When I first learned about seller financing, the idea of “becoming the bank” didn't sound appealing to me AT ALL.
In my mind, I just wanted to be cashed out as soon as possible so I could take my cash and move on with my life.
But once I realized the truckload of extra money I could make as a result of financing my properties; I decided to try my hand at it.
After selling one property with owner financing, and then another, and another – I realized how nice it was to have money deposited in my bank account every month, like clockwork, whether or not I continued to sell any more properties. Eventually, I found that it was adding a lot of stability and predictability to my revenue… and for that, I loved it.
Before long, I was utilizing owner financing whenever I possibly could, and it quickly became my preferred way to sell real estate. Why? Because whenever I offered this kind of financing for my buyers, I was creating a money machine that would continue to pay me years into the future.
Seller financing opened the doors of opportunity for a lot of my buyers, and it allowed me to work with MANY more potential buyers.
The truth is, a lot of would-be buyers won’t even consider buying real estate simply because they don’t have access to the cash they need to purchase it. When I started offering seller financing for these people, I was solving this problem right out of the gate, because I gave them the financial leverage they needed in order to do business.
The more flexible I was willing to be in when/how I received payment for my properties, the faster I was able to get my properties sold – plain and simple.
Before I started offering seller financing (when I was only willing to get cashed out in one lump sum), I found myself sitting with unsold inventory a lot longer than I needed to.
Sell at a Higher Price
One of the huge advantages of financing my properties was that I could almost always ask for a significantly higher price on the property and people were happy to pay it. In most cases, I could even charge a higher-than-market interest rate and most buyers didn't even care!
I was able to get away with this because in my buyer's mind, their primary concern was whether or not they could afford to make the monthly payment.
In most cases, when I advertise my properties with seller financing, I don’t even talk about the specific terms of the loan (interest rate, payment period, etc.). Of course, this information has to be included in my closing documents (I'm not hiding anything from anybody), but when it comes to marketing a property – most people will only get confused by the intricate details of the transaction (and a confused mind says “No”).
In the end, they ultimately want to know one thing,
“What it's going to cost me?”
With this in mind, I just advertise two things:
- The total purchase price
- The monthly payment
When people see a monthly payment, they have a pretty good idea whether or not it will fit into their budget – and at the end of the day, this is all that matters to most people.
The nice thing about this is, if my goal is simply to make the monthly payment affordable, there is almost always a way to make the payments work within a person's budget.
Remember, I am the bank. I can stretch out the term of the amortization (i.e. – The amount number of months it will take them to pay me back) as long as I'm willing to allow.
I can also adjust the numbers by giving them a lower interest rate.
Likewise, I can require a larger down payment up front (which will reduce the amount of the loan and thereby, reduce the monthly payment), or I can just lower the price of the property altogether.
At the end of the day, whatever it takes for me to sell a property and make money (creating a win-win for both parties involved), I do it! One of my goals with this strategy is to build up SEVERAL streams of income, and this only happens by selling SEVERAL properties with seller financing, in a way that will earn me a profit.
When I'm acting as the lender, I can generally do whatever I want (within the confines of the law, of course) to maximize my income over the long-term.
Note: Most states have some specific rules regarding the maximum interest rate you can charge your borrowers and the number of seller-financed deals you can maintain at one time – so be sure to check with a local attorney before you proceed.
Charging Interest, Servicing Fees and Closing Fees
In addition to getting a higher price on a property, seller financing also gives me the opportunity to pick up some extra income along the way by charging interest, servicing fees and closing fees.
Historically speaking, we're living in a time when mortgage rates are about as low as they've ever been. To put it frankly, money is cheap.
…but guess what – even with how low mortgage rates are right now, the standard interest rate I charge on my seller financed deals is 9.99% interest – and people are happy to pay it!
Why? Because if I don’t finance the property for them – they can’t buy the property, period.
Remember, for a lot of buyers, the interest rate is irrelevant IF they can afford the monthly payment. It’s all about making the property affordable for the borrower with a down payment and monthly payment they can live with.
With all the prospective buyers I've talked to over the years, I've found that different things matter to different people.
Some buyers want a lower price.
Some buyers prefer a lower payment.
Some buyers are attracted to the idea of paying 0% interest.
Whatever my buyer happens to care about the most (whatever the sticking point is), I can usually do whatever they want.
The ultimate goal is for me to make a monthly profit on each sale, so if I can meet their needs AND accomplish my objective, I'll do it! Generally speaking, as long as my buyer is getting a great value for their money, they’re happy to work with me.
A lot of people are huge fans of seller financed property – so don’t underestimate the power of simply offering this as an option in your property listings.
The funny thing is, whenever I offer seller financing in my property listings, almost everybody chooses to take the financing option and NOT pay all cash (even when there is a financial incentive for paying cash).
That's right! Even when people have the cash available, many of them would rather make long-term monthly payments and instead of losing all their cash by paying the full purchase price upfront. It may sound weird if you're someone (like me) who doesn't like debt, but you might be surprised at how common this is.
Monthly servicing fees are another way to tack on some extra monthly income from seller financed properties. I always charge a monthly servicing fee of $15 – $25 (this is on top of the borrower’s monthly principal & interest payments to me).
Why? Because with every existing loan – someone has to be in charge of:
- Collecting the monthly payment
- Updating the loan balance
- Sending a statement back to the borrower
- Dealing with delinquent accounts (if and when they come up)
On my first few seller financed deals, I tried to get my feet wet by servicing my own loans in-house.
I had a banking background and I understood how to do it, so the job was doable, but even so – I learned that I just didn't enjoy spending my time doing busy work.
Servicing a loan isn't terribly difficult, but it does need to be done right, and it takes a lot of left-brain thinking to do the job well. As a result, I eventually decided to outsource my entire loan portfolio to a loan servicing company, and let me tell you… it has saved me a TON of time and mental energy. If I could do it all over again, I probably would have started sending this work to them from day one.
Coincidentally, my loan servicing company charges a monthly fee of $15 – $25 for this service, so rather than me taking the hit for this cost myself, I just pass it along to the borrower and make them pay for it. Remember, if it works within their budget (if their monthly payment is still affordable), why wouldn't I let them pay for it? As long as I clearly disclose this information in the closing documents, I can't think of a compelling reason not to handle it this way.
Even if I did decide to service these loans myself, I would still be charging some kind of servicing fee to pay myself for the time and trouble. As long as I have money owed to me, the job will always be there, so it only makes sense to make sure I'm compensated for doing this extra work.
Whenever I close a loan, it's VERY important that I use the right documentation.
Whether I'm closing a deal in-house (preparing all the documents myself) or using a title company/real estate attorney, somebody has to put the paperwork together. Regardless of who handles this job, I always charge a minimum of $199 as a closing fee (and sometimes more, if the deal is large enough) and guess what… the buyer pays for it. Even if I’m working on a cash sale (no seller financing involved), I still charge this fee – because the work is always required to get the deal done.
Similar to the issue of loan servicing, the paperwork isn't going to take care of itself, so it's important to account for this cost and pay the appropriate person for doing this extra work (even if it means paying myself).
All of these costs are very typical in any type of loan arrangement. I guarantee you a bank would be charging these kinds of fees all day long for a conventional loan, so I always take advantage of my ability to charge fees upfront, charge servicing fees each month, and charge the highest interest rate I can get away with (and I don’t feel guilty about it). If people don’t want to do business under my terms, they're welcome to look elsewhere!
When I'm acting as the lender, I can be as flexible (or inflexible) as I want, because I am the bank and I can clearly define the terms under which I'm willing to do business. One of my greatest advantages here is my ability to play the game on my terms.
Putting The Problems in the Borrower’s Lap
Of all the things I love about seller financing, this might be my favorite.
When I finance the sale of a property – it becomes similar in nature to a rental property. It produces a steady stream of income, but without all of the problems and headaches that come with owning a rental property.
Once the deal is closed, my borrower essentially owns the property. Sure, I may still hold the deed (in the cases where I'm using a Land Contract), but as long as they keep making their payments to me, the property legally belongs to them.
In most standard loan documents, the loan agreements are written in such a way that if anything breaks, if anything needs to be fixed or if anything goes wrong with the property itself, it’s the borrower’s problem.
In the same way, I wouldn't expect my banker to come and fix my toilet after I buy a house – the borrower shouldn't expect me to come and take care of their property either. It's their property, and the problems are theirs to deal with.
Of course, a seller financed property is a stream of income that won’t last forever (because the borrower will eventually pay off the loan), but believe me – it’s great while it lasts (and it usually lasts for a long time). When I finance the sale of my properties, I don’t lose a wink of sleep at night, because once the deal is done; all the maintenance and upkeep issues are in the borrower’s lap, not mine.
Stability and Peace of Mind
As soon as I had built up enough cash reserves to run my business efficiently, I started financing my properties as soon as possible.
Why? Because I desperately wanted more stability and peace of mind in my business, and the regular cash flow that came from my seller financed deals played a big role in bringing this to the table.
I know some real estate investors who make over six figures per month just from the ongoing payments from seller financed properties (that’s right, I said PER MONTH).
The beautiful thing about the properties I finance is that in most cases, I only paid 10% – 20% of the property’s market value when I bought it.
Think about it, if you buy a property for $5,000 and sell it with seller financing for $50,000 – you can make your entire initial investment back with just the down payment! Once the loan is in place, every single monthly payment for the next five years is pure profit. How’s THAT for a return on investment??
Charging Prepayment Penalties
When a borrower wants to pay off their loan early – some lenders will require that the borrower pay a prepayment penalty in the process.
Why? Because the borrower is killing off a stream of income (with interest) that the lender was counting on.
A lender can't disallow this from happening, but one way to discourage these kinds of early payoffs is to charge a prepayment penalty for doing this. It will also serve to compensate the lender for the unexpected loss of income.
Personally, I've never bothered with charging prepayment penalties like this (because I'm already making a huge profit on the regular sale price of the property), but I certainly understand why some lenders require this.
If I wanted to add this extra security to my seller financed deals, I can have it written into the language of my loan agreement. There are many different ways of calculating exactly what this penalty could be, but one way is to charge an extra:
- 5% of the original balance if they pay off in the first year,
- 4% of the original balance in the second year,
- 3% of the original balance in the third year,
- 2% of the original balance in the fourth year,
If you’re working with an attorney to prepare your loan documents (which you should probably do, especially if you’re adding this extra feature to your loan documents), ask their opinion on this – they may have some good ideas for you as well.
Repossessing and Reselling the Property
Obviously, nobody wants to deal with a deadbeat borrower who defaults on their loan. I’ll be the first to tell you – it’s annoying, and depending on what shape they leave the property in, it could be costly.
That being said, there are also a number of reasons why this risk is still worth taking, even when considering the worst case scenario.
Consider the Down Payment
Given how little I typically pay for the properties I purchase, it usually isn't difficult to recoup 100% of my initial investment just by collecting a 10% – 20% down payment. Even if I only collect a 5% down payment (which by the way, would be very generous of me), I can usually recoup the remainder of my initial investment in the first few months. Essentially, the risk in this area is usually very low.
What I’m getting at here is – if I did my groundwork right when I purchased the property (i.e. – buying for the right price), I'm not going to end up in the hole – not by a long shot.
Now, on the other hand, if I borrow $100,000 to buy a property, and the property is only worth $125,000 – this would obviously be a different story, but as I indicated earlier, the ideal time to use seller financing is when I own a property free and clear. When I've paid a very low price to acquire a property in the first place, losing money not something I have to be overly concerned with.
Consider the Collateral
Think about it this way – I own a long-term, tangible asset. I own it without any debt or monthly payments whatsoever. If my borrower decides to quit making payments tomorrow, this could be a blessing in disguise. It just means I can repossess the property (which is probably the only real “hassle” of the process), re-list it, and resell it! I get to keep all the payments from this delinquent borrower and then start the process all over again. Some of the most profitable deals are the ones I get to repossess and resell.
Now, if my property is a residential home or a commercial building, then yes – there could certainly be some damage or cleanup to handle before I can re-list it for sale (this should always be expected in a foreclosure situation). Even so, the cost of rehab is almost always worth the extra time and effort, because I stand to make even more money when I resell the property. This isn't always the case, but most of the time – it is.
Consider the Likelihood of Default
When I first started selling properties with seller financing, I didn't do any credit checks whatsoever. I frankly didn't care who my borrowers were because I knew that if they ever defaulted, I stood to make even more money in the long run.
While this never ultimately hurt me, I eventually decided to change this practice after dealing with a few borrowers who defaulted on their loan payments to me (yes, if you do enough of these deals, it will eventually happen).
Even though I've always been pretty well protected (given the value of my collateral), it’s still annoying to deal with a deadbeat borrower. It took time, some money, and it was generally a headache. Even though I stood to make even more money from a repossessed property, I was more comfortable just knowing what my future was going to look like, rather than having to deal with an unexpected change of plans.
With this in mind, I eventually decided to start pulling credit reports. The cost is nominal, and it gives me an idea of what kind of person I’m dealing with.
Does this person have any other delinquencies in their life right now? If so, what are they and why? Why should I feel comfortable being their lender? If they can’t even give me a compelling story or excuse for missing other payments, why should I stick my neck out for them?
I typically don’t disqualify people right off the bat for having an imperfect credit score, but I do expect a good explanation as to why I should trust that they’ll be faithful in making their payments to me. If I go into this kind of relationship blind, I'm just leaving the door open for trouble – plain and simple. While this doesn't necessarily spell “disaster” in every situation, it can cause a lot of unexpected (and unwanted) surprises.
Again, if I bought my property at the right price to begin with, it’s hard to lose. Even so, I’m the type who likes to be fully informed on any business relationship I’m getting into. As such, I like to inquire about this basic information.
Seller Financing Makes Sense
As you can see, there are a lot of reasons why seller financing makes sense. In my opinion, anything that allows me to extract a lot more profit AND passive income from a property is worth taking a close look at. While it does involve some extra steps, I've found that in many cases, it's worth the trouble.
If you haven't considered this approach before, it might be time to give it some serious thought.