Seller-Financing Crash Course


Published on - This seller-financing/owner-financing presentation was first created in late 2007 during a special 3-hour session of the Investors Roundtable. I also gave an abbreviated version of this presentation in 2009.

The slides were much wordier than I had intended and meant as a reference afterwards.

Seller-Financing Crash Course

  1. 1. Seller-Financing Crash Course How to Negotiate & Buy Real Estate with Seller-Financing By Matthew Chan
  2. 2. Prerequisites <ul><li>Designed for students who have understanding of the basic concepts of real estate investing. (Deed, mortgage, liens, loans, interest rates, amortization, PITI, CCR, cash flow) </li></ul><ul><li>Best for someone who has done at least 1-2 deals conventionally. They will appreciate this much more. </li></ul><ul><li>Not for the absolute, stone-cold beginner. </li></ul>
  3. 3. Will not teach these subjects <ul><li>How to get started in REI </li></ul><ul><li>How to find good deals </li></ul><ul><li>How to calculate returns </li></ul><ul><li>How to inspect property </li></ul><ul><li>Rehabbing, flipping, short-selling, wholesaling </li></ul>
  4. 4. Buyers Point-of-View <ul><li>Seller-Financing is a legitimate and legal form of financing that requires more education and sophistication. </li></ul><ul><li>This course is focused and slanted towards using seller-financing to acquire investment property, not selling. </li></ul><ul><li>However, there are many concepts and ideas that can be applied to selling property. </li></ul>
  5. 5. Other Names for Seller-Financing <ul><li>Owner-Financing </li></ul><ul><li>Owner Carryback Financing </li></ul><ul><li>Seller Carryback Financing </li></ul>
  6. 6. Benefits to You as a Buyer <ul><li>Doesn’t impact your credit scores, reports, or borrowing power </li></ul><ul><li>Allows you to make a better offer and pay a higher price </li></ul><ul><li>Create flexible loan and payment terms </li></ul><ul><li>No origination costs and minimal closing costs </li></ul><ul><li>Often done without agents, no commissions </li></ul><ul><li>Opportunities to create goodwill with the seller </li></ul><ul><li>Quicker and simpler closings </li></ul>
  7. 7. Benefits to Your Sellers <ul><li>Helps to sell their property more quickly </li></ul><ul><li>Make an unsellable property more sellable (no equity, rough condition) </li></ul><ul><li>Get a higher sales price (sometimes over market value) </li></ul><ul><li>Tax benefits by accepting installments instead of taking lump sum </li></ul><ul><li>Earn interest income secured by real estate (slow principal paydown) </li></ul><ul><li>Quicker and simpler closings </li></ul>
  8. 8. Unsophisticated Sellers <ul><li>Seller-Financing is almost never their first choice </li></ul><ul><li>Cannot sell through conventional means </li></ul><ul><li>Property in rough condition (can’t afford improvements) </li></ul><ul><li>Cannot cope with conventional sales process with agents and lenders </li></ul><ul><li>Little or no equity and can’t pay commissions </li></ul><ul><li>Little ability to financially withstand holding costs (need immediate debt relief) </li></ul><ul><li>Sense of urgency to sell for personal or financial reasons (relocation, new house, lost job, etc.) </li></ul>
  9. 9. Sophisticated Sellers <ul><li>Lump sum cash-outs are not always the top priority </li></ul><ul><li>Concerned about tax consequences of cash-outs (capital gains) </li></ul><ul><li>Interested in CF & Interest Income </li></ul><ul><li>Can better cope with the possibility and issues of defaults and takebacks </li></ul><ul><li>Better understanding and sympathy of Buyer issues </li></ul>
  10. 10. Formal vs. Equitable Title <ul><li>Formal title conveyed by deed </li></ul><ul><li>Equitable title is ownership without formal title (e.g. buying & financing a new car) </li></ul><ul><li>Take Questions Here! </li></ul>
  11. 11. How Deals are Financed <ul><li>Equity (Cash, Down payment) </li></ul><ul><li>Debt (New loan or Seller-financing) </li></ul><ul><li>Goodwill </li></ul>
  12. 12. Components of a Loan (Debt) <ul><li>Promissory Note sets the following: </li></ul><ul><li>Term – Length of time on a loan (# months) </li></ul><ul><li>Principal (Finance Amount) </li></ul><ul><li>Interest (Cost of financing) </li></ul><ul><li>Amortization (Principal + Interest payments) </li></ul><ul><li>Monthly Payment </li></ul><ul><li>Escrow (Holding acct for important property expenses) </li></ul><ul><li>Origination & settlement fees </li></ul><ul><li>Secured by Mortgage, Deed of Trust, or Deed </li></ul><ul><li>Learn to Use Financial Calculator, important financial tool (TI-BA II or HP10B) </li></ul>
  13. 13. Overview of Traditional Loan/Mtg <ul><li>Down Payment – 10% for Investor Loans, Homeowner 0% - 20%, (will likely change to min. of 5%) </li></ul><ul><li>Term: 15, 20, 30 years (no balloons or calls) </li></ul><ul><li>Interest rate: Fixed for the entire term </li></ul><ul><li>Principal/Interest: Fixed for term </li></ul><ul><li>Annual Escrow: Property taxes, Insurance, PMI (varies each year) </li></ul><ul><li>Types: VA, FHA, Conventional (no ARMs) </li></ul><ul><li>Has Due on Sale Clause </li></ul>
  14. 14. Balloons vs. Calls (Limited term) <ul><li>Balloons are absolute of when they expire </li></ul><ul><li>Calls have optional expiration date and can be easily extended at the option of the seller </li></ul><ul><li>Discuss provisions of what will happen if the loan is not paid off </li></ul><ul><li>Discuss remedies for extending the loan (Goodwill, lump sum principal pay-down or additional monthly pay-down) </li></ul><ul><li>Most sellers do not want to the property back </li></ul><ul><li>Most sellers do not want to foreclose </li></ul>
  15. 15. “ Mirror” Terms <ul><li>“ Mirroring” is bringing forward the terms of the underlying loan to the existing instruments and then executing on them. </li></ul><ul><li>Length of loan, interest rate, payment amount, amortization, escrow, etc. can be mirrored. </li></ul><ul><li>Often done for financial simplification purposes or to allow the seller to “break-even” </li></ul>
  16. 16. Seller Protections in SF Deals <ul><li>Physical collateral is almost always the property being bought and sold. </li></ul><ul><li>Seller is protected by 1 of 2 instruments of choice: </li></ul><ul><li>Holding Formal Title (Give only equitable title) </li></ul><ul><li>Holding a 1st or 2 nd Lien (Mortgage, deed of trust, security deed. Foreclose to takeback) </li></ul>
  17. 17. Due on Sale Issues <ul><li>AKA the Acceleration Clause. </li></ul><ul><li>Is triggered by any changes of ownership. (Title/deed) </li></ul><ul><li>Designed to protect the lender from unapproved loan assumptions. </li></ul><ul><li>An area of concern for most beginning investors and some experienced investors. </li></ul><ul><li>People talk and gripe about it but very few have ever read it themselves. Feeds into fear. </li></ul><ul><li>As a practical matter, lenders don’t like to create more foreclosures than they already have. </li></ul><ul><li>They also don’t like to ruin an account that has a good payment record. </li></ul>
  18. 18. Remedies for Due on Sale Issues <ul><li>Have a POA that says you represent the borrower’s interests. </li></ul><ul><li>Say that you are the Property Manager for the borrower. </li></ul><ul><li>If asked if deed has transferred, don’t lie. Question almost never comes up. </li></ul><ul><li>If it comes up, tell them the reason. Seller couldn’t sell it in a timely manner and they needed to get out. They would have suffered. </li></ul><ul><li>Have investment partners to bail you out. </li></ul><ul><li>Negotiate with the lender to give you more time. </li></ul><ul><li>Threaten to publicize they will foreclose on a performing loan & ruin borrower’s credit. </li></ul><ul><li>Tell them you will not maintain the property or pay the loan anymore. You will not be responsible for what condition the property is left in since the lender plans on taking it back. </li></ul><ul><li>Use your own credit as a last resort to get a new loan. </li></ul><ul><li>Surefire way is to stick to “free and clear” & VA properties. </li></ul><ul><li>Sell the property to open market or give the property back. </li></ul>
  19. 19. Types of Seller-Financing <ul><li>1 st Mortgage (Free & Clear) </li></ul><ul><li>“ Subject to” mortgage </li></ul><ul><li>Wrap-around mortgage </li></ul><ul><li>Land Contract / Contract for Deed </li></ul><ul><li>Lease-Options </li></ul><ul><li>Order of preference for buyer </li></ul>
  20. 20. 1 st Mortgage (Free & Clear) <ul><li>Very simple concept. </li></ul><ul><li>Allows seller to earn a return on the equity sitting within the property while getting cash flow. </li></ul><ul><li>Only works if seller owns property “free & clear” and does not immediately need cash. </li></ul>
  21. 21. 1 st Mortgage Suggestions <ul><li>Make sure the 1 st mtg is truly the first position. You will need to verify the title is free of any liens. </li></ul><ul><li>Secured by mortgage, deed of trust, or security deed. </li></ul><ul><li>Seller will not likely want to carry for life. Will likely want a balloon, suggest a call instead. </li></ul><ul><li>Negotiate minimal or no late fee or prepayment penalties. Negotiate terms to extend balloons. </li></ul><ul><li>Take responsibility to pay property taxes and insurance directly. </li></ul><ul><li>Add seller’s name to insurance policy as Additional Insured. </li></ul>
  22. 22. Suggestions for all SF Loans <ul><li>Try to get longest term possible. If you must do a shorter-term, do a call over a balloon. </li></ul><ul><li>Never do anything shorter than 5-year term. (Time goes by quickly) </li></ul><ul><li>Negotiate terms of extension, by agreeing to lump sum principal pay-down or higher payment amount. </li></ul><ul><li>Do 30-year amorts! Minimizes cash crunches during tight months. </li></ul><ul><li>If sellers wants a 15 or 20-yr amort., fight for lower interest rate to lower payments. </li></ul><ul><li>Delay the first payment or skip a payment. </li></ul><ul><li>Minimize late fees and no prepayment penalties. </li></ul><ul><li>Offer to pay closing costs to get a better interest rate. </li></ul>
  23. 23. “ Subject To” Mortgage <ul><li>“ Assuming” a non-assumable loan </li></ul><ul><li>Deed is conveyed </li></ul><ul><li>Mortgage is left in seller’s name </li></ul><ul><li>Required doc: Limited POA </li></ul><ul><li>Mtg payments directly to lender </li></ul><ul><li>Greater level of responsibility to the buyer than others because you get so much authority unlike the other SF techniques. </li></ul><ul><li>Can be sued if you handle it inappropriately. </li></ul>
  24. 24. “ Subject To” Mortgage Suggestions <ul><li>Always get POA </li></ul><ul><li>Always provide Seller Disclosure of Acceleration clause, No specific time to cash-out </li></ul><ul><li>All loan statements are transferred to you </li></ul><ul><li>Follow the terms of the existing loan(s) </li></ul><ul><li>Treat the loan as if it were your own account. </li></ul>
  25. 25. Wrap-Around Mortgage <ul><li>Deed is conveyed </li></ul><ul><li>Provides seller additional protection against buyer default </li></ul><ul><li>New mortgage “encompasses” the original underlying one(s) </li></ul><ul><li>Conventional Wrap vs. “Mirror” wrap </li></ul><ul><li>Considered in public records as secondary or tertiary mortgage. </li></ul>
  26. 26. Wrap-Around Mortgage Suggestions <ul><li>Attempt to “mirror” the terms of underlying loan, if practical. Get POA if “mirroring”. </li></ul><ul><li>Seller’s underlying loan should be paid off before your contract is paid off (Don’t want seller to have no money to pay loan) </li></ul><ul><li>Pay directly to underlying lender, make the check directly to lender for seller to send, or have the ability to verify payments. </li></ul><ul><li>If the seller does not pay underlying loan, have the ability to deduct payments to seller if you make payments for them. </li></ul><ul><li>Close with closing attorney or title company </li></ul><ul><li>Record the wrap-around mortgage </li></ul>
  27. 27. Land Contract / Contract for Deed <ul><li>Provides seller strong protection </li></ul><ul><li>Promise to give deed upon payoff. </li></ul><ul><li>Deed is not conveyed until payoff. Receive Equitable title, not formal title during the finance period. </li></ul><ul><li>Conventional Contract vs. “Mirror” Contract </li></ul>
  28. 28. Land Contract/CFD Suggestions <ul><li>Negotiate terms of passing formal title in event of property resale or seller’s death. </li></ul><ul><li>Attempt to “mirror” the terms of underlying loan, if practical. Get POA if “mirroring”. </li></ul><ul><li>Seller’s underlying loan should be paid off before your contract is paid off (Don’t want seller to have no money to pay loan) </li></ul><ul><li>Pay directly to underlying lender, make the check directly to lender for seller to send, or have the ability to verify payments. </li></ul><ul><li>If the seller does not pay underlying loan, have the ability to deduct payments to seller if you make payments for them. </li></ul><ul><li>Close with closing attorney or title company </li></ul><ul><li>Record the land contract </li></ul>
  29. 29. Lease-Options <ul><li>Lease + Purchase Option </li></ul><ul><li>“ Weak” way to finance a property but excellent tool if you are not fully committed to the property </li></ul><ul><li>Allows you to “tryout” the property. </li></ul><ul><li>Easy for the tenant/buyer to exit relationship </li></ul><ul><li>Seller retains most of responsibilities while letting buyer easily use the property. </li></ul><ul><li>Better to use with sophisticated sellers, NOT unsophisticated sellers. </li></ul>
  30. 30. Lease-Options Suggestions <ul><li>Combine the lease with the option when you are buying! </li></ul><ul><li>Negotiate for a longer-term option </li></ul><ul><li>Negotiate for refundable option money or apply to purchase price </li></ul><ul><li>Freeze the rent rate or minimize rent increases </li></ul><ul><li>Negotiate for larger rent credits </li></ul><ul><li>Negotiate improvement and repair credits </li></ul><ul><li>Negotiate a preset number of automatic renewals </li></ul><ul><li>Record a memorandum stating the existence of the lease-option </li></ul><ul><li>Have the right to sub-lease and make cosmetic improvements </li></ul><ul><li>Verify there is insurance and property taxes are being paid </li></ul>
  31. 31. Due Diligence for SF Deals <ul><li>Collecting Information </li></ul><ul><li>Evaluate Underlying Loans </li></ul><ul><li>Determine Financial Viability </li></ul><ul><li>Evaluate the Seller’s Commitment to SF </li></ul><ul><li>Perform Title Check </li></ul>
  32. 32. Collecting Information <ul><li>Authorization to Release Information </li></ul><ul><li>Seller Information Sheet (House, seller, & loan info) </li></ul><ul><li>Collect paperwork from seller (loan, escrow, and insurance statements. Eye-ball appraisals, deed, and mortgage) </li></ul><ul><li>Call lenders and verify status of loans </li></ul><ul><li>Check sales & rental comparables </li></ul>
  33. 33. Evaluate Underlying Loans <ul><li>VA Loans (Military benefit. Certificate to buy houses with “no money” down & other favorable terms) </li></ul><ul><li>Any unusual terms? Gov’t asst program. </li></ul><ul><li>Multiple mortgages/liens (1 st , 2 nd , 3 rd ) </li></ul><ul><li>ARMs (fluctuating payments). We avoid them unless you can cash-out quickly. </li></ul><ul><li>Multiple layers of seller-financing (wrapping a wrap-around) </li></ul>
  34. 34. Determine Financial Viability <ul><li>Determine ROI and profitability (Equity position & cash flow, CCR) </li></ul><ul><li>Is this a “Good”, “Borderline”, or “Bad” Deal? </li></ul><ul><li>Will it positive CF or “break-even”? </li></ul><ul><li>What is FMV, “fire-sale” value, & appraisal value? </li></ul><ul><li>Is there “real equity?” (12% or more) </li></ul><ul><li>What are your returns? </li></ul>
  35. 35. Seller’s Commitment <ul><li>Does the seller understand what is being negotiated? Sound mind? Elderly? </li></ul><ul><li>Does the seller know the underlying loan will continue? </li></ul><ul><li>What is the seller’s “flake-out” factor? </li></ul><ul><li>Have spouses discussed this? </li></ul><ul><li>Have they evaluated all their sales options? (Agent, FSBO, Investor) </li></ul><ul><li>Do they have sufficient time? </li></ul><ul><li>Seller’s age & demographic </li></ul>
  36. 36. Title Check <ul><li>Most people will have to hire a title abstractor to do this. </li></ul><ul><li>Will find out what has been recorded? </li></ul><ul><li>Research deed, mortgage, liens, judgments </li></ul><ul><li>Beginners will want to incorporate this step earlier in the process. </li></ul><ul><li>If you are experienced, you can do this immediate prior to closing. </li></ul>
  37. 37. Closing the Deal <ul><li>Do a “Customary Closing.” Use Closing Attorney or Title Company </li></ul><ul><li>NO “Kitchen Table” Closings! </li></ul><ul><li>Warning: You might have to train or guide closing professionals! </li></ul><ul><li>Get HUD-1. Lines 203-209, 503, 506-509. </li></ul><ul><li>Get Closing Documents Packet. </li></ul><ul><li>Get the key or know when you will get full possession. Don’t start paying without getting full possession. </li></ul>
  38. 38. After the Closing <ul><li>Get possession of the property & begin prep! </li></ul><ul><li>Contact underlying lender, send in POA, and update mailing address, if appropriate </li></ul><ul><li>Maintain your own amortization schedule! You will need it to know loan balance, payoff, and mortgage interest. (Do not depend on your seller!) </li></ul><ul><li>Be proactive in checking on annual property tax payments </li></ul><ul><li>Be proactive in upcoming balloons and calls! </li></ul><ul><li>Create good history and goodwill immediately! </li></ul>
  39. 39. Insurance Issues <ul><li>Find a smart or knowledgeable insurance agent (You will likely have to train or teach them.) </li></ul><ul><li>Get a Landlord Policy, $1,000 deductible </li></ul><ul><li>“ Name Insured”. Your name, ATIMA </li></ul><ul><li>“ Additional insured”. Names of borrower on underlying loan </li></ul><ul><li>Will likely have to work/deal with underlying escrow, cannot remove it </li></ul>
  40. 40. Buyer Protections (For you) <ul><li>Make direct payments to the lender of the underlying loan </li></ul><ul><li>Issue partial payment in the name of the lender of the underlying loan </li></ul><ul><li>Verification of escrow payments for insurance and property taxes </li></ul><ul><li>Have the right to audit loan statements or verification of loan, tax, insurance payments </li></ul><ul><li>Close with reputable closing professionals (Closing attorneys or title companies) </li></ul><ul><li>Have provisions for late payments and unexpected administrative mishaps </li></ul><ul><li>Provisions for deed transfer in the event of seller’s death </li></ul>
  41. 41. Legal Environment Issues for SF Deals <ul><li>You prefer to be in area where foreclosure process is easier and quicker. More urgency for sellers to sell. </li></ul><ul><li>SF Deals are uncommon and sometimes unheard of in some areas. Check with closing professionals. You will need to be well armed with legitimization techniques. </li></ul><ul><li>Avoid areas where corporate expenses are very high. </li></ul>
  42. 42. Market Condition Issues for SF Deals <ul><li>More challenging during times of prosperity. </li></ul><ul><li>Easier during times of economic distress. </li></ul><ul><li>“ Training” the market makes the concept more favorable when you decide to do it. ( ads & video) </li></ul>
  43. 43. Real Estate Agents & Seller-Financed Deals <ul><li>Most agents don’t truly understand SF Deals. If they did, they would close more deals. </li></ul><ul><li>Agents are commission focused and worried about being sued. If they see little or no cash in the deal (down payment), they will not likely support it. </li></ul><ul><li>Most SF Deals will happen without an agent unless it is in the commercial arena. </li></ul>
  44. 44. How to Find SF Deals <ul><li>SF Deals are almost never “found”, they are almost always “created” especially with unsophisticated sellers. </li></ul><ul><li>They are created by working with FSBO’s that call you. It changes negotiation dynamic. Market for them. </li></ul><ul><li>Create a referral system. Have people who know you refer others to you. </li></ul><ul><li>Will likely bypass most real estate agents. </li></ul>
  45. 45. Negotiating to Buy <ul><li>Emphasize the following: </li></ul><ul><li>Higher sales price </li></ul><ul><li>Ease and no-hassles of closing privately (people wanting to avoid agents) </li></ul><ul><li>Speed of closing privately (people in a hurry to move on) </li></ul><ul><li>Low cost of selling (no agent commissions) </li></ul><ul><li>Improvement of credit scores (for sellers with troubled credit) </li></ul>
  46. 46. Success Tips for SF Deals <ul><li>Seller-financing will almost never be the first choice being offered. It is frequently a secondary and alternative choice. </li></ul><ul><li>Don’t do a deal just because seller-financing is being offered </li></ul><ul><li>Be confident, open, and reinforce benefits to seller </li></ul><ul><li>Do not hide the “downsides”. Acknowledge them, but counter them with benefits. </li></ul><ul><li>Keep conversations simple. Use simple terms. </li></ul>