When I find a seller willing to owner finance my real estate investment, what terms should I request?
Hallelujah, you’ve found a seller willing to owner finance your real estate investment! Now what? Owner financing only benefits you when you can negotiate favorable terms. You need to understand how to structure your payments, interest rates, and term of the loan. Let’s look at each in more detail:
Payments
With owner financing, you can set up your payment structure however you and your seller like, but the most beneficial structure to you involves no payments. If it’s at all possible, negotiate a period of six months or longer, where you don’t have to make any payments to the seller. During that time period, you should be able to make any necessary improvements and sell the property. Hopefully, without ever making a payment.
If that’s not possible, try minimizing the payments in the beginning. For example, make interest-only payments for the first six months and then principal and interest payments for the second six months. You might also try to defer all or part of the interest until later. If your monthly accumulated interest is $1000, offer to pay $500 and tack $500 on to the principal.
A third option is to make payments quarterly or semiannually, usually deferring interest between payments. By creating longer time periods between payments, you may be able to reduce the total number of payments you have to make before selling. Just be careful not to forget about a payment, as the seller might try to foreclose.
Interest Rate
The second most important piece of your owner financing structure is your interest rate. You want to negotiate as low of an interest rate as possible. Generally, I propose a period of six months or more with 0% interest, followed by a period of interest-only payments. I’m usually finished with the deal before the interest-only payments begin, meaning I didn’t lose any money on interest.
From a profit standpoint, this can have a big impact. For example, if your alternative to owner financing is hard money, you can expect three upfront points and at least 15% interest. If you keep a $100,000 loan for six months, you will pay $3000 in upfront fees and $7,500 in interest. So, by owner financing your purchase at 0% interest for six months, you would save a total of $10,500.
Term of the Loan
The term or length of your loan is also important. With owner financing, you’re usually limited to a short term, as most sellers don’t want to wait forever for their money. Where a conventional lender will offer you a 30 year term, most sellers want you to pay them off within a year or two at the longest. If you’re planning on holding the property for a short time period anyway, it shouldn’t be a problem though.
You can also use a short term as a bargaining chip. If your seller is concerned about waiting forever for their money, structure your owner financing to require a sale or refinance within one year. Or, if you’re certain of your ability to sell the property fast, you might even try six months or less. Most sellers are happier to owner finance if they know exactly when they’ll get the balance of their money. Just make sure it doesn’t put you in to a financially distressed situation.