Seller Financing Can Seal the Deal in Rough Market


Posted 10/2/2008 by Kathleen Doler

Owner will finance.

Those three words are coming back in today’s real estate market.

With financial markets in turmoil and lending very tight, home sellers who own, or have equity and a stable mortgage, are financing deals to lift their property’s attractiveness.

“The last time the market was down, creative financing was up,” said broker and owner-financing consultant Dawn Rickabaugh of Rickabaugh Realty, in Pasadena, Calif. “We’re hitting a time when creative financing is up again.”

Why Lend, And How To

In owner financing, sellers provide short- or long-term mortgages to buyers, augmenting traditional lender financing or taking its place.

These sellers may be more apt to get an offer and close a deal quicker. The loan may yield interest and an income stream topping mortgage payments or investment interest rates, and there can be tax perks.

Offering financing carries risk. It takes good judgment to avoid the missteps big lenders made in the subprime debacle. Sellers should consult experts to help set up a loan and maybe a trust, handle documentation, keep records and file taxes.

Done right, loans can potentially be sold to investors, says Salvatore Buscemi, a partner with Dandrew Capital Partners, a distressed real estate investment fund in New York.

Who needs seller financing? The list includes foreign buyers who may have trouble getting U.S. bank mortgages, and business owners or others who look cash-poor to a bank but have assets and income aplenty. Seller financing for luxury properties is especially in demand.

“Luxury homes sell much faster with owner financing, because most banks today are balking at large loans,” Buscemi said.

Sellers who finance can defer capital gains taxes for the period of the note and only pay income tax on the interest and principal income they get each year. Depending on how long a seller has held a home and the size of the down payment, he may not need to pay capital gains tax on that part of the transaction.

Jerry Hannan recently sold his luxury second home in Palm Springs, Calif., to a Canadian buyer by offering financing. He’d been trying to sell the property for over a year and had cut the price repeatedly. Now he’s getting an income stream from the new owners, which tops his payments on the home’s mortgage.

“It was scary at first,” he said. “But we actually have a positive cash flow and the note is for five years, though the buyer assures me he plans to act (pay off or refinance) before that.”

Rickabaugh was the buyer’s agent. For safety, a trustee-managed equity holding trust was set up to hold the deed until the note is satisfied. With such trusts, defaulting buyers can be evicted like tenants, avoiding foreclosure. And the “due on sale” clause in most first mortgages doesn’t kick in, so the bank holding that mortgage won’t call it in.

The trust system “allows me to put more transactions together, ones that would ordinarily represent too much risk,” Rickabaugh said.

Act like a bank when lending.

“Any seller who opts to do this has to talk to his or her financial and legal advisors to make sure they know all the pros and cons — there is risk,” said attorney Benny Kass, a real estate law specialist at Kass, Mitek & Kass, in Washington, D.C.

Rates And Costs

It can run a few hundred dollars for an attorney to review loan and sale papers. Usually the buyer pays.

Interest rates, amortization and note periods on these private loans are set by what the market will bear. Some undercut bank rates. Others get a premium. Usury laws make loans at unreasonable interest rates uncollectible, possibly illegal.

Get a buyer’s credit report before a deal. Verify ability to pay, with papers assuring income and assets.

“A credit score is not enough,” Buscemi said.

A seller should make sure the property is well-insured, and be a payee on the policy. Once a loan is in place, it’s crucial that it be serviced properly. Buyers should pay that cost.

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