Seller financing is one of the most powerful tools in your box when dealing with high equity owners. By using their equity in place of a loan from a a traditional lender you can drastically reduce your money costs and provide great advantages for your seller. But what additional concerns should you keep in mind when building a deal with seller financing? What exactly should be in your Seller Financing Addendum?
Before you can create a Seller Financing Addendum you need to know what kind of seller financing you will be using. Here are a few categories to think about slotting your deal into:
- Assumable Mortgage– Some VA and FHA loans are assumable with the bank’s approval. In these cases you typically pay a fee to your seller and assume their payments along with possession.
- Lease Option– Essentially allowing you to lease the property from the original seller but with the option to purchase at pre-arranged terms at a point in the future.
- Land Contract– Though less common, this creates a joint ownership with the original owner until the final mortgage payment is made whether from sale of the building or through monthly payments. This is more often used for long term buy and holds.
- Junior Mortgage– If you are using seller equity to bridge the gap between your capital and your lender’s equity requirements then you are using a Junior Mortgage. For example: if your lender will only finance 70% of the loan-to-value you can account for the remaining 30% with seller financing.
- All Inclusive– In this case the seller carries a promissory note for the entire balance of the property’s price.
Now that you know what kind of seller financing you have, its easier to identify the risks that your Seller Financing Addendum should address.
- Failure to Perform: Spell out the specific consequences and disposition of the money already paid to a seller and the potential future terms of sale. For example, assuming as a seller you suddenly become unable to pay the monthly costs of the seller financed property, what happens to the year of payments you have already made? What about the pre-arranged terms of future sale?
- Property Inspection: In most cases the purchase price is paid before new owners can discover hidden problems and at that point, legal action is their only option. If you are holding the property with an agreement to pay a final amount at a future date and you discover the property is not worth what it initially seemed to be when you originally agreed to a price, what option do you have? Can you renegotiate the terms of final sale? Under what circumstances and how?
- Interest Payments: If you plan to hold the property for only a short time before selling it (as a rehabber might) when will the interest payments occur? Is it to your advantage to pay interest as a lump sum on the sale date?
- Balance Due Terms: Another concern for short term holding is what happens when (miraculously) a project completes early. Is there a minimum term of your seller financed borrowing or a penalty for early repayment?
The overall tip here is to think about the length of the contract you have with this person and all the ways that could go sideways when writing our Seller Financing Addendum.
Did we miss anything? Comment below and let us know your tips for minimizing risk when working with seller financing.
By Nate Baumgart