Legacy Wealth Holdings

Seller Financing: What is it and how does it work?

A hot topic in a lot of discussions right now in the real estate world is around seller financing.

So what is seller financing? Instead of you going out and getting traditional financing on a property, you could also get hard money from an investor or a passive lender. Or you can approach the seller about it.  Then the seller would be your lender. 

The beauty of approaching the seller is that the seller is already comfortable with the property. They already know what the asset is and they have a level of confidence that, in the worst case scenario, if you default, they take back the property that they’re already comfortable with.

The types of people who are willing to seller-finance usually fall into one of three categories. 

#1: INVESTORS

These are seller financers who own that asset because they bought it for an investment.

They’re familiar with residual income. They like the idea of having passive ownership in something or doing something once and getting paid on it over and over and over again. So a lot of times they just don’t want to manage the property anymore. They don’t want to put more money into it, and that’s why they’re willing to sell.

It’s not that they don’t like the residual income, they just don’t want to manage it or deal with the headaches anymore. That’s a great place for you to come in and say, “Let me take the responsibilities and all the headaches and liabilities off your plate. You be the bank and I’ll make payments to you and pay you out over time.”

That’s a great way of doing it.

#2: PEOPLE WITH MONEY

The second type of person who’s usually willing to seller-finance is somebody who’s already pretty wealthy, and maybe they don’t need the money from that property anymore. I’ll give an example.

Somebody who was an owner-occupant of a beautiful home up in the mountains of North Carolina was looking to sell. This guy had made millions and millions of dollars in a traditional business. He didn’t need the cash right then and there, so I made an offer with seller financing. I said “Hey, will you be the bank? If I brought 20% down on this $3 million deal, that’s 600 grand. Would you carry back the balance at a 4% interest rate on a ten year term, 30 year amortization with a ten year balloon or I’ll pay off in ten years?”

Guess what?

He’s in his eighties. He wanted some sort of predictable residual monthly income, and he was wide open to doing it. So he accepted my offer. And that’s somebody who is already pretty wealthy and understood the value of seller finance.

#3: TRADITIONAL BUSINESS OWNERS

A business person thinks in dollars and decimals, so they’re going to look at this as a business transaction. And if they can either get better terms or more money by seller-financing the deal to you, chances are they’re going to be very open to doing that.

So those are the three types of people that I would definitely focus on talking to about seller finance: people who own a property as a rental property (not their primary residence), people who already have money, and business owners who own any sort of property.

What do seller financing terms look like?

Earlier, I talked about a typical seller-finance land contract. This is your seller being the actual bank. They’re going to be secured by four things. 

The first is a first mortgage or a lien on the property. This is filed at the courthouse and doesn’t allow you to either sell or refinance the property unless that lien is paid off.

The second is a promissory note, which is not filed publicly, but it outlines the terms of your agreement. For example, it could be $300,000 at a 4.5% interest rate on a 30-year amortization with a 10-year balloon payment or whatever that ends up looking like.

The third thing is you’re going to add them to your insurance. They’re going to be additionally insured so if the property burns down, they get the first $300,000. That way they can get paid off and you get anything above and beyond that.

And the fourth thing is going to be title insurance, insuring them that there’s not going to be any other title issues. There’s nobody else that has rights to that property or anything like that.

So that’s traditional seller finance or a land contract, and in that scenario you can do that if they own the property free and clear.

But what happens if they still have a loan on the property?

You have to be careful because if they go down this road, it could trigger a due-on-sale clause on whatever their current mortgage and promissory note paperwork looks like with their current lender. So make sure you read that, have an attorney read it and review it before you go down this path.

If there isn’t a due-on-sale clause for the transfer of interest in the property, then you have a couple other options. 

#1: LEASE OPTION

The first is a lease option. So a lease option is essentially you getting a lease or a master lease on the property – and actually you don’t need the property paid off and this wouldn’t trigger it, it just gives you the option to buy it at a certain price in the future.

So you come in and rent the property at a certain rate. Let’s say you rent this house for $400 a month, but you can put it on the market and rent it for $2,000 a month. You can arbitrage or make a spread on the rental difference.

That gives you a master lease on the property, and you can now make a cash flow on it. It also gives you the option to buy the property at a certain price point in the future.With this method, it doesn’t transfer interest to you right out of the gate, but it gives you the option of “Hey, I’m going to be managing and operating this property for the next five years, and I want to be able to buy it for $200,000 within that time.” 

And if anybody else tries to come in and buy that property, you have essentially first right of refusal on that property and are able to buy it at $200,000.

So you could potentially market it for $275,000, have a buyer that wants to come in, and then that way you can close on it at $200K, sell it to that end buyer at $275,000, and then you can walk away with a $75,000 check on any of the spread that you made on the property over the course of the past few years. So that’s a lease option.

#2: INSTALLMENT CONTRACT FOR DEED 

This is kind of like a car loan.

You don’t get the title to your car until you pay it off in full, right? So you make payments. The lender essentially maintains ownership and title to that vehicle until you pay them off in full. Then they send you the title. 

An installment contract or installment contract for deed works very similarly. So the seller would maintain the title to the property in their name and they give you an installment contract that says you make payments of X Amount and over the course of the next two years, you have to refinance and pay me off in full. At that time, we will transfer the title to you in your name.

NOW WHAT?

I’ve acquired and sold properties using these strategies. So if you’re looking to buy properties, understand that these are three new tools in your toolbox that you can utilize in a crazy, transitioning real estate environment right now.

As a buyer, maybe you can pay the seller’s price point if they offer you these kinds of terms because then you don’t have to raise as much money. Maybe they can do it at a lower interest rate than a bank can. There’s a lot of benefits to working with the seller on seller financing instead of doing it through traditional means.

If you’re a seller, realize that buyers have kind of hit a ceiling, and they’re not willing to come up because they’re concerned about what’s going to happen with the market. Sellers aren’t really willing to come down on the values that they think their property is worth. 

So how do you bridge that gap?

One way is if you as the seller say, “Hey, I need this price point, but I’m willing to carry back 20% of the down payment. You’re going to get a traditional loan for 80% loan to value. I’ll carry back the other 20% and you pay me off in the next five years.” That’s a great way as a seller to be able to get your price point on the buyer’s terms so it still makes sense for them. It still cashflows for them, but allows you to cash out your investors, cash out your mortgage, and then carry some of your profits forward and make some interest on it too. 

The other benefit is you don’t pay capital gains taxes on that money until it’s actually received.

So there’s a lot of benefits to doing that on the sell side. There’s a lot of benefits of doing it on the buy side. The question becomes, who are you talking to? What are their motivations? What level of competency can you convey these thoughts in? 

And if you can come to terms, make it a win for the buyer, the seller, and everybody  in the middle, you can still do deals and take down a lot of amazing projects in this market regardless of what you’re hearing on the news or social media and all the other nonsense that’s out there.

So go out there and learn a little bit more about seller financing strategies, and let me know how it goes!

We made a video on this! Watch it on the Legacy Wealth YouTube channel here:

https://www.youtube.com/watch?v=-UNEny6cBII