Understanding Seller Financing / Owner Financing can be a little tricky.
I am going to outline a transaction so you can see how things come together. The first and hardest thing I have to do is find a property with a motivated seller. That means someone who either has to sell quickly or doesn’t have a choice and the time has come when they must sell. These are not necessarily foreclosures. About 3 out of 10 houses out there will eventually be sold by a motivated seller. I want to Own the property if I can but sometimes when I have to I will Lease Option. When I own the property, I can do with the property as I please. When I lease Option I have to have their permission in writing for each thing that I do.
Maybe a real estate agent told them to fix up the place before they put the house on the MLS. Maybe the owner doesn’t want to fix the place up to sell or can’t afford to fix it up, so they never list. Maybe the house is in beautiful condition, but they don’t have enough equity to put the house on the MLS and still pay the realtor fees. For each of these, that’s where we come in, among many other scenarios.
We are looking for “average family houses” of 3 bed 2 bath in average neighborhoods.
Usually between 1200 sq ft and 2800 sq ft. Not particularly concerned if some repairs are needed. There is a psychology for these characteristics that I’ll explain in a future post.
Before I buy the house, I have to keep in mind what my “exit strategy” will be.
1) Do I want to Live in the House, or
2) Use it as a Rental (Buy & Hold), or
3) Fix it Up and Flip it or
4) Use it for “Cash Flow” with a Tenant Buyer or
5) Resell it right away or
6) Wholesale it or
7) Something else . . .
Each exit strategy affects the way that I buy the property.
There are over a hundred ways to find properties, but that doesn’t mean the seller is motivated. Sometimes I start my search by looking at FSBOs (For Sale By Owner.) Most FSBOs are over priced and unrealistic in their expectations & 95% end up listing with a real estate agent. Sometimes I go “door knocking”, sometimes I send Yellow Letters and so on.
Once I get a good lead, on the phone I ask the number of bedrooms and baths and when the kitchen was last updated. I ask then to tell me about the house and why they are selling. I ask “are you willing to consider owner financing?”. If they say “yes”, (there are more steps here and that will be coming in a post) but generally I arrange to meet them at the property.
So, once I have found a property, I ask how much they are asking & determine an ARV (After Repair Value). I like to know how much they owe, if there are any arrears, just ask, (but there are ways to find out if they won’t say), I need to know how much the monthly payment is, if there is an HOA and on and on. Then I look to see how much I can get for rent. Once I know the numbers I can decide if I want to proceed and what offer I want to make.
|ARV||$200,000||The After Repair Value|
|Realtor 6%||($12,000)||If Using A Realtor|
|Principal||$147,467||Amount Remaining on Loan|
|Asking||$200,000||Seller Asking Price|
|Equity||$ 52,533||Asking minus Principal|
|Arrears||$ 0||Missed Payments|
|PITI||$ 902||Principal, Interest, Taxes & Insurance|
|HOA||$ 0||Home Owner’s Assoc.|
|Rent||$1,450||What I can Rent it for|
|Cash Flow||$ 548||Amount I get for rent minus my Payment|
So, in this case, they have $52,533 in equity. That is the asking price minus the amount necessary to pay off the mortgage. Keep in mind that since they are selling to me, they don’t have to pay the $12,000 realtor fee. I bring that to their attention when we are negotiating price and we reduce the selling amount.
So in this case I would do a Wrap. I would buy the property for their asking of $200,000. I would have an attorney draw up a mortgage for $200,000 for 30 years at 4.5% and my payment would be $1,014. I would make payments to the seller. The seller would continue making payments to the bank for $902 buy I would own the property. Then:
OPTION 1: I could move into the house and live there.
OPTION 2: I could Rent Out the property to a new renter for $1,450 per month. I would get to keep the $1,450 – $1,014 for cash flow of $436 a month. The renter is paying down my mortgage, I got into the loan with no bank involvement, as the property goes up in value I get that appreciation and I get the tax write offs for the property. You can see from these spreadsheets how you need about $55,000 and bank approval to buy a Rental in the traditional way. Your $55,000 is tied up in the rental. Or, for $50,000 we can get the same property, usually for a lot less expense, with no bank financing and get $25,000 back when we sell to a Tenant Buyer and any unused funds go back to you instead of to the bank. That leaves us lots of money to do the next one.
OPTION 4: Cash Flow – I then could Sell the property to a Tenant Buyer for $225,000 with $25,000 down. I would get to keep the $25,000 into my pocket for me. I would charge $1,650 per month. I would get to keep the $1,650 – $1,014 for cash flow of $636 a month. The Tenant Buyer is paying down my mortgage, I got into the loan with no bank involvement, as the property goes up in value the Tenant Buyer gets that appreciation and I get the tax write offs for the property.
OPTION 6: Wholesale – If I buy it cheaply enough, I can turn around and wholesale it without doing any repairs for “quick cash”.
OPTION 7: I can do any number of things. I can rent it out to a business if it is on a main street and zoned properly, I can turn it into a day-care center, I can turn it into offices, I can rent out rooms to college kids, etc.
You can see that they are many variations and much flexibility with buying with Owner Financing. The main thing is that you don’t have to get approved by the bank, you don’t have to put 20% down, you don’t have to show your taxes, and you can do as many of these as you wish. You do want to keep some “reserves” in the bank to cover expenses and a few months rent payments to follow good business practices.