A real estate investor explains how seller financing works and benefits
- With seller financing, the buyer buys directly from the seller, rather than going through a traditional mortgage lender.
- The buyer and seller set the terms of the loan, such as the interest rate and down payment.
- Investor Mike Newton likes this type of financing because the process is faster and cheaper.
If Mike Newton could buy all of his investment properties with seller financing, he would.
“Seller financing is the holy grail of real estate investing,” the 31-year-old real estate investor told Insider. “I wish I could do all the transactions like this.”
With seller financing, rather than using a traditional mortgage lender such as a bank, credit union or government agency, the property owner acts as the lender and provides a loan with terms agreed upon at the ‘Buyer. In other words, the buyer buys directly from the seller in installments as he would with a conventional loan.
“Seller financing is fantastic for a bunch of different reasons, but perhaps the best reason is that you can set the terms of the loan, like the interest rate and the payment schedule,” explained Newton, who has purchased two of its eight investment properties with the seller. funding in 2020 and 2021. Insider confirmed these details while reviewing the closing documents. He and the owner of the two properties (both purchased from the same person) agreed to a 20% down payment at a fixed interest rate of 4.9%, amortized over 15 years.
Newton would have preferred a 30-year amortization schedule because it would further split his payments, give him a lower monthly payment and improve his cash flow on the investment property, he noted: “But when I was discussing with the seller, he said: “I am 70 years old. I’m not going to live another 30 years.” I said, “All right. You make a good point. I understand why you want a 15 year amortization.”
That’s the beauty of seller financing, he added: “It allows you to solve the problem the seller might have and solve the problems you, the buyer, might have.” As a buyer, if you find yourself in a financial situation where a traditional mortgage lender might not qualify you for a loan, “you could very realistically buy a house with bad credit and no money that way.”
Common cases where a buyer would seek a seller-financed deal are buying vacant land, buying an aging or labor-intensive property that a seller has had trouble unloading, or purchase of a property under $100,000. The process benefits sellers as these agreements provide cash flow, they reduce costly agent commissions, and in the event of default, the seller still owns the property.
Although the terms are usually negotiated between buyer and seller, the amortization period and interest rate are closer to those of a commercial real estate loan than a residential loan.
When you work directly with the seller and remove the bank, the process is usually faster and cheaper.
“There are no closing costs, there are no origination fees and there are no valuation fees,” Newton explained. “You can always do an inspection if you want, but it’s not mandatory.”
As for the seller, they receive a constant stream of passive income with each monthly payment, which is extremely beneficial for sellers living on a fixed income or who do not necessarily need or want a large one-time lump sum of a sale of property.
“It’s a much more efficient way to generate really passive income than traditional real estate investing,” Newton said. “Because the seller is no longer responsible for managing the property and the tenants. They are effectively the bank. They’re not involved.”
Once Newton and the seller agreed on the terms, they drew up a contract. Newton now makes payments directly to the seller every month.
“We have a contract like you would with a bank,” he explained. “At the end of the payments, I will own the property. I can also pay it off earlier if I wish.”
The one big caveat with seller financing is the “due on sale” clause, real estate consultant and investor Dana Bull told Insider: “When you take out a mortgage, there’s a clause in that promissory note called the ‘due on sale’ clause. This means the bank can demand that the borrower pay the remaining balance. of the loan if there is a change of title.” Essentially, if the building society sees that there is a new owner, they will consider the house sold and may demand payment in full of the remaining debt.
“While it’s possible, it becomes very difficult for a seller to do seller financing if they don’t own the property,” Bull said. “Because technically if you have a mortgage, you don’t own the property. The bank also has an interest in the property and their security for the loan is the asset.”
Part of the reason seller financing isn’t very common is that most people don’t completely own their properties, she said.
It can be difficult to find someone willing and able to fund the seller. In Newton’s case, he told his property manager he was interested in this type of financing. She happened to have another client who was selling a bunch of her rental properties and was looking to do seller financing, so she connected the two.
If you want to go this route, “start networking and telling people you’re interested in vendor financing,” Newton advised.
When you actually look at properties, “you can usually figure out what someone owes on a mortgage or you can see if they’ve refinanced in the past,” Bull added. “This is information available in the public records.” You can look for places that are fully paid or about to be paid, “but the main thing is to just ask the salesperson,” she said.
Both Bull and Newton expect seller financing to become more popular in the near future.
“It hasn’t been very popular recently because interest rates were 2.5-3%. Why would a seller want to offer this to a buyer if there’s not a lot of juice to squeeze ?” said Taurus. “But now we’re in a rising interest rate environment and a seller might think there’s a pretty good return here if I don’t need that lump sum.”