Dispel the 5 Myths of Seller Financing
Are you tired of the Lost Sale and Expired Listings? Do you know that notes can get your clients cash now and get your escrows closed?
- Do you have a seller stuck on price?
- Do you have a buyer who can’t qualify?
- Have a property that’s non-conforming?
- Is your deal falling apart?
If you answered “Yes” to any of these questions, you need to know about one of the most trusted techniques in the country for closing real estate transactions. The Installment Sale is a proven strategic tool allowing property owners to effectively defer capital gains without an Exchange.
Use “Owner Will Carry” to double the number of potential buyers for your listing. If sellers understand that they can get cash even when they carry, they are more likely to say “yes” to owner financing, which greatly…
increases your chances of closing the deal and getting paid!
Nine times out of 10, even agents who regularly use seller financing to close transactions fail to tell their listing clients that they can sell their carry back note. It can be sold for top dollar IF…. it’s put together with a keen understanding of what note buyers want.
Agents can either save or cost their clients $$$ thousands.
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More than $94 billion dollars of private real estate notes are created each year, and many are sold for Instant Cash.
Many real estate professionals lack a good understanding of the Installment Sale, more commonly known as Seller Financing, Seller Carry Back, or Carrying Paper. Only the agents that have the widest range of tools to get escrows closed are going to succeed in the market that is developing today. Here are some common misconceptions:
- Myth #1: Only Desperate Sellers Carry Paper
- Myth #2: You Can’t Trust Creative Financing
- Myth #3: Seller Financing is Risky For My Client
- Myth #4: Seller Financing Can Only Be Used When Someone Owns a Property Free & Clear
- Myth #5: Seller Financing Means My Client Can’t Get Cash at Closing and I Won’t Get My Commission
Can you afford not to know about notes? In the ever changing world of real estate, the answer is, no.
This report is designed not only to dispel five common myths of seller financing, but to give you the edge you need to help your clients out-perform the competition.
With that in mind, let’s talk about some of the common myths surrounding seller financing.
Myth #1: Only Desperate Sellers Carry Paper
It is true that in challenging markets when financing is tight and buyers are few and far between, many sellers who want all cash end up carrying a note just to get the transaction closed. It wasn’t their intent to carry paper, but they did , just to be able to sell and move on.
Other sellers may have non-conforming real estate that makes it hard for a buyer to get a loan. In order to sell in this situation, the owner will have to be flexible and take a combination of cash and paper just to get the deal done.
But is that really a bad thing? At least they had the tools they needed to close the transaction . . . something that was a win-win for all involved. The Seller gets to sell, the Buyer gets to buy, and YOU get paid!
These sellers are generally happy to sell their note at some point, and when they do, they will hope that the transaction and the note itself were structured properly, or they’ll end up taking a big discount.
What tends to escape many real estate professionals is that many people carry paper on purpose! Seller Financing is NOT just for the desperate seller in desperate times. Far from it! In fact, over $94 billion of privately held notes are created each year. Many owners, along with their attorneys and CPAs, use the Installment Sale as a calculated estate planning tool. Here’s an example:
John & Patricia bought a commercial building in which they ran their travel agency for many years. Now they are ready to retire, and they own the building free and clear. They paid off their commercial building before they paid off their home because they intended for the commercial building to be an important part of their retirement plan.
They now want to sell the building for $370,000. They want 15% down, and they want to carry the rest at 7.5% over 30 years, due in 15.
Why? To defer capital gains and have a steady stream of income for a comfortable retirement.
Getting 7.5% on a first trust deed far exceeds what bank CDs are paying, and they don’t have the capital gains hit. Besides, they feel comfortable because the note is secured by a property they already know. The worst that could happen is they get the property back, keeping the down payment and any monthly payments made to that point.
Why due in 15? Because they expect they will probably be dead within 15 years, and they want their son to be able to cash out if he wants to. He could always choose to restructure the note to continue that nice steady flow of income. (A balloon can increase the value of a note, preventing the Time Value of Money from decimating the present value of future payments).
Let’s look at how the numbers work out:
- Sales price: $370,000
- Down payment: $55,500
- First Deed of Trust: $314,500
- Interest rate: 7.5%
- Amortized over: 360
- Monthly payment: $2,199.03
- Due in 15 with a balance of: $237,216.74
The down payment pays off the mortgage on their home, covers their closing costs, and they have $2,199.03 coming in each month on top of their other retirement income. That is more than comfortable for their needs, and they are getting a good return on their money. They receive:
- 180 payments of $2,199.03: $395,825.40
- In 15 years they still have: $237,216.74
- TOTAL: $633,042.14
Not bad . . . over $633,000 on a property they only sold for $370,000! What would the numbers look like if they had sold for all cash? Click the link below for a quick lesson in capital gains and the installment sale (adapted with permission from material written by Anthony Phillips, CPA and owner of Downstream Exchange in Pasadena, California):
Implications for the Real Estate Professional
The real estate professional that understands the basics of the Installment Sale, or Seller Financing, can easily out-perform their counterparts who, in general, are unaware of alternative ways to dispose of property.
Being able to educate clients on the benefits of Seller Financing can:
- Increase the number of listings you take
- Increase the number of escrows you close
- Save the lost sale through knowing alternative ways to structure transactions
- Broaden the base of potential buyers for your listings
- Help you negotiate more effectively
- Have faster closings
- Be more competitive
- Earn higher commissions
- Build a solid referral base
Knowing about Seller Financing and the secondary Trust Deed market can help more Buyers buy, and Sellers can sell more quickly, and you close more escrows.
The real estate agents with the most tools for putting transactions together are the agents that will continue to thrive regardless of market conditions. Knowing about Installment Sales, Seller Financing, and the secondary Trust Deed market could very well give you the competitive edge now and into the future.
As sales slow down and loan are harder to come by (not to mention the impending increase in the Federal capital gains rate to 20%), Seller Financing is going to make more and more sense. There is no credit crisis for flexible sellers!
The 1031 exchange has been a popular vehicle for deferring capital gains and building wealth; however, many owners of investment properties have absolutely no desire to exchange into another property. Many owners would rather sell, but here are some of the reasons they won’t:
- “I refuse to pay all those capital gains . . . and I don’t want to exchange into another property, because I’m tired of managing and dealing with tenants.”
- “I need the income . . . this is my retirement!”
- “I want to give my children a good inheritance. I’m leaving the rental properties to them . . . we already have a trust set up.”
You will take listings by showing clients (who may think they can’t sell) that they can DO LESS and GET MORE by selling and carrying the paper. Structured properly, this is one of the safest, most coveted investments in the market today.
Here are some of the benefits of Seller Financing:
- Defer capital gains
- Keep equity at work at interest rates higher than the bank is paying
- Get a good cash down payment at close of escrow
- Collect hassle-free monthly income for years into the future
- The note is secured by a property the Seller understands
- Many times the Seller gets more each month than they could collect in rent
- No more tenant or maintenance issues
- No more property taxes or insurance
- If the buyer stops paying, the Seller keeps everything and gets the property back
- If they or their heirs ever need money, they can sell all or part of the note for cash
- Larger number of prospective buyers and a quicker sale because you offer seller financing. SELLER FINANCING or OWNER WILL CARRY are powerful words you can add to a FOR SALE sign or classified advertisement.
Myth #2: You Can’t Trust Creative Financing
One of the more common myths about seller financing is that creative financing is somehow shady and borderline illegal. It’s something a respectable real estate professional should definitely stay away from.
If you’ve read this far, it should be obvious to you that this is absolutely false. It’s just that in Southern California, there just hasn’t been a need to be fluent in anything but the conventional and traditional.
We all know that things have changed. Now it might behoove us to open our minds to techniques that are “business-as-usual” in many parts of the country. Sellers are going to have to create their own liquidity in the current financial climate.
The time has come to be well-versed in the many benefits of the Installment Sale. Carrying paper and other “creative financing” techniques are as old as time . . . they’ve been around much longer than sub prime Mortgage Backed Securities and imploding hedge funds.
There are IRS guidelines, and legal guidelines, and boiler plate documents from the California Association of Realtors supporting the existence and legitimacy of Seller Financing, Subject-To Financing, and the All Inclusive Deed of Trust, or Wrap.
Accountants and attorneys generally work well with a knowledgeable real estate broker who is also familiar with the secondary trust deed market. This way, their clients’ short and long term needs are calculated for. The transaction and note get structured properly when a team of experienced professionals work together.
Myth #3: Seller Financing is Risky for My Client
When many real estate professionals think of Seller Financing, they think of having the Seller carry back a high-risk 2nd Deed of Trust. For a while, the 80-10-10 financing structure was popular. There would be a 10% cash down payment with an 80% bank financed first, and a 10% Seller financed second.
That can work well in an appreciating market, but even then, the Seller is basically holding a worthless instrument. That kind of a second has no market value. It could not be sold for instant cash without a large discount (if at all). It the Buyer decided to quit making their payments, it wouldn’t be economically feasible to foreclose and repossess the property.
Keeping a huge defaulting first current to protect a small second usually doesn’t make sense. The exposure is just too great. The holder of a high-risk 2nd needs to sit back and keep their fingers crossed and hope that the payments keep coming in. So, yes . . . carrying back a small second is risky. Sometimes the risk is acceptable, sometimes it’s not. It all depends on the individual circumstances of the people involved.
If your seller wanted or needed to carry a second, it is usually better for them to structure something closer to a 50-30-20, or a 60-30-10 . . . a 10% – 20% cash down payment, with a seller financed second that is about 50% the value of the first. A 2-to-1 ratio is best in protecting the value of a second deed of trust. The first TD should usually be no more than 3 times the value of the second behind it.
Why? Because then your Seller has options. What if they need a lump sum of cash a year after the sale? If they’ve got a high-risk 2nd, then too bad . . . they can’t get it. But, if they’ve got a valuable, well-protected 2nd, then they can usually sell a portion of their 2nd for minimal discount and raise the cash they need, still have some monthly income, and defer capital gains to boot.
In the traditional sense, a low down payment (anything less than 10%) is considered risky. However, there are loads of buyers out there with only 3-5% down who still want to buy and would be good payers. Can these deals still be put together? Yes, and when we do, we use additional strategies to minimize the risk to the seller when he accepts a low down payment. The Illinois land trust model comes in very handy.
Myth #4: Seller Financing Can Only Be Used When Someone Owns a Property Free & Clear
Yes, it is simplest when there is a large equity position in the property, but even someone who has a large mortgage can use the Installment Sale effectively if they’ve got good underlying financing.
One of the bonuses of the last real estate cycle is the preponderance of amazing financing in place. Many people were able to avail themselves of 30-year fixed rates at 6% or better! So, let’s say your client has a large, but nice 30-year fixed at 5.5%, what are the possibilities?
He wants to sell for top dollar, but there’s a lot of competition out there, and not many buyers able to qualify for the loan they’d need. His property is just sitting on the market, and he doesn’t want to drop the price. As his listing agent he’s thinking that you’re not doing your job to market his property, and he’s waiting or the listing to expire. What could you do?
What if you were able to inform him that to get his price, he could offer to finance the sale of his property? If he’s stuck on price, then have him consider terms. But how could he? He doesn’t have that much equity. Here’s how:
- Sales price Seller wants: $500,000
- Underlying financing: $400,000
- Interest rate: 5.5%
- Seller’s monthly payment: $2,271.16
- Sales price Buyer agrees to: $500,000
- 10% Down payment: $50,000
- Seller wraps his loan/AITD: $450,000
- Interest rate: 7%
- Buyer’s monthly payment: $2,993.86
The Seller not only gets his price, he makes a spread on the bank’s money! He gets enough of a cash down payment to more than cover closing costs, and he pockets $722.70 per month for the next several years. Offering terms got a lot more buyers looking at his property, and he was the first in his neighborhood to get into escrow.
The Buyer is happy because he doesn’t have to try and qualify for bank financing, the escrow closes quickly, and there are no points or origination fees to pay. And you’re happy, because you got paid!
What about when the seller has absolutely no equity?
In that case, advertise Owner Will Carry, Low Down and Take Over My Payments. You can get paid by creating solutions, even if the buyer is simply taking over the seller’s payments. Many sellers these days are happy to leave their existing financing in place in exchange for the chance to unload and walk away.
But what about the infamous acceleration language in almost all loans? Isn’t it illegal to violate the “due-on-sale” clause? No, it’s not illegal. All it states is that the lender, at its discretion, has the right to call the loan due if the property is transferred.
In most instances, it is very unlikely that they are going to call a nicely performing loan. Right now the banks have enough trouble keeping up with the massive wave of non-performing assets on their books. Additionally, there are simple, perfectly legal measures that can be taken to minimize the risk that a due-on-sale clause will ever be triggered. I’ve come to love the Title Holding (Land) Trust model.
Myth #5: Seller Financing Means My Client Can’t Get Cash at Closing and I Won’t Get my Commission
Quite to the contrary, there is nothing more flexible than carrying a note when there is a substantial equity position in the property. If your Seller needs cash at closing, he can get it, even if he does finance the sale.
Seller Financing can be a great tool to get a property sold, especially in a slow market. If the Promissory Note and Deed of Trust are structured properly, the Seller can turn around and sell the note for instant cash. The term for this is Table Funding, or Simultaneous Closing.
Let’s say your client owns a condo free and clear, and because the condo market is especially slow, you suggest that your client carry paper to attract more buyers and get into escrow. He wonders what you’re thinking because he already told you that he needs cash to help his aging grandmother. Here’s how it could work:
- Sales Price: $300,000
- Down Payment: $30,000
- Note Amount: $270,000
- Amortized Over: 360
- Balloon Due In: 5 years
- Interest Rate: 7.5%
- Monthly Payment: $1,887.88
- Balloon Amt: $255,467.06
A TD investor comes in at the close of the first escrow (in which the house was sold) and buys all the monthly payments for the next 5 years, plus half of the balloon payment:
- TD Investor Gives Seller: $166,488.75
- Buyer’s Down Payment: $30,000
- Half of Balloon (in 5 years): $127,733.52
- TOTAL to Seller: $324,222.27
This example gives you a rough idea of how the numbers work out. Even selling the note immediately for a discount, the Seller still walks away with more than the original sales price of his property. And with the Seller getting $196,488.75 cash at closing, I think there’s enough to cover your commission, don’t you?
If you have a deal that is threatening to fall apart, Dawn can help you and your clients explore alternative and legitimate ways of meeting the needs of both Buyers and Sellers. Let me help you find cash in your trash…
The important thing is to GET THAT ESCROW CLOSED!!
What’s the minimum amount of cash that the Seller needs? What’s the maximum amount of cash that the Buyer can put down? How long does the Seller want to hold the note? Do they plan to sell it and when? How can we structure the note to work for the Buyer and still give the Seller a negotiable instrument worth selling in the secondary trust deed market if need be?
Professionals need to know how to put and keep their deals together. Dawn can be scheduled for a speaking engagement at your office. She is also available for consultation.
Do you have past clients that have carried paper? Do you think they may want to sell it for instant cash? The Note Queen buys Seller Financed real estate notes, providing another valuable service to your past clients, who will thank you again and again for the referral.