A good, honest real estate deal should be a win-win for both the seller and the buyer. This what I strive for at Ocala Road Investments. In my view, owner financing (also called seller financing) is one of the clearest ways to create a win-win deal in real estate investing. The advantages for both the seller and the buyer are clear and undeniable. I love to do owner financed deals.
What is owner/seller financing?
In an owner financed real estate deal, the seller essentially becomes the bank. However, unlike a bank, the terms agreed to by the seller and buyer can be much more flexible and creative. For example, a buyer may put $0 down for for the seller’s property in return for paying the seller a slightly higher interest rate for the term of the loan. The bottom line is all terms are negotiable: the down payment, interest rate, term of the loan, contingencies for the loan, and more.
Owner financing can only happen on properties where the property is owned “free and clear” (no mortgage or liens.) While it’s possible to do owner financing on properties where there is a mortgage or lien, they’re more difficult and not usually advisable to do.
How sellers and buyers benefit
So how do sellers and buyers benefit from owner financing?
You may wonder why a seller would agree to do owner financing. Sellers benefit in several key ways:
- Big Tax Savings: The main benefit for sellers are the substantial tax savings. If an owner sells their property outright, they’ll face a big tax bill in the form of capital gains come tax time. Owner financing allows a seller to dramatically reduce their tax bill by receiving mortgage payments over an extended period of time as opposed to one big sale. Interest payments to the seller are taxed at ordinary income rates while principal payments are taxed at the (low) long term capital gains rate.
- Secure, Passive Income: The steady monthly payments from the buyer to the seller over time are very attractive to individuals and businesses looking to develop passive streams of income. Landlords in particular who’ve been managing tenants for many years and are ready to retire see owner financing as a perfect option to give up the stress of property management while still getting steady income each month. Finally, this passive income is secured by tangible real estate. If the new owner fails to keep the terms of the loan, the former owner can foreclose and take the property back just like a bank.
- Attractive To Buyers: An owner needs to sell their property for any number of reasons. Sometimes they’re a homeowner looking to develop passive income without becoming a landlord. Sometimes it’s a landlord looking to retire. Other times it’s a property owner that would like to sell but deferred maintenance or other issues would make traditional financing from a bank difficult. Seller financing is the ideal solution in each of these cases and can be very attractive to buyers because of the flexibility of financing involved.
Buyers win with seller financing, too:
- Flexible Terms: I’ve touched on this a few times already, but it’s the main advantage for buyers. Unlike a bank which will require an investor put 20-30% of the sale price into a down payment etc., this is negotiable with the seller. The length of the loan and the interest rate are also negotiable. A seller may want a near retail price for their property, which under traditional bank financing probably wouldn’t be economical. However, because you can negotiate the other terms of the loan, you may be able to still negotiate a good deal for you while helping the seller get the price they’re looking for. The possibilities are endless.
- Imperfect Buyers: If a buyer is in the middle of trying to improve their credit or only recently been hired at their new job, they may have trouble getting a loan from a traditional bank. Owner financing would allow an imperfect buyer to purchase a property for reasonable terms.
- Attractive To Banks: For real estate investors, purchasing a property or several properties with owner financing can end up being very attractive for bank financing down the road. A property or group of properties held over time has a solid financial history that most banks would be more than happy to help refinance. A refinance like this needs to be approved by the former owner, but it’s a great option that’s available if the former owner is looking to get “cashed out.”
Both buyers and sellers benefit from lower closing costs as well as traditional bank financing fees along with tax and insurance prepayments aren’t part of the equation.
When owner financing doesn’t make sense
As stated previously, owner financing really doesn’t make sense if the seller already has a mortgage on their property.
In addition, owner financing only works if it’s truly a win-win for the seller and buyer. A seller should ensure they’re getting a fair price for their property along with the passive income they’re looking for. At the same time, the buyer shouldn’t blunder into a bad deal that will end up being either too much of a hassle or have negative cash flow simply because owner financing is involved. Not every owner financing deal is a good deal.
Owner financing is a great option
At the end of the day, if you own your property free and clear, owner financing is a great option you should strongly consider offering to buyers. The tax savings and passive income are fantastic and buyers have more flexibility to put together a good deal that works for them too.