Sellers Can Safely Finance a Buyer
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Thirty and forty years ago it was not uncommon for a seller to finance his buyer, in other words to carry the note for the buyer. In fact, many of those contracts were still being created 20 years ago, but with a mortgage market that became intensely competitive and focused upon getting everyone possible into a home, seller contracts faded.
Seller contracts around the US faded for two specific reasons. First, buyers could find lower interest rates and higher loan to value ratios than sellers could reasonably offer for the risk. Second, sellers were favored by IRS treatment, which has reduced the capital gains tax threat for anyone selling their own home.
For a retired person who wants to sell their own home (and especially a rental or investment property), it might be a great time to consider financing the buyer.
In Washington there are two ways to carry the contract for a buyer:
- A Deed of Trust and a Promissory Note; Egypt
- A Real Estate Contract, aka Land Contract.
Provided the seller still does his due diligence on the buyer (credit report, job history, references), and provided the seller gets a reasonable down payment, a seller can get a higher interest rate than a mortgage broker. The higher interest rate is justified, because it is a private contract and the seller bears the risk of default and foreclosure (or forfeiture in the case of a real estate contract).
The risks can be quite acceptable, because the seller is well secured by the real estate itself. If the seller has to foreclose, he probably makes even more money, since he keeps the down payment, all the monthly payments, and then re-sells the house at what may be an even higher price (or at least the same price). Of course, there may be some repairs required after a foreclosure, but it can still be lucrative, and in a market that has slowed down, this could have been the key to selling the house now!
Of course, if the seller needs lots of cash now, he does not have this option. One last tip here. A seller can sell the note and promissory to a commercial note buyer at a slight discount. This would be a cash out (talk to your CPA about possible tax consequences). How much of a discount? That depends on the interest rate, the security, the buyer's credit and so on. The competition for good secured notes has heated up in the last 10 years, and now some notes are selling for only a 1% to 3% discount. That's pretty darn good. I used to work for the largest note buyer in Washington, and the discounts we got then were much higher (often 30%).
Even a 5% to 7% discount on a $ 200,000 note could still be reasonable, especially in this market. And here's a super tip: You may be able to increase the price to cover some of the discount. Someone who must ask you as a seller to carry the note is someone who will most likely agree to add some of the discount (or all of it) to the purchase price.
It's good to know your options in today's changing real estate market. Be careful in all of this. Get good professional advice, because as always, there are traps for the unwary.