Seller Financing Explained and the Smart Way to Structure A Deal
All of Your Questions Answered
Whether you’re a beginner investor looking to pull in your first deal, or a seasoned investor looking to scale your portfolio, fully understanding seller financing can be an extremely useful tool to have in your arsenal.
This short piece will answer:
What Is Seller Financing?
How Does It Work?
Why Would I Go This Route Rather Than Using A Bank or Traditional Lender?
What’s the Smart Way to Structure Seller A Financed Deal?
What Is Seller Financing?
Seller Financing - often referenced as a Seller Carry - is a non-conventional method of acquiring real estate in which you bypass working with a bank.
It enables you to negotiate more favorable financing terms compared to that which you’d be offered from a traditional lender.
Allowing you to work directly with the seller or owner of a property, to structure purchase financing parameters that work best for both of you.
How Does It Work?
When it comes to seller financing, the owner is essentially replacing the role of a bank or third party lender. Rather than securing an outside loan for the purchase of a property, you and the owner put together a promissory note and you make payments directly to them (the owner).
Here’s An Example:
Sally is selling her property for $750,000. Rather than working with your bank or a mortgage broker, you and Sally agree to the following terms:
Purchase Price : $750,000
Downpayment: $100,000
Seller Financed (or Carried) Portion of Purchase: $650,000
Interest Rate: 5%
Amortized Over 30 Years
What does all of this mean? It means that you are purchasing the property from Sally for the full asking price - $750,000. You will be putting forth a $100,000 downpayment; giving Sally a sizable upfront payment. Then the remaining $650,000 will be financed, or ‘carried’, at an annual interest rate of 5%. The life of the loan will be amortized, in other words spread out, over 30 years. Setting you up with monthly payments of about $3,500 ($3,489) not including property taxes and insurance.
As you can see, the terms of a seller financed purchase work just like any other loan, the only difference is that you are not making payments to the bank or lender; instead, the loan is serviced by the seller and perhaps an independent escrow company.
Why Would I Go This Route Rather Than Using A Bank or Traditional Lender?
The primary reason buyers and sellers utilize a creative carried transaction structure rather than the traditional purchase and sale style, is for the flexibility.
With seller financing, the buyer can lock in a lower interest rate, pay less points or fees, and even put forth a smaller down payment depending on the terms that are negotiated.
For sellers, it gives them a large lump sum check, plus consistent monthly payments similar to rental income. Allowing for potential tax savings and additional net profit on top of the agreed upon purchase price.
What’s the Smart Way to Structure A Seller Financed Deal?
When structuring a seller financed purchase there are a multitude of ways in which you can craft more advantageous terms than you’d be offered from the bank or any other source of funding. Here’s how we approach our deals:
Lengthier Pay-Back Periods (aka Balloons): Similar to certain conventional and bridge loans, it’s common for seller financing agreements to have a ‘balloon payment’ clause. The balloon is synonymous with the pay-back period; it determines when the loan balance must be paid off in full. Some loans will have a shorter pay-back period such as 18 or 36 months; others will extend as far as 15 years. When we’re able to, we like to push out the balloon date as far as possible. This allows us to be patient with repayment, and more selective in our search for alternative financing.
Interest Only Payments: We typically structure the promissory note in such a way that it allows for interest only payments. Depending upon the interest rate, this can drastically reduce your monthly payments. For instance, in the previously listed example, the monthly payment is around $3,500 a month; this includes both principal and interest. If we were to negotiate interest only payments, the monthly payment would be less than $2,710.
No Pre-Payment Penalty, Points or Other Fees: With no pre-payment penalty, we can refinance at any time without having to fork over a fee for exiting the seller financed loan earlier than anticipated. Points are a common fee that banks and mortgage brokers assess. But when you have the ability to negotiate your own terms, the loan should be free of any points or other borrowing costs.
Negotiate Title and Escrow Fees, Property Taxes, and Insurance: Lastly, we do our best to have the seller take care of all title and escrow fees; this can save you thousands. And for the sellers that are highly motivated to work with us, we’ll also urge them to cover the property taxes and insurance for the duration of the loan. Depending on the age, size, and value of the property, taxes and insurance can be pricy. If the seller is willing to take care of these recurring costs, you can keep your monthly payments to a minimum.
With this thorough understanding of seller financing and exactly how it works, you’re now equipped with yet another tool that you can use to pull off your next deal.
The Firebrand team owns and operate assets across multiple states, throughout three different regions of the country. If you’re considering purchasing a home or adding an investment property to your portfolio, we’re here to help.