SHOW NOTES FOR EPISODE 490: SELLER FINANCING – A GREAT TOOL IN RECESSIONARY TIMES

Economists and leading real estate investors are warning that 2021 could mark the beginning of a significant recession.  And, as with previous recessions, some savvy real estate investors are poised to acquire as many underpriced properties as possible.  In today’s podcast, Bill shares how Seller Financing is an invaluable tool you should know to leverage your cash and create win-win scenarios for both buyers and sellers.

Tip of the Week – Reducing Maintenance Charges

When you hire a property manager, you still need to be diligent.  You don’t just hand over the keys to the farm and just walk away. You need to stay on top of them. So here are a couple of little things that will be helpful for you in terms of property management accountability:

• Pre-Approval of Expense Items Over a Certain Dollar Amount – You can just build it into your property management agreement that you require a written or verbal approval of any expense over a certain amount of money.  You can keep that amount low, say like $100, until you feel comfortable and confident with your team and increase it over time.  If they charge you something above your maximum, you know you need to pull in the reins on them and make sure they stick to the agreement.  You can also make sure they take a picture with their phone and send it with the invoice.  A picture of the repair will help verify the items was done as well
• Get Three Bids – And when more substantial work needs to be subcontracted out, always ask for at least three bids that you can review.
• I’ve had some property managers who say no, we don’t do that. We have our crew and we use these people.  I’ve had to break the bonds with people with property management who weren’t willing to do this.  It’s not a lot to ask for them to get reasonable bids out to others so you can see that this price is is in the in the in the ballpark of where it should be.
• Verify Contractors – The winning bidder should also provide a copy of his or her driver’s license. You also want to make sure that they have a contractor’s license, workman’s comp policy and liability insurance.  Lien waivers should be signed when the work is paid for and pictures submitted with the bids.
• Set a Monthly Budget Limit – So those are just a couple of key things that you might want to do to help better control maintenance expenses.   In addition, when you set up your monthly budget, come up with a target maximum amount to not exceed, if possible.  Granted, things may happen there may be something that collapsed or you had to do some more major repairs, but at least try to stay within your bounds as much as you can.

Seller Financing: A Great Tool in Recessionary Times

• Today’s topic can be a valuable tool for real estate investors today, especially as we face uncertain economic times.
• Mortgage performance, understandably, has deteriorated over the course of 2020 because of COVID.  And, even though the housing market appears strong, there are still a number of underlying issues.
  • The year ended with 1.54 million more delinquent mortgages and 1.7 million more seriously delinquent mortgages than at the start of the year — a looming reminder of the challenges facing the market in 2021.
  • We have forbearance and moratorium on foreclosures that are obfuscating the true picture of where we are at.  It’s difficult to say what the real results of what may be happening out there in the economy.
• And so today we’re going to focus on a tool that we, as real estate investors, can use during recessionary times.

More Seller Financing Opportunities

• There is going to be more and more opportunities to negotiate some good deals that, hopefully, will benefit both the seller and buyer.  This is a great opportunity right now to find those discounted properties as lots of investors are just holding on to cash right now.
• A lot of investors are holding on to cash right now, including Warren Buffett.  Now whether you have an extra $5, 000, $25,000, $100,000 or $1 million, you want to try to make that money last as long as you can.  And one of the ways you can do that is through seller financing.
• We’ve talked about this a lot on this podcast how you can obtain properties with little or nothing down.  And it can be done, but it’s not always easy.  However, in a recession, it is definitely easier because people are in a position where they have a strong need and they’re looking for quick solutions.  Seller financing can be that solution and it’s probably one of the oldest creative options out there.
• In recent years, and with the increase of easy credit and record low mortgage rates, seller financing hasn’t been used as much.  But, knowing how to use it, especially as we move into uncertain economic times like this, is important to know what seller financing is and how to use it.

What is Seller Financing?

• So, the first I’m going to do is to educate you a little bit on what seller financing is. And I’m going to be referencing one of my favorite books that should be in every real estate investor’s library.  It’s called The Book on Investing in Real Estate With No and Low Money Down by Brandon Turner.  This is a great reference!
• Well, let’s take a look at what seller financing is.   It’s just pretty much like it sounds – it’s when the seller provides the financing of the property and acts as the bank.  Legal ownership of the property changes and the payment is sent directly to the previous owner, rather than to a bank, for a specific duration and with a defined monthly payment.
• For example, I may want to purchase a rental house but am unable to get traditional bank financing.  The seller would like $100,000 for the property but is willing to carry the contract or “carry paper” so the buyer (me) doesn’t need to get external financing from a lender.  In this case, the owner would ask for, let’s say $5,000 down and a 10% interest rate on the remaining $95,000, amortized over 30 years, for a monthly payment of $833.69, before taxes and insurance.
• If I agree with the terms and, after doing my due diligence, I would close on the property through my local title company.  I then would look for a tenant who would rent the home for $1,600 per month, and collect the cash flow difference each month.
• Now, in this scenario, the seller gets a great interest rate on their money.  I get to buy the house for just $5,000 down and I don’t have to deal with the bank at all.
• Seller financing can be a complete win-win situation for buyer and seller

The Problem with Seller Financing

• What’s the catch?  Why isn’t this a popular thing that’s being done all the time?  The problem with seller financing is that it puts a wrench in the whole strategy for the millions of American homes that currently carry a mortgage with a “due on sale” clause.
• I’ve talked about the due on sale clauses quite a bit in previous episodes.  Whenever you get into various types of creative financing where you are selling properties outside of the norm, the due on sale clause may come up.
• So you can see, the core problem here with the seller financing can be directly related to the due on sale clause.  If you try to go around the bank and around your mortgage to set up a loan directly with the seller, and he’s still got a mortgage, and you default on that mortgage, it could cause him to possibly go into foreclosure or worse.

Will that actually happen?

• The due on sales clause gives the bank the right to demand full payment – it doesn’t require the bank do so.  The bank may be perfectly accepting of the arrangement and never say a word.  However, the risk you carry is great whenever you sell a property that has a due on sale clause.  That can always be something that holds you back because, obviously, it’s not a situation you want to find yourself in.  Especially. where you know the person financing.
• If there’s a default on payments, then it’s not going to be you that’s going to suffer for it but the seller.  So, I would say, to avoid this risk, the best situation is without a doubt, to find somebody who basically owns their house outright.
• That way, there is no loan to be paid off  and your goal, when using seller financing, is to find sellers who don’t have that mortgage, although this may seem difficult.
• However, the LA Times reported that 29.3% of American homeowners do not have a mortgage on their property, therefore, there are literally millions of properties that are still prime for you to buy using seller financing.

Why Buy Using Seller Financing?

I talked about the benefits when I said it’s going to make your initial cash last longer.  If you don’t have to spend a lot of money, and you can get the owner of the property to carry that note for a little while, you can use the rest of your resources to buy more properties.  That’s one of the key benefits that comes to mind.

Other benefits include:

• Ease of financing.  You don’t have to go through the bank and all of the you know the paperwork and qualifications and, You know the possibility that deal not going through. If you know if you’re, or maybe you’ve already got a number of mortgages and, and you’re maxed out and you can’t get any more mortgages and if you’re in that situation, you know, this would work out really well.
• Low even no down payment. This is where you might be able to work out a deal with them. Or at least, low down payments because you’re dealing directly with the homeowner seller.  There are no cut and dry rules regarding the down payment you aren’t dealing with rigid rules imposed by Fannie or Freddie, which require 20 to 30% down on an investment property instead.  You get what you negotiate with the seller, the seller may want nothing down, or they may want 50% but you won’t know until you ask and negotiate.
• Option for creativity in structuring a deal.  As I mentioned earlier, the rules when dealing with banks can be extremely rigid, but this is not the case with seller financing.  Seller financing allows you to get creative to solve a problem – rates, terms, the payment amount, payment dates and everything else is completely negotiable, which can turn a mediocre deal into a great deal.
• Purchase “unfinanceable” properties.  Sometimes the condition of a property, may be too poor to allow you to use traditional financing. And, in these cases, seller financing can give the buyer a chance to own the property.  Begin fixing it up and then, possibly refinance into a more traditional form of financing down the road, after you’ve got their property to where you think it’s going to be for maximum value.
• Doesn’t show on your credit report.  Unless the seller of the home signs up with one of the credit reporting agencies to report the debt (which is very unlikely) chances are your seller finance deal will not end up on your credit report.  This can make obtaining other loans and mortgages in the future, that much easier.

There are, no doubt, numerous other reasons why you might want to use seller financing, so don’t be afraid to seek it out opportunities where you can apply it.  It truly can be a great way to finance properties of any size. It doesn’t hurt to ask either way.

Why Would a Seller Use Seller Financing?

If I gave you a choice between getting $100 today, or $1 per month for the next 30 years, which would you take?  Most of us would want the $100 right now.  But if you do the math, $1 per month for 30 years is $360, which is more than three times the lump sum of $100.  Still want the $100?

Perhaps.

Some of you reading would take the $1 a month, whereas others would take the lump sum.  It all comes down to personal choice.  The same principle this question demonstrates is true for home sellers.  Many home sellers who own their home free and clear  would rather take the cash and move on.  However, for a large number of sellers, the value of getting monthly payments outweighs the needs for a lump sum check.

Let’s look more closely why owners might want to use seller financing rather than just getting cashed out.

• Monthly Income – Perhaps the most common reasons sellers would prefer to sell via seller financing is to get monthly income now!  If they’re a landlord and maybe they’ve been renting properties out for years already, they understand the value of that monthly mailbox check.  They know the value of getting that consistent cash flow coming in all the time.  This is what the banks do. right?  The banks basically are in the business of lending money and they’ll take that $100,000 you owe and turn it into $500,000, once you include the interest over 30 years — so there there is an advantage for you to do that!
• Better ROI – Many homeowners choose to sell with seller financing because the interest they get from the financing is greater than what they would likely get elsewhere.  For example, if a homeowner were to sell a home for $100,000, they could put that money into a certificate of deposit at the bank and maybe receive, if it’s a high paying cd, 1.5% annual percentage, or they could use the seller financing to get 6%, 8%, 10%, or even 15%. It’s all part of the negotiation part of it.
• Spread Out Your Taxes – Anytime you make money, the government wants a share.  And when you sell real estate, it’s no different.  This issue may not be as important for homeowners because of the IRS rule that allows homeowners to avoid paying taxes on up to $500,000 in profit from selling their primary residence.  As long as it meets certain specific criteria.  However, real estate investors are not always so lucky and must pay taxes when they sell.  For example, if an investor spends 30 years paying off a rental property mortgage and now owns the home free and clear, and he decides to sell the property for $100,000, that investor would need to pay taxes on that gain, which could result in a hefty tax bill.
• Cash Flow – Many investors choose to sell rental properties using seller financing to continue generating cash flow.  Rather than getting a lump sum, they would prefer to spread out most of those payments over the life of the loan on the seller financed property.  The advantage there, too, is that investors are people who already like cash flow or they wouldn’t have been a landlord in the first place.  So if you’re buying from an investor, seller financing can be a point of negotiation.  You can basically say, “Hey, you can keep getting monthly cash flow, avoid capital gains tax and not have to deal with the headaches of having to unclog toilets and deal with troublesome tenants.
• Can’t Sell Otherwise – Also, you can use seller financing to sell a property that you just can’t sell otherwise.  As I mentioned earlier, many properties simply are not sellable to a typical bank finance borrower because they are in such poor condition.  Seller financing can allow the seller to not only unload such a property without needing to fix it up first but you can also ask a higher sales amount for the property because you are helping finance the buyer.

Example of a Win-Win Seller-Financed Deal

So how does seller financing work in the real world?  The following is an example of how you might structure a seller-financed deal to create a win-win for all parties involved.  Keep in mind that this is not legal advice; this is just an example of how one investor structured a purchase.

Paul owned a nice triplex in the suburbs of Chicago.  He purchased the property with all cash ten years earlier and has now decided it’s time to retire and began looking at his options.  Paul knows the property is worth approximately $250,000, and if he tries to sell it through a real estate agent, he’ll spend $15,000 in commissions and another $10,000 in seller-assisted closing costs, netting him $225,000.  However, after paying taxes, he’d likely have only around $150,000 remaining, which he may be able to earn 8% on in the stock market.

Instead, Paul talks with Samantha, an up-and-coming real estate investor excited to get her first property.  Samantha had been learning from Paul for several months and built a great relationship with him.  So Paul sells Samantha the property for $250,000 with just $3,000 down to cover closing costs and an 8% interest-only loan on that $250,000.
Paul now makes $20,000 per year from the property, 100% passively, while Samantha owns and manages the property and collects the cash flow every month.

Example of Partial-Seller-Financing

Up to this point, I’ve discussed seller financing mostly from an “entirety” position, meaning that the entire property is sold using seller financing.  However, seller financing lets you get your creative juices flowing.  One such creative way to use seller financing is known as partial seller financing.

What if a seller doesn’t own their home free and clear but does have some good equity in it?  What if the owner has 50% equity in his home, or 90%?  This kind of situation allows you to let the seller finance just part of the deal, while a traditional lender finances the other part.  This can get a little bit confusing, so let’s look at an example.

Charlie owns his home, which is currently for sale for $100,000, but he owes only $50,000 to the bank on his mortgage.

Susan is a buy-and-hold investor who is looking to buy Charlie’s property, but she doesn’t have the large down payment needed for a conventional mortgage.

So, Susan works a partial seller financed arrangement with Charlie and her lender in which the bank provides a $65,000 first mortgage, Charlie agrees to “carryback” a second mortgage for $30,000, and Susan can put just $5,000 down.  The $65,000 goes to payoff the original $50,000 loan of Charlie’s, and he ends up with $15,000 in cash, plus a “note” (mortgage) for $30,000, giving him some monthly income for the next X number of years.

Don’t worry if that was confusing, this is pretty advanced stuff.  The point is, seller financing allows for some creativity, and using a seller’s equity to partially fund a real estate deal is a path you may want to take some day.

Keep in mind, however, that many banks and lending institutions do not allow sellers to carryback second mortgages anymore (this was much more common in the past) and may require you to still put a down payment into the deal, no matter how much the seller agrees to carry. However, you won’t know until you pick up the phone and start asking different lenders what their rules are.

Three Ways to Find Seller-Financed Deals

So you now have a pretty good idea of how seller financing works and how you can use it in your real estate investing to get more deals.  But how do you find owners who are willing to carry the contract and provide seller financing?  Here are three simple ways to find these sellers:

1. Ask – It may seem obvious, but sometimes all it takes is a simple question.  When talking with sellers, whether directly or through your real estate agent, simply ask the question, “Do you need to be 100% cashed out, or are you able to provide any seller financing:  As I hope I have made clear, seller financing is about creating a win-win situation, not trying to take advantage of someone.  Therefore, never be afraid to ask about seller financing, because the seller may be ecstatic to provide it but had just never thought of it before. Besides, it never hurts to ask. What’s the worst they can say?
2. Look for Keywords – When scanning the MLS, Craigslist, and other sources for finding properties, keep an eye out for phrases such as “owner will carry,” “owc,” “flexible terms,” “seller financing,” and “motivated” as well as any other indication that the seller is open to a conversation about seller financing
3. Direct Mail – You can also purchase lists of homeowners that specify shows how much equity the homeowner has in their property.  Although the list companies, such as Listsource, doesn’t always get the numbers correct, you can at least begin to market to individuals who probably have a good deal of equity in their property.  Significant equity is a good sign that seller financing may be a possibility.  So, when sending out direct mail, keep an eye out for high equity, and again, don’t be afraid to ask.

Risks and Drawbacks of Seller Financing

Seller financing can provide some excellent options for you as a buyer, but the strategy is not without some risks and dangers.  This section will outline three of the most common concerns when dealing with seller financing and offer some tips on overcoming those potential problems.

1. The Due-on–Sale Clause –  I’ve covered this topic quite a bit already but I can’t help but rehash it here.  It’s vitally important that you understand what the due-on-sale clause is and why it matters. You don’t want to endanger the seller’s credit or your relationship with a seller by trying to circumvent this clause.  Understand that if you buy a home using seller financing and the home has a mortgage with a due-on-sale clause, the bank may foreclose on the seller, leaving both of you in a financial mess.  Again, the simplest solution is to use seller financing only on properties that are owned free and clear. The one exception I would have to this rule (maybe, in certain situations) is for very short-term financing.  Some investors out there use seller financing with existing mortgages (often called a “wrap,” because you wrap one mortgage over another) despite the due-on-sale clause, because they believe they can quickly fix the property up and either sell or refinance before the bank finds out and has an issue.  I won’t tell you this is a great idea; I’ll leave that for you to decide based on your risk tolerance level.
2. Higher Interest Rates – Although seller financing allows for incredible creativity, generally speaking, you will pay a higher than normal rate with seller financing. This has not always been the case, but in today’s lending environment, with loan rates under 4%, getting a seller to accept an interest rate as low as that is difficult (though some investors do negotiate 0% interest seller financed loans).  Just be sure to run the numbers with the interest rates you plan on obtaining, and make sure they work for the deal.
3. Fewer Potential Properties – Let’s face it, even though seller financing can be a great win-win for both parties, the vast majority of homeowners are either unable (because of existing mortgages) or unwilling to carry a contract and provide seller financing.  Therefore, the pool of potential deals is significantly smaller when you are looking to work with seller financing.  But don’t let this discourage you!  As I mentioned earlier, approximately 30% of the homes in America do not have a mortgage and could be great options for seller financing.

Seller Financing Doesn’t Mean “Buy a Bad Deal”

• Before we move on from the topic of seller financing, I want to make something very clear: although seller financing allows you to obtain properties without using a bank, this does not give you an excuse to overpay for a property.
• Many real estate investors like to sell using seller financing because they can charge a premium for the property.  However, you should not pay a premium. Leverage is only leverage when used responsibly; otherwise, it simply becomes a liability.

So go out there, add the seller financing tool to your toolbox, and go make some great things happen.

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