Seller financing is what allowed us to start building wealth in real estate at seventeen years old.
At the time, we were wholesaling and flipping houses, but seller financing was the strategy that earned us our first rental, which showed us the power of cash flow, wealth, and real estate as an asset class.
In the multifamily space, seller financing is similar to how it works with ranch homes. Except the numbers are (much) bigger - which means the stakes are higher.
With interest rates as volatile as they are right now, seller financing has become more mainstream, and many multifamily investors are using this strategy to close multimillion dollar deals in a rising interest-rate environment.
So what exactly is seller financing?
What is Seller Financing?
Seller financing is essentially when the seller of a property becomes the bank. Rather than taking a lump sum of cash for the property, the seller accepts payments over time, or offers credit to the buyer that is equal to the purchase price, subtracted from whatever payment the buyer puts down. The seller is put in second position as a mortgage on the property. The buyer typically makes monthly payments overtime to pay down both mortgages. A promissory note is used to outline the details of the loan, and both parties sign it.
When seller financing is used to buy a property, it’s likely because traditional financing through a bank wasn’t a feasible option on its own.
Here’s a quick example:
Let’s say Adam is selling a multifamily property, and he agrees to sell it to Kim with seller financing. They agree to a purchase price of $2,000,000. The down payment is $400,000, the first mortgage is $1,200,000, and the seller is offering to carry the remaining $400,000.
This deal works because the equity in the deal is at least 20%, and the seller isn’t financing more than 33% of the first position mortgage.
When Seller Financing Doesn’t Work…
Despite how good it sounds as an alternative method to finance the purchase of a property, most lenders are not fans of seller financing. In fact, many explicitly prohibit it in the loan documents investors sign when taking out a loan with them.
Are lenders just being buzz kills? Not exactly.
The truth is that foreclosing on a buyer who purchased a property using seller financing is challenging. Even if the foreclosure goes through, the original seller will still be left with the property, and all the debt associated with it.
This means that buyers must have high confidence in the buyer’s ability and willingness to keep their end of the bargain and make payments as promised.
As a buyer seeking seller-financing from a current property owner, here are some things to keep in mind.
The goal should be to put down as least as possible, while still keeping the seller comfortable with the terms overall. If the property needs repairs, you can negotiate with the seller to use the down payment for these needed upgrades.
When we were taught seller financing, one of the core principles was that we could give the seller their desired asking price, assuming they were willing to take payments on it. As long as the property cash flows (which would mean the monthly payments to the original lender and other expenses are less than the revenue the property generates), then everyone wins.
“Are you willing to give me terms?”
We asked sellers this question when we went direct-to-seller for single family investing.
If you give the seller their desired price, then you’ve got some room to negotiate on the terms of the agreement. As mentioned above, the property must cash flow for it to make sense for you as the buyer.
A deal might not have strong cash flow at first. If that’s the case, you can negotiate interest-only payments with the seller. This means you can use more of the rental revenue to fund the property and increase overall cash flow.
Interest rates on a seller finance deal need to be attractive to the seller, but you can still negotiate on it to see what the best rate you can get is. It’s unrealistic to get a market-competitive rate. Seller financing usually involves a trade-off between better financing terms and a potentially higher interest rate than you can find with a traditional lender.
For seller financing a real estate deal, it’s important to use a real estate attorney to draft the documents and agreements. This attorney or a title company can facilitate the closing, and they’ll also be essential in verifying that the title is clean before you proceed.
Not a “One-Size-Fits-All”
Seller financing isn’t a one-size-fits-all solution. As our mentor Pace Morby described it, seller-financing is a useful tool that earns its place on an investor’s tool belt. It’s one option, one strategy, one avenue, among a variety of strategies an investor can utilize to solve real estate problems and get deals done.
From a single family ranch home to a 100+ unit apartment complex, seller-financing is an example of what it means to get creative as a real estate investor. Seller financing is an example of investors taking a non-linear approach to real estate, leading to more opportunities - and more profits.