What happens when you want to sell a rental property and have a great tenant already living there? Two words—seller financing.
Never heard of seller financing? It’s a simple concept, really. You sell your property directly to a buyer and provide the financing. You, in other words, become the lender in a seller-financing deal. This arrangement works particularly well for landlords and tenants. The tenant is already there!
Seller financing works particularly well for landlords and tenants.
Mary Pitman, a Vero Beach, FL, renter who became an owner, explains how she started the ball rolling on a seller-financing deal.
“My pitch to [my landlord] was he would basically be making about the same amount without any of the expense.” Pitman explains that her landlord would no longer be responsible for paying property tax, homeowner’s insurance, or maintenance and repairs because those expenses would go to her.
“He said ‘yes’ and agreed to owner financing,” says Pitman. “By the time my security deposit, pet deposit, and last month’s rent were factored in, my closing costs were covered, and I had $750 credit.”
Your tenant has already been making payments to you in the form of rent, so you know they’re responsible. And the beauty of seller financing is that neither you nor your renter need to put out any effort—other than some paperwork—to complete this real estate transaction. No hiring a real estate agent to sell your home. No listing, staging, showing, or waiting for someone to make an offer. You already have someone who wants your house.
After you set up a seller-financing transaction, allowing your renter to buy your property, the payments the seller makes to you will go toward buying the house.
Seller financing is especially attractive to homebuyers who don’t qualify for a mortgage. This makes these buyers risky. But in this case, the buyer is someone you already know—your tenant. Because you have a relationship with this person, you know whether they are responsible and can afford to continue making payments to you. If they’ve been a good tenant so far, the risk factor is reduced since you already have a history with this person.
So what are you waiting for?
Here’s how to set up a seller-financing deal:
1. Get a professional to help you
Seller financing, although a simple concept to understand, can be complicated to set up. It’s a good idea to hire a real estate attorney to structure the deal and a tax professional to help ensure you set up the deal advantageously to you.
Just because you’re hiring pros doesn’t mean your job ends. If you will be entering into a big financial transaction such as this, it’s a good idea to understand as much as possible. These next steps will give you an idea of what you can expect to happen.
2. Write a promissory note
A promissory note is a legal document, like a lease, and is used in place of a mortgage loan. Its purpose, like a lease, is to spell out the details of the deal. The promise part of the promissory note is the buyer’s promise to pay you for the house. All the details of the deal will be listed in the promissory note, such as repayment amount, interest rate, terms, consequences of nonpayment, and how much of a down payment you require. Seller and buyer both sign the note.
3. Use your home as collateral
Your home acts as collateral on the promissory note. If your buyer defaults on payments, the deal is off, and you keep the house.
4. Accept a down payment
You can be flexible here. Although you can do a seller-financing deal and ask nothing for a down payment, it’s better if you collect something. This makes it less likely for the buyer to walk away, and you get to keep the down payment if they do. Collecting 10 percent or more would be something to shoot for.
5. Figure out how much interest to charge
You’re a lender here, so you deserve to collect some interest on your loan. You, however, don’t have to turn into a loan shark. Ask for interest comparable to what the banks in your area charge.
6. Structure the loan with a balloon payment
You may be acting like a bank in a seller-financing arrangement, but you don’t want to wait 30 years to get your money. Avoid that by amortizing the loan as a 30-year loan so your buyer can afford the monthly payments. But structure the loan so the balance is due in a short time.
A standard time frame for this is five years. After five years, the loan will be due. Your buyer, presumably, would have built up their credit at this point, having paid you consistently and on time for the past five years, meaning they can now get a traditional loan from the bank.
Optional: Sell your promissory note to an investor. If you have an attractive deal set up, such as a good buyer, a quality home, and a loan with favorable terms, and you want cash now—maybe to buy another rental property—consider selling your note to an investor. Note that you might need to discount the price of the note to sell it.
It’s easiest to enter into a seller-financing arrangement with a house you own free and clear. If you still hold a mortgage on the house, you’ll need permission from your own lender to do the deal.
But if this is a good fit for you, seller financing is something to consider.
Have you done a seller-financing deal as a buyer or a seller? Let us know how it worked out for you in the comments!