Seller finance, also known as owner financing, acts as a private mortgage for investors purchasing a property. Therefore, the vendor is essentially financing your purchase of their property instead of a financial institution. It sounds like a strange concept, and a lot of you will wonder why anyone would agree to this, although there are benefits for both parties. In the following, we cover the completed process:
- How seller finance works
- Examples of how seller finance works for real estate
- The pros and cons of seller finance for both parties
- Typical seller finance terms
- Seller finance summary
BUYING RENTAL REAL ESTATE WITH SELLER FINANCe
By buying real estate under these terms, buyers can pay for a new home or rental property without relying on a traditional mortgage. Instead, the seller or owner finances the purchase, often at an interest rate higher than or equal to the current mortgage rates, with a lump-sum payment due at an agreed-upon date(s) in the future. This can simplify the process of buying and selling a home by eliminating the need for a lender, appraisal, and inspection.
How SELLER FINANCe WORKS
Depending on the original structure, the buyer will obtain title to the property from the start of the deal, and the seller will have a first reserve over the property until the loan from the seller finance is paid off in full in the agreed timeframe.
At the end of the agreed loan term, the buyer either makes the lump sum payment or refinances to a traditional mortgage and pays off the seller with the new loan. Another option is to dispose of the property and pay the financing off with the proceeds of the sale.
EXAMPLES OF SELLER FINANCe
Adding significant value to a property, like a renovation, is a great way to maximise seller finance. Through seller financing, you can own the property through a private mortgage and not worry about satisfying a traditional lender requirement, such as a fixed 2-year term or a functional kitchen. Moreover, you are able to negotiate the interest rate, loan duration, and deposit amount.
This provides the ability to own a full title and gives flexibility in terms, so you can remortgage once the refurbishment is complete. After finalising the refurbishment and the value of the property has increased, you have the option to repay the seller finance using a loan based on the inflated property value from the price previously purchased.
Alternatively, if you’re buying a property and the business that operates in the building, you can use seller financing to facilitate the complete purchase. By negotiating a longer term of seller finance with, say, a baby boomer as the seller who is looking to retire, you could offer the seller a retirement income. It would work by paying the capital and the agreed interest rate over a longer period of time, say 10–20 years. This benefits the seller as it provides tax advantages and guaranteed income into retirement. Moreover, the buyer’s loan would be paid off using a portion of the cash flow from the business over an extended period of time.
THE PROS AND CONS OF SELLER FINANCe
Advantages for Buyers
- Can give access to financial terms that high-street banks don’t provide.
- Reducing selling time as the bank’s due diligence time is not required.
- Eliminates bank valuation costs and bank fees.
- Negotiable deposit levels, duration of the loan, and interest rate.
Advantages for Sellers
- Owners don’t have to satisfy a lender’s appraisal requirements.
- Presents an investment opportunity with a strong return in the short to medium term.
- Reduces the selling process by reducing bank due diligence.
- Still offers the ability to sell the agreement to an investor for an up-front payment.
- Provides the first right to the property if the buyer is unable to pay.
- Possible capital gains tax advantages by pushing the payments over multiple tax years—please check with your accountant.
Disadvantages for Buyers
- Often involves higher interest rates than a traditional mortgage.
- It doesn’t commonly last for a long period of time and will require a balloon payment at the end of the loan term.
Disadvantages for Sellers
- Exposes sellers to the risk of non-payment and subsequent default.
- Delayed receipt of capital.
TYPICAL owner FINANCE TERMS
An offer for owner finance should be set out in writing in a letter of intent (LOI) so both parties understand their responsibilities under the seller finance model. The common terms of a seller financing agreement are:
Purchase price. This is the total transaction price, which will therefore dictate the deposit and loan amount.
Deposit payment. A seller finance agreement should establish the deposit payable on completion.
Loan amount. Subtracting the deposit payment from the purchase price will generate your loan amount.
Interest rate. Normally, seller finance rates are higher than on traditional mortgages, but this is a negotiable factor when discussing terms.
Loan term schedule. The loan term is the amount of time a buyer has to pay back the loan.
Monthly payment. Normally, owner finance terms include the number of monthly payments, the due date, and whether there is a grace period.
Lump sum payment. The balloon payment, or lump sum, is the loan amount left that must be paid at the end of the loan term. It can be through cash, refinance of a traditional loan, or disposal after the seller’s finance agreement ends.
Tax and insurance payments. The owner finance agreement should describe who will be responsible. Normally, each party bears their own taxes and insurance; however, this is a negotiable factor.
Additional terms. Every real estate deal is different, so make sure your seller’s financing LOI spells out anything that’s unique to your deal.
OWNER FINANCING SUMMARY
Seller finance is a very creative way to purchase investment property. It has the ability to create a win-win situation for both the seller and buyer. Furthermore, it generates flexibility in terms for the buyer and creates a lucrative return and possible tax savings for the seller. This only works if the seller is open to this arrangement.
Therefore, the way to find this out is in initial discussions with the seller or their agent. You’re aiming to find out their reason for selling or their pain points, and from there, you can gauge whether they might be open to the option.
