Archive for February, 2008
February 20th, 2008 categories: Seller Financing
Seller carryback financing can be an attractive option for the reasons listed in the last post; however, it is important that the transaction be structured properly for maximum safety. If the note holder ever needs cash down the road, the note will command a top price (require a minimum discount) if it is well-structured, safe and secure.
The first items usually negotiated between the buyer and seller are: down payment, face value of the note, interest rate, monthly payment, and term or due date (or balloon payment, if any).
A seller should require no less than 10% of the purchase price as a down payment, with 20% being ideal. There is no substitute for protective equity. A seller needs to be able to protect their interests even if the payor defaults on the note and foreclosure is necessary. The higher the protective equity, the lower the discount if the note is ever sold for cash.
The interest rate on a note, in most instances, should at least be the going rate in the market at the time. It can often be a point or two higher. Even with a higher interest rate, the buyer is saving cash at closing by not having to pay points or loan origination fees.
Usury means charging a rate of interest that exceeds the interest rate allowed by state law. In California, seller carryback trust deed notes are not subject to usury limits. The opposite of usury is charging too little interest. While not illegal, it can have serious tax consequences. Ask your accountant or attorney for the current imputed interest rate formula.
To minimize the discount should the note be sold, it is important to understand that the due date is normally more important than the interest rate or the monthly payment. A dollar to be received today is more valuable than a dollar to be received in the future. The sooner the note pays off, the more the note is worth today.
The sellers carrying back a note would want:
1) A due-on-sale provision. If the buyers sell in the future, the note holders may want the loan paid off, or at least want the opportunity to determine the credit and financial strength of the new buyer/borrower. It also gives them an opportunity to adjust to current interest rates.
2) A balloon payment due on the note five years from closing.
3) A late charge of 6% of the payment if it is not made within 10 days of its due date.
4) A prepayment penalty (if early pay-off would generate adverse tax consequences).
5) The buyer to pay all closing costs.
The buyers would want:
1) No due-on-sale provision. If they sell, they want the note to be assumable.
2) No balloon payment. Where will they get the money in five years?
3) No late charge.
4) No prepayment penalty.
5) The seller to pay all closing costs.
A compromise would look something like this:
1) A due-on-sale provision will give the sellers some control in the event the buyers sell. They will be able to approve the new buyer.
2) A balloon payment in ten years, not five.
3) A late charge of 6% of the payment if not paid within 15 days.
4) A prepayment penalty only if the buyers make additional payments that reduce the principal balance by more than 10% in any given year.
5) Buyers and sellers agree to share closing costs equally.
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February 20th, 2008 categories: Seller Financing
Many sellers of real estate automatically think they need an all cash buyer, but do they? What many people need is a steady flow of income. If someone received $100,000, likely they would spend some and invest some. In that portion that they invested, would they be able to earn 6% or more on their money? A note secured by real estate can provide a good rate of return and a steady income for many years.
For the last several years, money has been inexpensive and easily available for owner-occupied single family homes. Perhaps money will be less available in the future, but even when money is cheap and plentiful, some borrowers who would be excellent buyers still cannot qualify under institutional standards, and there are always some properties that are non-conforming and don’t meet traditional lender standards. In these situations, seller financing can be a great solution.
When the seller helps the buyer by acting as a lender, the seller may finance all or part of the sale. The term given to such seller financing is “seller carryback financing.” A seller is literally carrying back part of the financing on the property being sold.
The more equity a seller has in his property, the easier it is for the seller to structure carryback financing. Some experts estimate that up to half the homes in America have no existing debt. Often times the best candidates for seller financing are free and clear homes being sold by elderly people who need retirement income.
CARRYBACK ADVANTAGES FOR THE SELLER:
1) Getting top price by taking terms rather than all cash.
2) Deferring taxes now on any gain by using an installment sale.
3) Receiving a higher interest rate than if you put the proceeds from a cash sale in the bank, a CD, or money market fund.
4) Monthly income secured by property you understand and whose value you know.
5) Larger number of prospective buyers and a quicker sale because you offer seller financing. Using the terms “SELLER FINANCING” or “OWNER WILL CARRY” on a FOR SALE sign or classified advertisement will attract a larger number of prospective buyers.
Always consult with an attorney and an accountant before consummating any real estate transaction.
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