If Mike Newton could purchase all of his investment properties with seller financing, he would.
“Seller financing is the Holy Grail of real estate investing,” the 31-year-old real estate investor told Insider. “I wish I could do every deal like this.”
With seller financing, rather than using a traditional mortgage originator such as a bank, credit union, or government agency, the owner of the property acts as the lender and provides a loan with agreed upon terms to the buyer. In other words, the buyer buys directly from the seller in installments as they would with a conventional loan.
“Seller financing is fantastic for a bunch of different reasons but possibly the best reason is you get to set the terms for the loan, like the interest rate and schedule of payments,” explained Newton, who purchased two of his eight investment properties with seller financing in 2020 and 2021. Insider confirmed these details by looking at closing documents. He and the owner of the two properties (both were purchased from the same person) agreed on 20% down at a 4.9% fixed interest rate, amortized over 15 years.
Newton would have preferred a 30-year amortization schedule, since that would divide his payments up more, give him a lower monthly payment, and improve his cash flow on the investment property, he noted: “But when I was chatting with the seller, he said, ‘I’m in my 70s. I’m not going to live another 30 years.’ I said, ‘Fair enough. You make a good point. I understand why you want 15-year amortization.'”
That’s the beauty of seller financing, he added: “It allows you to solve the problem that the seller might have and solve problems that you the buyer might have.” As the buyer, if you’re in a financial situation where a traditional mortgage lender might not qualify you for a loan, “you could very realistically buy a house with bad credit and no money down this way.”
Common instances where a buyer would seek a seller-financed deal is on a purchase of vacant land, buying an aging property or one in need of a lot of work that a seller has had difficulty off-loading, or for buying a property under $100,000. The process benefits sellers in that these deals provide cash flow, they cut out costly agent commissions, and in the case of default, the seller still owns the property outright.
While the terms are typically negotiated between the buyer and seller, the amortization period and interest rate are closer to those of a commercial real estate loan versus a residential loan.
When you work directly with the seller and cut out the bank, the process is typically quicker and cheaper.
“There are no closing costs, there’s no origination fee, and there’s no appraisal fee,” explained Newton. “You can still have an inspection if you want but it’s not required.”
As for the seller, they’re getting a steady flow of passive income with each monthly payment, which is hugely beneficial to sellers living on a fixed-income or who don’t necessarily need nor want a big one-time lump sum from a property sale.
“It’s a far more effective way of generating truly passive income than traditional real estate investing,” said Newton. “Because the seller is no longer responsible for managing the property and the tenants. They are effectively the bank. They are uninvolved.”
Once Newton and the seller agreed on terms, they drew up a contract. Newton now makes payments directly to the seller every month.
“We have a contract just like you would with a bank,” he explained. “At the end of the payments, I will own the property outright. I can also pay it off early if I want to.”
The one big caveat with seller financing is the “due on sale” clause, real estate consultant and investor Dana Bull told Insider: “When you take out a mortgage, there is a clause in that promissory note that is called the ‘due on sale’ clause. What that means is, the bank can require the borrower to pay the remaining balance of the loan if there is a change in title.” Essentially, if the mortgage company sees that there is a new owner, it will consider the home sold and can demand payment of the remaining debt in full.
“Although it’s possible, it gets really tricky for a seller to do seller financing if they don’t own the property outright,” Bull said. “Because, technically, if you have a mortgage, you don’t own the property outright. The bank also has interest in the property and their collateral for the loan is the asset.”
Part of the reason seller financing isn’t super common is because most people don’t own their properties completely, she said.
It can be challenging to find someone willing and able to do seller financing. In Newton’s case, he told his property manager that he was interested in this type of financing. She happened to have another client who was selling a bunch of his rental properties and looking to do seller financing, so she connected the two of them.
If you want to go this route, “start networking and telling people you’re interested in seller financing,” advised Newton.
When you’re actually looking at properties, “you can usually figure out what somebody owes on a mortgage or you can see if they’ve refinanced in the past,” added Bull. “That’s information that is available through public record.” You can look for places that are completely paid off or close to being paid off, “but the main thing is just asking the seller,” she said.
Both Bull and Newton expect seller financing to become more popular in the near future.
“It hasn’t been super popular recently because interest rates were 2.5- 3%. Why would a seller want to offer this to a buyer if there isn’t much juice to be squeezed?” said Bull. “But now we’re in an environment where interest rates are picking up and a seller might think, there’s some pretty good return here if I don’t need that lump sum.”
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