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Seller financing is a powerful tool for selling real estate.
It may sound confusing or foreign to many, but the power of this investment strategy is undeniable.
I worked as a real estate investor for years before I grasped why this approach was so important. It can be a game-changer if you implement it in your business.
When I started using it, it allowed me to create several passive income streams that required very little work from me on an ongoing basis.
Seller financing is essentially the same as “lending money” to the person buying your property. In essence, you are becoming the bank when you finance the sale of real estate in this way.
Dictionary.com defines “lend” as,
to grant the use of something on the condition that it or its equivalent will be returned.
Did you notice how the words “cash” or “money” weren’t mentioned anywhere in that definition?
How Seller Financing Works
When you finance the sale of a property you own, you aren’t advancing any money to the borrower. You are simply granting the permanent use of your property and accepting payments for it in cash over several months or years in the future.
These payments typically include principal, interest, and ongoing servicing fees for the life of the loan. Remember, you can also collect a reasonable closing fee on the front end.
This kind of seller financing can go by several different names. Some call it “land contract,” “contract for deed,” “deed of trust,” “mortgage,” and even a “lease purchase.” These can be interpreted as a form of seller financing (depending on how the deal is structured and what type of loan documentation is used).
One of the best things about seller financing is that it can provide you with passive income. This means you earn money regardless of whether you continue to work. Essentially, seller-financed properties are similar to rental properties without the headaches of the latter.
When I finance the sale of my properties, I usually get 100% of my initial investment back almost immediately (usually at the closing or within the first few months of the loan closing). This means that almost all the payments I receive for the loan's remaining term are pure profit.
What Are the Benefits of Seller Financing?
Seller financing is a fantastic tool because it allows you to do any or all of the following things with your real estate:
- Sell your property at a significantly higher price.
- Make substantial extra income from interest, servicing fees, and closing fees.
- Wash your hands of the property’s ongoing maintenance issues by putting these problems in your borrower’s lap (after all, they're the property's new owners).
- Add significant stability and peace of mind to your business operation with a dependable monthly income.
- Charge prepayment penalties if or when the borrower chooses to pay off early.
- Repossess and resell the property if the borrower ever defaults on their loan.
Why Isn’t Everyone Doing Seller Financing?
When I first heard about seller financing, I hesitated to start selling my inventory this way. The whole idea seemed complicated, confusing, and even scary.
My mind was filled with uncertainty and skepticism. I kept telling myself things like:
- Let’s just keep this simple! Why over-complicate this thing?
- I don’t understand all the math, banker terminology, and finance lingo (e.g., what the heck is an “amortization schedule?”)
- I’m not a bank! How can I keep up with servicing a loan, invoicing payments, handling missed payments, and so on?
- Why would I want my properties to be “stuck in limbo” for years as I slowly get paid off? Wouldn’t I be better off getting a lump sum of cash?
- What if one of my borrowers stops paying me? How am I supposed to repossess a property?
If you’re anything like I was, you may be dealing with similar thoughts as you consider selling properties with seller financing.
Let me just reiterate that seller financing is one of the most important things I’ve discovered in this business. While it isn’t always appropriate for every deal, it can be a powerful generator of additional income when the situation is right.
When Is Seller Financing Appropriate?
Here are some criteria I use to determine when seller financing makes sense for the properties I'm trying to sell. I use seller financing when:
- I have substantial equity in a property or when I own it free and clear.
- I’m stuck in a buyer’s market (i.e., real estate is moving very slowly, and buyers are difficult to find).
- Banks aren’t willing to lend on the type of property I’m trying to sell (this happens quite often with vacant land, where banks don't like to originate loans under 150k, leaving a BIG opportunity for land investors).
- These banks won’t lend to anyone due to market conditions in general (this was a common issue from 2008 to 2011).
- I can sell a property for FAR more than I paid for it (this can work great with quick flips).
- My buyer can come up with a good down payment (20% or more of the sale price), and they’re willing to pay my full asking price, but for whatever reason, they still don’t fit the exact profile that their banker wants to see.
Don’t get me wrong; I don’t need ALL of these conditions to be met. But usually, when I see two or more of them, I’ll know I’ve got a good seller financing opportunity.
Opening the Doors of Opportunity
When you list your property for sale and offer seller financing as part of the deal, you'll find that many more buyers will start reaching out to you. MANY more than if you were only willing to accept the full sale price in cash (like most sellers).
Why does this happen? It’s simple. By offering seller financing, you make this property significantly more attainable for the buyers in your market. Seller financing will open the doors of opportunity to many people who otherwise wouldn't be able to purchase your property at all.
This doesn’t necessarily mean that your buyers won’t be creditworthy. This is why it’s important to understand how banks work.
How Banks Lend Money
Most lenders are in the business of offering financing to a broad demographic of people for various purposes (one of which happens to be real estate). Very few bankers can approve loans on their own authority. Given a bank’s situation, with hundreds of loans on their books for different purposes—who can blame them?
Instead, banks evaluate every borrower using some pre-determined criteria called the 5 Cs of Credit:
- Capacity to Repay: Does the borrower have the resources to repay the loan?
- Capital Invested: How much “skin” does the borrower have in the game?
- Collateral Availability: Will the bank be able to cover themselves if the borrower stops paying?
- Conditions: What is the intended purpose of the loan?
- Character: How does the lender perceive the borrower? Is the borrower a good person? Are they trustworthy?
Many, many times, prospective borrowers aren’t able to qualify for loans simply because they don’t fit into one or more of these five boxes.
In addition to the 5 Cs of Credit, banks also look at many other things when considering lending money to a prospective borrower. They generally want to see the following:
- A solid credit score (most lenders consider the 700+ range to be “good”).
- A proven level of historical income (years of employment, dollars earned per year, etc.)
- A minimum sum of cash available for a down payment (usually 20% or more).
- The asset (the property in this case) should meet specific criteria (size, condition, built-to-code, etc.).
- Its value needs to be supported by a current appraisal.
- The property usually needs to be situated in the right geographic location.
- The property’s chain of title must be flawless.
And the list goes on.
What Seller Financing Does Differently From Banks
The real kicker is that I’ve seen a lot of would-be deals get completely blown up—all because the loan applicant was missing one small item on the banker’s checklist of qualifying criteria. Everyone goes home sad, and it’s a shame.
Measuring tools like the 5 Cs of Credit do matter. The fact is, some people should be disqualified. For instance, if somebody has no income and is a convicted felon, that probably represents a character issue and their capacity to repay (and these are both extreme examples, by the way).
On the other hand, if somebody has one “blip” on their credit report, most banks simply don't have the freedom to see past this. Banks are very risk-averse, and as a rule of thumb, they won't lend money to a borrower unless there's practically zero risk in the deal.
It’s unfortunate for the loan applicant, but the advantage that YOU have as the lender is that even when a person doesn’t fit into all of these boxes, they still may be a viable candidate for a loan! Unlike a banker, you can think critically and consider ALL the factors with your buyer.
I’ve seen a lot of inflexibility from banks over the years. Ultimately, many of my buyers will never be able to buy my properties unless I am willing the finance the sale for them.