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Is Seller Financing A Bad Deal?

Old Abandoned Farmland And Barn


By Robert Duplicki      July 7, 2023

Is seller financing a bad deal? You might think so if you can get a much better deal. But that doesn't make seller financing a bad deal for others.

Is it a bad idea to brush your teeth? Of course not! But would you brush your teeth if it wasn't so important that you do? And how many alternatives do you have? By comparison there may be many alternatives to finance certain purchases, but how many are actuallly realistic? The number will vary from person to person and business to business. So seller financing can be an excellent deal for a seller, and/or a buyer, depending on their circumstances.

A Bad Deal Now Could Be A Solution In The Future.

Whether you are selling or buying a home a business or any other asset, some of the same concepts apply. If you are selling your home, you might prefer an all cash buyer, or the equivalent from a buyer who obtains a mortgage. If you need to offer seller financing instead, then the financing changes the amount of money you receive at closing. In effect the price has changed.

You still have the choice to sell for the same price either way, but the value changes based on the financing used. And the perception of the value received will vary depending on the needs of the buyer or seller.

There is plenty of information on this website about seller financing, creating notes and selling notes. And there is always more to learn. You need to determine if any of these options work for you. If not now, what future opportunities could you pursue, and then utilize these techniques? A bad deal now could be a solution in the future.

What Makes A Seller Financed Real Estate Note Work?

The starting assumption for this topic is the creation of a seller financed promissory note, secured by real estate. Here are some reasons why a seller financed real estate note works:

  1. A seller financed real estate note works because it offers flexibility, and you make it work.

  2. A real estate note works when you are able to receive a higher price by offering terms instead of requiring all cash.

  3. You access a much larger pool of potential buers by adding those people who choose not to deal with banks, or who would not qualify for bank financing.

  4. A seller financed real estate note charges no loan points and the buyer pays substantially less closing costs. This is a better deal for the buyer, and the seller can advertise "No Points."

    Seller financing also includes no origination fees and underwriting charges that a buyer would face with a traditional lender. Also no reserves for principal, interest, taxes and insurance as may be required by a bank. And no private mortgage premiums (PMI) will be charged.

  5. The closing will take place sooner without a bank involved. Neither buyer nor seller will be burdened by the bank loan being turned down. So closing becomes more likely and easier to schedule after the initial due diligence, The advantage of this point can become greater if the seller allows the buyer early occupancy.

    Realtors typically discourage early occupancy because of the problems other such sellers have experienced. So a seller financed real estate note works by expediting the closing, providing greater control in setting the closing date, and avoiding the need for early occupancy.

  6. Your note will work because of the tax benefits you receive. Just like the other considerations to weigh when considering seller financing, your individual circumstances will be determining factors.

    As defined by IRS rules, the profit or gain from the sale of your property, is subject to capital gains tax. If the property is your main residence and you have occupied it for at least two of the five years prior to the sale, you are exempt from the capital gains tax with certain limitations. You are exempt for up to a gain of $250,000 or up to $500,000 of that gain if you file a joint return with your spouse. So if you qualify for these exemptions and your gain is less than these limits, seller financing does not provide additional tax benefits.(2)

    These specific criteria will not apply to all residential sales and will not apply at all to commercial property sales. For tax purposes seller financing is referred to as an Installment Sale. This allows you to pay taxes on your profit as you receive it, which is spread out over time. An installment sale can also be combined with a 1031 Tax Deferred Exchange for further tax benefits. This is another way that a seller financed real estate note could work for you. For a more comprehensive look, check out What Are The Tax Implications of Seller Financing?

  7. A seller financed real estate note works because when the time is right for you, you can convert your note into cash by selling all or part of the payments. If you sell a partial, the discount in selling your note is lower, and the remaining payments after the partial will revert back to the seller. And you have the option at that time, of selling all or part of the remainng payments. When you sell all or some of the payments, your taxable gain must be calculated accordingly. You may take action here to sell your note.

  8. If you adverise "Seller Financing" of "Owner Will Carry" you give yourself an advantage in the marketing and sale of your property, over all other sellers unwilling to do so. This doesn't preclude you from accepting other forms of financing. But the option of offering a seller financed real estate note is already working for you in the marketing process, because some buyers will only purchase a property that way.

    By offering seller financing in your marketing, the potential seller financed note is exactly what some buyers are looking for. When we are in a sellers' market as we have been in recent years, the need for a marketing edge is less of an issue. In a buyers' market, offering seller financing can give you the marketing edge to sell your property that much more easily.

  9. For some sellers, seller financing is the only way they are willing to sell their property for whatever reason(s). Despite the advantages of seller financing, for a lot of sellers this isn't the best deal. So part of the trend in in these next few points is that a seller financed note works to overcome obstacles.

  10. What happens if bank mortgage departments don't like something about your property. For example, do you own more land than meets conventional bank requirements? Do you have an in-law apartment? These features will be attractive to certain buyers. A seller financed real estate note will work to close these sales when a bank will not. So the seller could still consider this a bad deal if they were counting on all cash at closing. But seller financing provides a solution.

  11. Is your house overimproved for the neighborhood? This makes it tougher to get comparable values for appraisals. You probably have enjoyed the renovations to your home, and anticipated a high return on your investment when you sell. But the overimproved aspect makes it tougher for banks to get satisfactory appraisals. So this just another reason your buyer will have a tougher time getting a bank mortgage. A seller financed real estate note could resolve this problem for you.

  12. Are your prospective buyers applying for an FHA mortgage? Doing so is subject to meeting tougher appraisal requirements than a standard appraisal. This will not be a problem for a seller financed real estate note.

  13. What happens if a buyer was pre-approved for a mortgage, but the mortgage is declined prior to closing? If a buyer changes jobs after signing a contract to buy your property, they no longer meet the bank requirement for consistent emplyment. A small change in credit scores can be enough reason for the bank to later decline a pre-approved mortgage. These changes may not concern you, so seller financing provides a solution for buyer and seller.

  14. A popular misconception is that owner financing is only for people with bad credit. On the contrary, many creditworthy buyers are simply unable to qualify for a conventional mortgage because they don't fit the lender's guidelines. Ownership of multiple income properties, self-employment, a short job history, difficulty proving income and other uses for their cash than making a 20% down payment, are all reasons why buyers seek owner financing as an alternative to the traditional lending market.

  15. In addition, there are more specific ways to make a seller financed note work. The starting point is to examine your needs, then use your creative imagination.

"Condensed List of Reasons Why Mortgages Get Denied" (3)

  1. Loan amount too big
  2. Income too low
  3. Inability to document income
  4. Using rental income to qualify
  5. DTI ratio exceeded
  6. Mortgage rates rise and push payments too high
  7. Payment shock
  8. LTV too high
  9. Inability to obtain secondary financing
  10. Underwater on mortgage
  11. Not enough assets
  12. Unable to verify assets
  13. No job
  14. Job history too limited
  15. Changed jobs recently
  16. Self-employment issues
  17. Using business funds to qualify
  18. Limited credit history
  19. Credit score too low
  20. Spouse’s credit score too low
  21. Past delinquencies
  22. Past foreclosure, short sale, BK
  23. Too much debt
  24. Undisclosed liabilities
  25. New or closed credit accounts
  26. New/changed bank account
  27. Credit errors
  28. Unpaid tax liens
  29. Unpaid alimony or child support
  30. Divorce issues
  31. No rental history
  32. Fraud/lying
  33. Undisclosed relationships with seller (non arms-length transaction)
  34. Attempting to buy multiple properties
  35. Property doesn’t appraise at value
  36. Defects with property
  37. Home business on property
  38. Non-permitted work
  39. HOA issues
  40. Investor concentration in complex too high
  41. One entity owns too many units in complex
  42. Title issues
  43. Lender overlays
  44. You own too many properties
  45. Co-signer for other loans
  46. Property not really owner-occupied
  47. Layered risk (lots of questionable things added up)
  48. Incomplete application
  49. Inability to verify key information
  50. Plain old mistakes

From a property buyer's perspective, sellers are typically more flexible than a bank. For some buyers, even if they can qualify for a bank loan, the terms may actually be a bad deal. While the process may not be easy, finding a seller willing to offer seller financing will be a better deal for some buyers. As the list above demonstrates, there are many reasons why mortgage applications get declined.

I'm not suggesting that sellers should disregard the reasons that banks deny mortgage applications. As stated before on this website, sellers who do provide seller financing, should often do a more complete job performinge due dilligence before finalizing their transactions. But seller financing does provide much more flexibilty than what banks offer.

Banks are faced with external regulations that are not faced by seller financing. Internally banks have their own underwriting standards that leave them little to no room to negotiate around some of the reasons for declination listed above. Even if you are preapproved, the information that banks use in their marketing solicitations is limited and not always accurate. So the prospective financing that a buyer can get excited about is not always realistic, and leaves you with the feeling of a bad deal. At that point the seller financing that looked like a bad deal, could be exactly what is needed.

In A Typical Year, Landlords File 3.6 Million Eviction Cases.(4)

If you are someone who has been evicted recently, perhaps it's unlikely that you are considering purchasing a home. Whatever the details of your situation, you could be like many other potential buyers who think that they wouldn't qualify for a bank loan, so there is no way to purchase property. For some ideas and methods to help first time home buyers make their purchase, you should check out my article How Do You Overcome The Barriers To Home Ownership In 2023?

If you have a note for sale, get started now. please submit a business note worksheet, and I will start working to produce a deal for you.

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