Aaron Mazzrillo:
Also, why are you paying 5%? If he got cash and put it in the bank how much would he get? If he got 1% and you paid him 2% to carry paper that is 100% more than he would get in a savings account! 5% is what banks get for loaning money. He isn't loaning you any money at all so why even pay interest?
why would the seller want 2%, the property can be rented out and get wayyy more than 2%, and yes he is loaning money consider he purchased the property with money, by owner financing he/she allow you to have access the money so the seller have to charge fees/interest
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes14y
Saying a seller should only get 1-2% assumes that their only investment is in deposits at the bank. The seller could easily get more yield in literally thousands of other investment products. I don't find this argument very compelling. It may work on some unsophisticated sellers, but it is arguably taking advantage of sellers.
There are also imputed tax issues with below-market interest rates:
A lot really depends on your exit strategy. There is little value in terms if you plan to monetize quickly. If your plan is to hold property for the long haul then your loan constant matters a great deal. So the interest rate AND the amortization period both matter to compute the lender's effective yield from the loan constant. Your LTV multiplied by your annual constant must be lower than your capitalization rate to get positive cash flow. Positive cash flow generally only happens when your loan constant is low or your equity contribution is higher than 30% or so under normal (non-distressed) circumstances.
So the price of the debt from a loan constant perspective (the lender's yield) matters a great deal when you use seller-financed money for the long haul. You would need to model your intended exit date to decide how much more you are willing to pay for the project to obtain said seller financing at a given loan constant, down payment, and project-level yield. I would think of the inflated price as akin to a prepayment penalty or lockout because it will commit you to a project for longer to reach your required yield.
- Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes14y
The biggest issue I have with over paying for seller financing is the balloon. If you get true 30 year terms, not an issue at all. But when that balloon hits, you're not forced to make up the difference. If you put 10% down on $100k on a house only worth $80k you're trying to finance $90,000 in 10 years on something a bank will only loan $60,000... you've walked yourself into a pretty big financing hole. Now that's over paying by 25% ($100k vs $80k) to emphasize the point... but still.
Over paying gives you no out. You can't refi, you can't sell. You are now forced to throw whatever cash flow you get from the property back into the property to get the principle down. What does that do to your true cash on cash return? You've tied up your $10 grand and are essentially getting $0 return for a few years as you pay down your overpayment which you have to do because you have to refinance.
Again, if you can get true 30 year terms... then it becomes a simple CoC analysis (can it still cash flow at higher sale price enough to give you a decent return on your DP), but the moment you throw that balloon on there things get ugly.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes14y
Yes I can tell you deals are owner financed for a reason.Either they do not want to get hit with stiff taxes owed or they are passing off a property with issues.
Owner financing is great especially if you get nothing down and just pay closing costs.As long as you have not signed a personal guarantee,cross collateralization of other assets,or made the loan recourse in another way you can walk away unscathed if things go bad.
What you will have is time put into the deal fixing the problems and even with no money down have to ask yourself what the return will be for the time invested fixing the problems.
I see many owner finance deals I would not touch with a ten foot pole.They are wanting 20 to 25% down.It's better in that case to pay 30% and drive down the price harder with bank financing.
One price - all cash
One price - Bank finance
One price- owner finance
One price- Hybrid of bank and owner held secondSo what a seller will accept and what you will accept and pay vary greatly by the circumstances involved.
I will say good luck in finding a bunch of smoking hot deals in seller finance.If they are that low they will go for cash real quick instead.
The imputed interest provision is real.Sellers do not want to go below prevailing market loan rates as you can get penalized for doing it.There are many other ways however you can structure the deal once you have the interest rate down as low as possible to add value to your purchase.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes14y
I would also add as a seller doing owner finance if there was an assumption clause in there I would make sure the assumption could not be granted without written approval from the seller that owner financed.
You don't want to let a buyer off the hook that is well capitalized to a buyer that is weak and cannot sustain the property if a problem arises and you have no recourse or assets to go after.
In that case you would leave the original buyer on the hook with a personal guarantee and have a buyout penalty then original buyer has to pay to get out of the contract.
At the end of the day with owner finance you as a seller want the buyer to have the most responsibility with the property and the buyer wants the least.If times get tough you want the buyer to have to stick it out instead of give it back to you more run down than when you gave it to them.
It's a chess match really of who negotiates the best for their position to protect themselves now and down the road.
- Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes14y
Once again I have a somewhat contrarian viewpoint. As they say, there are owner finance deals and there are owner finance deals. Not all are created equally in my opinion. I have definitely paid more for the owner financing benefit than I would've paid in cash there are reasons that it proves beneficial to me in doing it that way. I've mentioned many times on BP that I have different investment programs of which one is strictly highly leveraged and mostly owner finance properties. If I'm able to purchase a property that is cash flow neutral but has a fully assumable loan, and a full amortization schedule with no balloons, and a low down payment, I will take a look at it. This cash neutral property would have to include expenses as well as property management.
I would not suggest this to all BP members. You would need to make sure that you have adequate reserves and a legitimate reason you really like this property. I buy many properties for long-term appreciation and believe the cash flow will increase as rents go up. I also take full benefits from the depreciation on each of these properties to help reduce the amount that I owe in taxes from other income. Rich
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