Is seller financing worth the premium price?

By Tara-Nicholle Nelson
Inman News™

Question: My wife and I have recently entered into a contract to buy a beach house in Charleston, S.C. This is an owner-financing deal where the house has no liens. We are paying $785,000 for the house, with 10 percent down. I think we are paying 10 percent too much, as the market is still dropping in the Isle of Palms.

Do you see a bottom in pricing for this type of investment? We do plan on renting it out as much as possible. Anything in particular we should look out for?
--Roger



Answer: I know human nature is not to want to be predictable or fall into a clichéd stereotype -- at least here in America it is. We all want to be respected for our individual talents, style and preferences. But the fact is, Roger, almost all buyers think they paid too much for their home -- and especially buyers in today's market, which in many areas is still depreciating, as you've pointed out.

First, you must take into consideration that you are receiving seller financing, which often comes with a premium price and a premium interest rate payable to the seller. Why? Because the seller is taking on some level of risk by virtue of forgoing the possibility that a buyer who can pay the full price would come along and buy the place, allowing them to cash out.

And they are often doing so on the word of someone who couldn't qualify for a loan to buy the home otherwise -- either because they are credit-, income- or asset-impaired or, as may be your situation, because a mortgage lender requires 25 percent or 30 percent down on an income property, while you may be willing or able to put down only the 10 percent you mentioned.

Additionally, seller financing can favor the buyer in that many of the mortgag-qualifying hoops through which both the buyer and the property would have to jump are eliminated, as are many of the costs that accompany mortgage loans, like origination fees, doc fees, and the like.

That's a long way of saying that I do believe some premium price is acceptable for seller financing. What the premium is is negotiable, but if the market could bear a lower price for the home at the terms on which you're buying it, it seems that you would have negotiated that lower price upfront.

I can't predict what the bottom of your investment is, but I can give you a number of things to watch out for. Because there's no mortgage lender demanding it, many buyers of seller-financed properties forgo protections like home inspections, title searches and title insurance. Don't fall into this potentially costly trap. Make sure you get these items done, and that you obtain hazard insurance on the property, effective the date the transaction closes.

Also, I'd encourage you to have a real estate attorney work with you and the seller on the contract and the seller-financing documents, as well as to record them with the county recorder's office.

This should prevent any of the tragically unfunny funny business that occasionally happens with seller-financed properties, like the one where the seller goes out and takes on a bunch of new mortgages against the property, then defaults on them, pocketing the buyer's cash and leaving them to be evicted when the house forecloses. That's certainly a worst-case scenario, but recording your interests in the property publicly will avoid this and a myriad of lesser evils.

In terms of evaluating your investment, for all but the most seasoned rehabbers buying foreclosures at extreme discounts, I am discouraging investors from the flip mentality of trying to project out when they'll recoup their money and how much their return will be.

At this moment in time, in your situation, you should not buy at bizarrely inflated prices, but your focus should be much more on (a) planning to hold the property over the very long term, which is absolutely necessary to stack the decks against losing money on the deal, and (b) projecting out completely accurate and favorable cash flows from the property -- before you buy.

Talk with property managers and other rental property owners in the area to get a realistic sense for how frequently their homes are rented out, and at what rate. Build in easily forgotten line item expenses like local business income taxes (which are often charged to landlords of vacation homes, as many cities consider them to be businesses), insurance, property management, and age- and weather-related maintenance reserves.

Do that math and talk with your tax adviser before you remove contingencies or otherwise finalize the deal. And good luck!

Tara-Nicholle Nelson is author of "The Savvy Woman's Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Tara is also the Consumer Ambassador and Educator for real estate listings search site Trulia.com. Ask her a real estate question online or visit her website, www.rethinkrealestate.com.