Seller Financing Notes 102

By Joe Mueller (Be sure to read part one by Joe entitled “Seller Financing 101“)

I remember reading several books a few years ago that referred to seller financing as being a primary method to purchase real estate.  I had also seen ads in the paper referring to owners carrying a second mortgage and even the occasional ad for the seller to finance the right buyer. But I was skeptical, to say the least.  My real estate education was mainly self-taught through books and hands-on experience, and I believed that those sellers running those ads were just fishing for buyers or that they were referring to some type of a lease-option.  Simply put, too good to be true.

Seller Financing Notes

Seller financing can take on many names and some differing definitions such as land contract, contract for deed, or installment sale – all essentially referring to the same type of executable instrument or document.  Seller financing also refers to a seller second or seller carryback type mortgage, as well.

Historically, the term “land contract” was derived by our forefathers in a time when land was bought, sold, and monopolized in this country as a source of control and power – not too different from today!  Land was (and still can be) difficult to finance through banks.  Sizable down payments were required and impeccable credit and job/business history had to be in place.  So land owners would sell to each other on contract (for deed), and once the financial obligation was fulfilled, the deed was passed to the new owner.   The same practice is still in place today, not having changed much through the ages.

A typical land contract, or contract for deed, type sale customarily means that the seller is actually holding the full note on the property, acting as the bank would in a conventional purchase.  The seller may require as much, or as little, documentation about the buyer as he or she wishes, possibly requesting credit scores and requiring minimum bank balances, or even a personal financial statement.

Seller Financing Notes

This type of financing can be utilized for any type of property, not just raw land.  It is commonly used for the purchases and sales of commercial, land, and residential single family /multi-unit properties.

There doesn’t necessarily need to be, but normally there is a down payment provided by the buyer in the transaction on the closing date – one of two that you will typically see.  This amount is commonly between 5-20% down, due at the first closing, and at this time a ‘memorandum of deed’ is sometimes recorded, showing a vested interest of the property by the buyer.  (Be sure to consult your attorney whenever utilizing a land contract style of financing.)  I mentioned two closings because the second closing will occur once the note is being released and/or satisfied.  Typically, this occurs because the new buyer is now selling the property him/herself or because they have decided to refinance and pay off that debt.  At this second closing is when that buyer will formally take title, even if only for an hour.  Your contract for deed has now been satisfied and has resulted in the procuring of a deed to that buyer.

Since we’re on the topic of banks, you may be wondering how the bank holding the seller’s original loan or mortgage would allow this.  My answer is, technically they don’t!  This transaction would result in the activation of the due on sale clause and start the foreclosure process by the bank.  So how is it still possible?  Well, to be honest, I have personally never heard of a bank actually foreclosing a loan that was still getting paid!  Banks are in business to lend money and not in the business of foreclosing, managing, or selling property.  The seller still owes the money and, in their best interest, will still be paying the loan they owe back to the bank – especially since now that new buyer is making a payment to that seller, as well.

Interest rates can be variable when dealing with seller financing.  I can say from personal experience that it is more common to see a higher interest rate, perhaps a few points above prime, when dealing with this type of financing.  This is acceptable because essentially that seller is taking on a great amount of risk by handing over their property to you.  This is a negotiable item and can be as low as 5% or as high as 12%, 15%, or 20%.  Every situation is different.

Amortization, or the amount of time scheduled for a loan repayment, is also another variable option that can play a role during negotiations, but is commonly seen at 20-30 year amortization.  I will throw one wrench in the gears in regards to this though, the balloon repayment.  Most sellers will offer to hold the note for let’s say a 25-year amortization, but the note is due within 3 or 5 years.  As of this writing, I am currently involved in a transaction that is seller financed with approximately 20% down, amortized over 30 years, but due within 18 months.  This is an add-value opportunity for an apartment building that at the time of initial acquisition was in serious disrepair and only 26% occupied.  Very few banks would finance this property given its state.

The previous information was referring to a situation where the owner was financing the whole note for the new buyer, a very lucrative situation!  But that is not the only time seller financing can be used.  You may be more familiar with the next topic I am going to reference about seller financing – the seller carryback note.

Seller Financing Notes

A seller carryback note, simply put, is a second mortgage that the seller of the property is going to hold to facilitate the sale.  This can be offered by the seller or negotiated during the contract discussions on behalf of the buyer.  The seller’s note is typically between 5-15% of the purchase price, but it varies once again up to 20% depending on the lending institution holding the first mortgage on the property.  The seller’s note will be held in second position, meaning that the first position note holder will be the primary lender (normally) and essentially gets paid back first.  If the property were to go into foreclosure, the first note holder essentially controls title to the property, not the second, unless the second note holder also purchases that first note, or its position.

There are also a few additional things to consider regarding seller carryback loans.  Be careful of the buyer’s financial situation, depending on the mortgage lender or the buyer’s credit.  There may be a limit on how much financing the seller can actually provide as part of the transaction.  Also, make sure that the note gets recorded on public record and on title.  This will guarantee the seller gets paid back that remaining balance if the property is sold or refinanced.  A good attorney involved on either end of the transaction should take care of this.

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For more information regarding seller financing, please feel free to contact Joe Mueller, Owner and Managing Broker of the TANIS Group LLC @ his office: 847-594-4215.  Joe is also available via email: jmueller@tanisgroupllc.com.

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