Owner financing is confusing to many newbie investors, as well as seasoned investors. It is referred to by other names, such as seller financing, holding paper, and private money mortgage. Owner financing is simply a loan provided by the seller to the buyer to help fund part of the down payment or for the primary financing. Buyers use this to assist in the financing of their deal and agree to make installment payments usually on a monthly basis over a specified timeframe until the loan is repaid.
In this article, I want to describe how owner financing can make you extremely wealthy, how to identify a potential owner financed deal, what it takes to put together a deal with owner financing. I also want to highlight a couple of our case studies from our past deals as a way to illustrate the effectiveness of this technique.
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
How We Used Owner Financing as New Investors
In our first deal, we had no credibility and even less money, the two unmistakable qualities of fledgling investors. The property was listed for $750,000, but had been listed on Loopnet for over two years. We approached the seller and asked if she was willing to hold paper as part of the down payment. We agreed on a $600,000 sales price, with 10% cash down from us, 10% seller financing, and 80% bank financing.
There are several factors that are needed in a deal to be able to utilize this strategy. Your deal may have one of these factors or a few of them. Amazingly, our deal contained them all.
What You Need to Utilize This Strategy
First of all, you need a motivated seller or what we refer to as a “mom and pop” owner.
Here is a list of motivated sellers:
- Retiring people
- Out-of-state owners
- Those experiencing partner acrimony
- Those going through bankruptcy
- People experiencing health issues
- Those faced with a new business opportunity
- Relocating people
- Code violators/Board of Health violators
- Those who have inherited property
- Burned out landlords (I’ve been there!)
- Families fighting amongst themselves
As you can see, the list is rather extensive. It is our duty as buyers to discover the true nature of the seller’s motivation to sell and then create a plan to solve their problem. Our sellers conveniently fell into the first description. They were an older couple preparing themselves for retirement. Seller financing solved three problems for them — they were able to defer capital gains, rid themselves of an annoyance, and receive a monthly income check with a rate of return far superior than a savings account.
A Broker Who Understands Owner Financing
Second, you need a broker who understands owner financing and can convince the seller to consider it. I would use the word “educate” rather than “convince” because there are benefits to the seller. This piece of the puzzle is crucial in seller financing. If you can’t convey the benefits to the seller, then it will be nearly impossible to structure a deal. Our broker was the one who recommended owner financing due to the nature of the property and the willingness of the sellers.
A Willing Bank
Third, you need the participation of a bank that is willing to lend money on a deal with owner financing. The bank involved in the financing was holding the seller’s mortgage, so there was no need to convince the bank on the operations of the property. They knew firsthand that the property was positively cash flowing and would support the mortgage obligations.
The Right Property Condition
Another criteria that can assist in negotiating owner financing is the condition of the property and the type of property. The property in question was a mixture of cottages, duplexes, four-plexes and a six-plex, not ideal for your typical Fannie Mae financing. It would be more challenging to secure traditional bank financing with this property due to its age and its non-conforming nature.
The Correct Market Phase
Finally, the phase of the market plays into owner financing. We purchased this property early in the expansion phase. As real estate gets “hotter” and deals become harder to find, sellers are less willing to owner finance a property. In their mind, if the market is hot and they can sell their property with ease, why should they become creative to sell their property? We were fortunate that this property had very little interest and even less competition bidding for it.
Let’s recap what helps to achieve seller financing:
- Motivated seller
- Broker participation
- Bank participation
- Property condition
- Market phase (recession and expansion phases are optimal)
You can check out our previous BiggerPockets article on market phases here.
We were able to control an asset that was valued by the bank at $600,000 with only approximately $80,000 out of our own pockets. This is one of the main reasons why owner financing leads to achieving massive wealth. Most successful real estate investors have heard of the term OPM (other people’s money), and being able to control the most amount of properties with the least amount of money leads to an explosion in wealth creation. One note: Leverage works in the other direction. If your investments begin to falter, then your losses will also skyrocket.
Fast forward three years. We have just refinanced this first deal. The bank appraised the property for $800,000, and we were able to distribute $180,000 to ourselves, while using a portion of the funds to complete exterior renovations. The power of leverage allowed us to purchase a property with only $80,000 of our own money, and with excellent management, we were able to increase the value of the asset and cash out more than we had invested into the property. We have no more money left in this deal, yet it continues to cash flow $3,000 per month.
Related: 4 Ways to Use Hard Money & Private Financing for Your Rental Business
What happened to the note with the seller? We decided to offer the seller $10,000 toward the note if she would extend the note an additional five years. She agreed, and the length of the term of the note is now eight years. We will revisit the seller in a couple of years and ask if she wants the remaining note paid in its entirety. My hope is that we will be able to offer a discounted price on the note and she will accept it. There’s no harm in wishful thinking.
The moral of the story is — to create wealth in real estate, create value and think outside the box. The most common phrase I hear from other investors is “you can’t do that.” Most people are stuck inside the box. Change your mindset to “how can I do that” and force your mind to come up with creative solutions.
Our next owner-financed deal was even more creative. If we had listened to the naysayers, we would have never landed this owner-financed deal, a 281-unit, $11,000,000 asset with NO money down. The seller offered to hold 20% as the down payment, and the bank provided 80% financing. This deal was more complex and had more problems to solve, but the payoff is much larger. If you look for opportunities instead of problems, they will begin to appear.
Contact real estate brokers and discuss seller financing. Start to identify properties that fit the criteria of seller financing: motivated sellers, distressed properties, sellers that want deferred payments, properties that are difficult to secure traditional financing, properties with substantial equity.
Look to create these favorable terms with owner financing:
- Long amortization (at least 25 years)
- Lower interest rates
- NO prepayment penalties
- Longer terms (at least 10 years)
- No due on sale clause in mortgage
Remember, you need to ask the seller for these terms. You will never know the answer unless you ask!
Have you ever used owner financing?
Please leave us a comment below and let us hear of your experiences. We are always looking for creative and unique ways to expand our portfolio and our lives.