Your Guide to Buying Commercial Real Estate with Seller Financing

Using “seller financing” is one of the most popular ways to put little or no money down when investing in real estate. Although it may be one of the earliest “creative financing” strategies, it seems to be losing favor in recent years, largely for the reasons to follow. All things considered, seller financing out the window, though. Knowing how to use it efficiently in your business might help you close more deals faster and for less money. This post will define seller financing, explain how to use it, and discuss potential pitfalls.

Just as it sounds, seller financing involves the seller providing the financing. In other words, although legal title is transferred, the payment is sent directly to the prior owner rather than a bank, and the property owner serves as the bank.For instance:

I want to buy a specific investment property, but I don’t want (or am unable) to obtain typical bank financing. Although the seller wants $100,000 for the property, he or she is prepared to “carry the contract,” as investors say when they agree to finance a piece of real estate they own. The owner requests a $5,000 down payment and a $95,000 balance with a 30-year amortization period at 7% interest for a $632.03 monthly payment. I accept his terms, and, after performing my due diligence, I close on the property using a title company in my neighborhood. Then, in order to collect the monthly cash flow difference, I search for a tenant  who will pay $1400 a month to rent the property.

The seller in the aforementioned situation receives an excellent fixed interest rate on their investment, I get to purchase the home for only $5,000 down, and I never have to interact with a bank.What’s the catch, though? Why don’t these have greater appeal?

Why Doesn’t Everyone Use Seller Financing to Buy?

The due-on-sale provision, which is a legal component of practically every mortgage and provides the bank the authority to demand that the loan be repaid, in full, immediately if the property is sold, is a significant issue with seller financing that throws a kink in the whole plan.

You can now see why seller financing is problematic: since the property is being sold, it doesn’t work well if there is already a mortgage on the property. In other words, if you have a mortgage on a property and use seller financing to sell it, the bank may contact you and demand immediate payment or proceed with a foreclosure.

Will that occur?

However, keep in mind that the “due on sale provision” only gives the bank the RIGHT to do so, not a commitment to do so.The bank might approve of the arrangement and say nothing about it, or they might never learn. However, whenever you sell a property with a due-on-sale provision, there is a significant risk involved. I personally don’t dabble with the due on sale clause since I want to reduce the amount of risk I take when investing in real estate. So, how do I benefit from seller financing?

How, therefore, can the “due on sale” clause be avoided?

As noted above, the risk of using seller financing when the seller already has a mortgage is that it may result in the “due on sale clause,” which could result in the property being foreclosed upon if you are unable to repay the bank the full loan total. In the event that you purchase a home from a homeowner, both of you would lose the property if the homeowner went into foreclosure. There is just one straightforward remedy because, obviously, you do not want to find yourself in this situation:

Use seller financing only if you have free and clear title to the property. (There are a few exceptions; we’ll discuss them later.)

In other words, if the property owner currently owes money on the house, you shouldn’t use seller financing to acquire it from them unless you first settle the debt. To purchase with seller financing, you must locate sellers without a mortgage. In this manner, they can offer the financing without having to worry about facing foreclosure.

The Advantages of Seller Financing
Let’s look at a few of the most frequent perks of employing seller financing, but there may be many.

1. 1. Ease of Financing: As was already noted, using pure seller financing eliminates the need to work with a bank, which for many people can mean the difference between a sale and no deal. Seller financing is a fantastic weapon in your toolkit if you have “tapped out” on the number of mortgages you can receive and need to buy more investment property.
   2. Due to the fact that you are negotiating with seller directly, there are no black-and-white regulations regarding the down payment. As opposed to Fannie Mae or Freddie Mac, who demand 20% to 30% down on investment properties, you are not subject to their strict requirements. As an alternative, you agree on a price with the seller. You won’t know until you inquire and negotiate what the seller wants in terms of a deposit, whether they want nothing or 50%.

• The rules when dealing with banks can be very rigid, but not with seller financing. This leaves room for creativity in transaction structuring. You might think outside the box to find a solution to a problem with seller financing. Rate, period, payment sum, due date, and every other aspect are all subject to negotiation, which can transform a fair deal into an excellent one. Speaking of being inventive, I’ve seen investors work out 0% seller financing terms with the seller.

1. 1. Purchase “Unfinanceable” Properties: On occasion, a property’s condition could be too bad for conventional financing. In these circumstances, seller financing may offer the buyer the opportunity to acquire the property, make repairs, and subsequently refinance into a more conventional form of financing.

• Doesn’t Show Up On Your Credit Report: Chances are that your seller-financed agreement won’t land up on your credit report, which can make it simpler to get additional loans and mortgages in the future, unless the home seller joins up with one of the credit reporting agencies to report the debt (which is extremely rare).

• Monthly Income: Obtaining a monthly income is probably the main reason why sellers choose to use seller financing. Many people would simply prefer to receive regular checks each month rather than a single lump sum, just like in the scenario I presented above with the $100 or $1 per month. For older sellers who depend on monthly income to make ends meet and pay the bills, this is especially true. For an older seller, a $100,000 lump sum would only last them so long. However, if that income is financed over 30 years, it will last them much longer until retirement.
• Better ROI: Because the interest they receive from the financing is higher than they are likely to receive elsewhere, many homeowners and investors choose to sell with seller financing. For instance, if a homeowner sold a property for $100,000, they had the option of investing the money in a bank’s Certificate of Deposit to earn 1.5% APY or seller financing their home to earn 8%. What is superior? This idea is well understood by many seasoned real estate investors, who eventually transition their portfolio from a “holding” phase to a “selling phase” by using seller financing to eliminate the hassles of ownership while continuing to generate monthly income by carrying the contract and offering seller financing. The investor then transitions from the “landlord” company to the “note buying” industry.

1. 1. Spread out taxes: The government always wants a piece of your earnings, and selling real estate is no exception. Due to an IRS provision that exempts homeowners from paying taxes on up to $500,000 in profit from the sale of their principal residence provided certain requirements are met, this issue may not be as crucial for homeowners. Investors, on the other hand, are less fortunate and must pay taxes when they sell. For instance, if an investor pays off a rental property mortgage over the course of 30 years, becomes the owner free and clear, and decides to sell the property for $100,000, the investor would be responsible for paying taxes on the $100,000, which might result in a tax payment of close to $50,000. A “recapture of depreciation” tax that the investor will also be responsible for paying might substantially increase that tax bill. As a result, many investors opt to sell using seller financing rather than receiving a lump sum payment in order to postpone the majority of those tax payments. The seller may only have to pay a small fraction of that tax payment each year while the loan is being paid off because the IRS has specific tax regulations for installment transactions, such as those involving seller financing. This brings up the “ROI” issue once more. If an investor sold a property for $100,000, they might lose as much as half of that—or more—to taxes, leaving them with only $50,000 to put toward other investments. Even if they were to make 12% on the stock market, they would only make that on the $50,000 they sold, not the $100,000. They will, however, actually make more money if they offer seller financing at 8% because the interest they receive is on the “pre-taxed” interest.

• Can’t Sell Otherwise: As was said in the section before, many properties are just not marketable to a regular borrower with bank financing. By providing seller financing, a seller may be able to sell a home without having to make the necessary repairs.

Although seller financing might give you as a buyer some great possibilities, you should be aware of the risks and hazards associated with the tactic. This section will examine three of the most frequent worries when dealing with seller financing and provide some advice on how to avoid those potential issues.

1. The “due on sale” clause has already been discussed in great detail, but I feel compelled to recapitulate it here. You must fully comprehend the meaning of the due on sale clause and why it is significant. By attempting to go around this provision, you don’t want to jeopardize your credit or your connection with the vendor. Be aware that if you use seller financing to purchase a home and the property has a mortgage with a due on sale provision, the bank may foreclose on the seller, placing you both in a difficult financial situation. Again, the most straightforward answer is to limit the use of seller financing to assets that are owned free and clear. I only have short-term finance as an exception to this rule. There are investors out there who 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 think they can fix the property up quickly and either sell it or refinance it before the bank finds out and has an issue with it. I won’t advise you to do this; that is up to you and your level of risk tolerance.
2. Higher Interest Rates: Although seller financing encourages tremendous innovation, you will generally pay a higher interest rate than usual.Though some investors negotiate 0% interest seller-financed loans, it is difficult to convince a seller to accept such a low interest rate in today’s lending environment with loans under 4%.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: Although seller financing can be a fantastic win-win situation for both sides, the vast majority of homeowners are either unable (due to existing mortgages) or unwilling to carry a contract and provide seller finance. Therefore, when trying to cooperate with seller finance, the pool of viable offers is substantially smaller.

We’d like to reiterate that seller financing does not justify overpaying for a property, even if it allows you to purchase properties without utilizing a bank. Only when leverage is used appropriately does it remain leverage; otherwise, it simply turns into a liability.