Seller-financed mortgage always a priority when looking for a primary residence?

[jeromedawg]

Hey guys,

I started reading through the "Building Wealth One House at a Time" book by John Schaub. In it, he seems to heavily promote looking for (or perhaps instigating) deals on private sales that are seller-financed in the context of investment/rental properties.

Practically, would the same thing apply for if I were to start looking for a primary residence? I really don't have much real estate knowledge and am a total noob when it comes to this stuff but it seems like taking a mortgage from the bank is just a bad idea in general if you can avoid it. But it seems like every person I know has gone down this route... am I missing something? Of course, I wouldn't think this would be in the context of a cash-buy as that seems like it would be preferable most the time.

And as far as finding those private sales and seller-financed mortgages, how would you go about even *starting*? Like I said, I just started reading Schaub's book so if he talks about *how* to do this, I guess I'll just have to finish reading it but the part where he suggests going that route really piqued my interest because I would have no idea how to actually go about finding something like that (even with his suggestions of "walking around the neighborhood and asking neighbors about a vacant home" - I imagine myself looking like a potential thief/squatter doing something like that and camping out in my car in random neighborhoods watching houses all day to see which ones don't turn their lights on, etc)....

[matchewed]

Personally I don't think it's a priority for a primary residence.

Also with interest rates where they are now is cutting out the banks really going to save you that much money?

[Lski'stash]

I have started reading this and also would like to know about how to bypass the banks when making a new mortgage. Has anyone done this? Also, are investment mortgages something that other banks do? Also, are credit unions considered different from banks? I think our credit union could be a huge asset in this endeavor, if they do investment mortgages, of course. I have checked if our local credit union does yet.

[zephyr911]

I don't know if I'd call it a priority. My rental LLC and I are currently exploring some owner-financed opportunities, but only because the guy is offering better than market terms.

Be wary, because this is often NOT the case. Most of the owner-financed offers I've seen were clearly structured to take advantage of buyers who either had shitty credit and couldn't get commercial financing, or just didn't know any better. You absolutely have to be able to do your own analysis and compare actual terms for a specific deal to know if the seller financing option is better.

Why do you think a cash buy would be preferable? Leverage is one of the easiest ways to increase the ROI of real estate properties. There's a huge thread going on about that right here (started by ARS) with the math to prove it. I'd leverage 10 to 1 if I could, with the returns I'm getting.

[Louisville]

jplee3, while it doesn't address your question exactly, this other thread I started about that book might give you something to think about:
http://forum.mrmoneymustache.com/real-estate-and-landlording/does-landlording-have-to-be-this-complicated/msg817734/#msg817734

[jeromedawg]

I don't know if I'd call it a priority. My rental LLC and I are currently exploring some owner-financed opportunities, but only because the guy is offering better than market terms.

Be wary, because this is often NOT the case. Most of the owner-financed offers I've seen were clearly structured to take advantage of buyers who either had shitty credit and couldn't get commercial financing, or just didn't know any better. You absolutely have to be able to do your own analysis and compare actual terms for a specific deal to know if the seller financing option is better.

Why do you think a cash buy would be preferable? Leverage is one of the easiest ways to increase the ROI of real estate properties. There's a huge thread going on about that right here (started by ARS) with the math to prove it. I'd leverage 10 to 1 if I could, with the returns I'm getting.

Thinking cash is preferable is probably just a noob preconception that isn't correct. What you say makes sense, but what about in the context of a HCOL area? Maybe I meant "preferable" in the sense of the amount of risk taken? I dunno... it just seems like if you're in a HCOL area, it's much harder to find something 'affordable' that you could pickup for investment income. And if you did, there would be even more pressure for you to get renters in to pay off the mortgage... but I guess the other factor in all of it is "finding a great deal" right? My question though is, what practically constitutes a "great deal?" Like $100k under market price on a property (the only time I've seen that around here is when the bubble burst)...

[arebelspy]

I really don't have much real estate knowledge and am a total noob when it comes to this stuff but it seems like taking a mortgage from the bank is just a bad idea in general if you can avoid it.

What gave you that idea?

At today's rates, I'd be borrowing from the banks as much as you can.

Once you're past fannie/Freddie limits you can start to get more creative (or if deals happen before that). But for a primary, owner occupied rates?  Long term fixed debt from a bank (or credit union or whatever) will likely be much better than a private note.

[jeromedawg]

I really don't have much real estate knowledge and am a total noob when it comes to this stuff but it seems like taking a mortgage from the bank is just a bad idea in general if you can avoid it.

What gave you that idea?

At today's rates, I'd be borrowing from the banks as much as you can.

Once you're past fannie/Freddie limits you can start to get more creative (or if deals happen before that). But for a primary, owner occupied rates?  Long term fixed debt from a bank (or credit union or whatever) will likely be much better than a private note.

Thanks for correcting my misconceptions - like I said, I'm pretty noob with my understanding of all of this. I've been raised/trained to think that taking loans and debt is just a bad thing in general, so I sort of go on to apply that everywhere in life. But when I think about it in the context of real estate, that doesn't really apply [at least, not all the time]. So it's more of a risk thing then - take a loan BUT expect to rent in order to pay the loan off. Risk *should* be low assuming rent in the area is highly desirable AND if rent will cover and exceed the monthly loan amount.

[arebelspy]

Search the forums for the 50% rule.

Assume 50% of your expenses go to non-mortgage expenses (insurance, taxes, vacancies, repairs, capital reserves, management, etc.).  Then make sure the other half covers the mortgage.  What's left is profit.

[CashFlowDiaries]

Typically, rates on owner financed notes are significantly higher then conventional mortgages.   I would only attempt to get an owner financed loan if I had no other choice.  Whether its a primary residence or rental.  Conventional is the way to go if you can do it.

On the other end of things though, I would consider selling a house via owner finance so that I can charge a high interest rate and make passive income that way.  Assuming I didnt want to rent that house out.

[Louisville]

Search the forums for the 50% rule.

Assume 50% of your expenses go to non-mortgage expenses (insurance, taxes, vacancies, repairs, capital reserves, management, etc.).  Then make sure the other half covers the mortgage.  What's left is profit.

I've read this 6x, but I don't see where the profit is. If 50% is mortgage and 50% is non-mortgage expenses, that's 100%. Where's the profit?

[Pooplips]

50% non-mortgage. The other 50% - the mortgage payment = Profit

[matchewed]

Search the forums for the 50% rule.

Assume 50% of your expenses go to non-mortgage expenses (insurance, taxes, vacancies, repairs, capital reserves, management, etc.).  Then make sure the other half covers the mortgage.  What's left is profit.

I've read this 6x, but I don't see where the profit is. If 50% is mortgage and 50% is non-mortgage expenses, that's 100%. Where's the profit?

Sure you read it, but did you follow what he said? Make sure the other 50% covers the cost of the mortgage. That doesn't mean all 50% is needed for that mortgage just that your mortgage needs to be less than that 50% in order to turn a profit (over a long period of time).

I searched the forums and came up with a few gems for the search side of things.

http://forum.mrmoneymustache.com/real-estate-and-landlording/breakdown-of-the-50-rule/msg868460/#msg868460
http://forum.mrmoneymustache.com/ask-a-mustachian/challenging-the-50-rule/
http://forum.mrmoneymustache.com/real-estate-and-landlording/struggling-with-the-50-rule/

[arebelspy]

Search the forums for the 50% rule.

Assume 50% of your expenses go to non-mortgage expenses (insurance, taxes, vacancies, repairs, capital reserves, management, etc.).  Then make sure the other half covers the mortgage.  What's left is profit.

I've read this 6x, but I don't see where the profit is. If 50% is mortgage and 50% is non-mortgage expenses, that's 100%. Where's the profit?

The other half covers the mortgage and what's left is profit.  If none is left, no profit.  :)

[zephyr911]

Thinking cash is preferable is probably just a noob preconception that isn't correct. What you say makes sense, but what about in the context of a HCOL area? Maybe I meant "preferable" in the sense of the amount of risk taken? I dunno... it just seems like if you're in a HCOL area, it's much harder to find something 'affordable' that you could pickup for investment income. And if you did, there would be even more pressure for you to get renters in to pay off the mortgage... but I guess the other factor in all of it is "finding a great deal" right? My question though is, what practically constitutes a "great deal?" Like $100k under market price on a property (the only time I've seen that around here is when the bubble burst)...

HCOL areas are less likely to have good rental investment options to begin with.]http://www.mrmoneymustache.com/2015/07/27/rent-vs-buy/]HCOL areas are less likely to have good rental investment options to begin with. It's a simple question of ratios.

People still make money in those markets but the investments are more speculative in nature and therefore inherently more risky.

[zephyr911]

The other half covers the mortgage and what's left is profit.  If none is left, no profit.  :)

Since I love to quibble: in that example, you would have profit, but no cash flow. The profit's all tied up in equity as the loan is amortized using rents received. ;)

But that's no fun if you want to reinvest profits to grow the portfolio, obviously.

[arebelspy]

Good point.  If none is left, no cash flow.

There may or may not be profit, especially if the mortgage is over half the rent and you're cash flow negative in the long run (even if positive in the short run).

Thanks for clarifying that!

[matchewed]

The other half covers the mortgage and what's left is profit.  If none is left, no profit.  :)

Since I love to quibble: in that example, you would have profit, but no cash flow. The profit's all tied up in equity as the loan is amortized using rents received. ;)

But that's no fun if you want to reinvest profits to grow the portfolio, obviously.

Even more quibbly your property has to be appreciating in the market for you to have that particular profit you're claiming.

[arebelspy]

The other half covers the mortgage and what's left is profit.  If none is left, no profit.  :)

Since I love to quibble: in that example, you would have profit, but no cash flow. The profit's all tied up in equity as the loan is amortized using rents received. ;)

But that's no fun if you want to reinvest profits to grow the portfolio, obviously.

Even more quibbly your property has to be appreciating in the market for you to have that particular profit you're claiming.

Even more quibbly: it doesn't have to be an appreciating market, just NOT depreciating, as you're paying down the mortgage, so even if it's not an appreciating market, you have profit from that.

EVEN MORE QUIBBLY: The above quibble only true if it's an amortizing, not interest only loan, because then you WOULD need an appreciating market.

How many quibbly caveats can we add before we all agree the basic point was probably good enough?  :)

[matchewed]

The other half covers the mortgage and what's left is profit.  If none is left, no profit.  :)

Since I love to quibble: in that example, you would have profit, but no cash flow. The profit's all tied up in equity as the loan is amortized using rents received. ;)

But that's no fun if you want to reinvest profits to grow the portfolio, obviously.

Even more quibbly your property has to be appreciating in the market for you to have that particular profit you're claiming.

Even more quibbly: it doesn't have to be an appreciating market, just NOT depreciating, as you're paying down the mortgage, so even if it's not an appreciating market, you have profit from that.

EVEN MORE QUIBBLY: The above quibble only true if it's an amortizing, not interest only loan, because then you WOULD need an appreciating market.

How many quibbly caveats can we add before we all agree the basic point was probably good enough?  :)

Oh I like my rules of thumb (rule of thumbs?). Easier to start there and learn more. I'll accept the basic point.

[zephyr911]

Even more quibbly: it doesn't have to be an appreciating market, just NOT depreciating, as you're paying down the mortgage, so even if it's not an appreciating market, you have profit from that.

EVEN MORE QUIBBLY: The above quibble only true if it's an amortizing, not interest only loan, because then you WOULD need an appreciating market.

How many quibbly caveats can we add before we all agree the basic point was probably good enough?  :)

I did explicitly state the amortization assumption. ;)
One of my partners sometimes mixes up cap rate and cash-on-cash return rate, with amortization representing the difference. The owner-fi stuff we're looking at has a shorter amortization period that produces a huge spread between the two - leveraged cap rates @ 25-35%, slightly negative cash flow using the 50% rule. I'm still trying to convince him it's worth having negative cash flow if we can 1) buy more property with current cash via higher leverage (seller will do 85% vs. 80%); 2) offset the slightly negative cash flow with existing profitable holdings; and 3) refinance at 75-80% LTV with conventional loans after only 6-7 months. I see lower total cost of credit and a faster acquisition curve.

[arebelspy]

Even more quibbly: it doesn't have to be an appreciating market, just NOT depreciating, as you're paying down the mortgage, so even if it's not an appreciating market, you have profit from that.

EVEN MORE QUIBBLY: The above quibble only true if it's an amortizing, not interest only loan, because then you WOULD need an appreciating market.

How many quibbly caveats can we add before we all agree the basic point was probably good enough?  :)

I did explicitly state the amortization assumption. ;)
One of my partners sometimes mixes up cap rate and cash-on-cash return rate, with amortization representing the difference. The owner-fi stuff we're looking at has a shorter amortization period that produces a huge spread between the two - leveraged cap rates @ 25-35%, slightly negative cash flow using the 50% rule. I'm still trying to convince him it's worth having negative cash flow if we can 1) buy more property with current cash via higher leverage (seller will do 85% vs. 80%); 2) offset the slightly negative cash flow with existing profitable holdings; and 3) refinance at 75-80% LTV with conventional loans after only 6-7 months. I see lower total cost of credit and a faster acquisition curve.

Yeah, it's counter-intuitive and hard to visualize sometimes.

For your partner: Do total return projections for the timeframe you want to compare to illustrate it, and break down the total return by the various components.  Becomes much easier to compare apples-to-apples.

[SwordGuy]

I'm going to give you the best advice I got on these forums about real estate purchasing.

Buy this book.  Read it cover to cover and do the exercises in it.  Then you'll know enough to ask about the other stuff.

http://www.amazon.com/Every-Estate-Investor-Financial-Measures/dp/0071603271/ref=sr_1_6?s=books&ie=UTF8&qid=1450970265&sr=1-6&keywords=real+estate+investing

The other real estate investing books spend a huge number of their pages giving you the rah-rah!! you can do this!!! spiel.   

This one just tells you how to compute the numbers so you know how to structure a good deal.   It does that very well.

[arebelspy]

I'm going to give you the best advice I got on these forums about real estate purchasing.

Buy this book.  Read it cover to cover and do the exercises in it.  Then you'll know enough to ask about the other stuff.

http://www.amazon.com/Every-Estate-Investor-Financial-Measures/dp/0071603271/ref=sr_1_6?s=books&ie=UTF8&qid=1450970265&sr=1-6&keywords=real+estate+investing

The other real estate investing books spend a huge number of their pages giving you the rah-rah!! you can do this!!! spiel.   

This one just tells you how to compute the numbers so you know how to structure a good deal.   It does that very well.

A new, updated version came out last month: http://smile.amazon.com/Estate-Investor-Financial-Measures-Updated/dp/1259586189/

The old one is fine though, I'm sure.  I'd probably buy a used copy of that second edition you linked to (just read the used descriptions and get one that's not written in).

But just wanted to point out that there is a newer one.

[zephyr911]

For your partner: Do total return projections for the timeframe you want to compare to illustrate it, and break down the total return by the various components.  Becomes much easier to compare apples-to-apples.

Yeah, too busy mucking around on MMM forum. I vaguely indicated I'd work up such an analysis after our last meeting. Heh

[elaine amj]

Typically, rates on owner financed notes are significantly higher then conventional mortgages.   I would only attempt to get an owner financed loan if I had no other choice.  Whether its a primary residence or rental.  Conventional is the way to go if you can do it.

On the other end of things though, I would consider selling a house via owner finance so that I can charge a high interest rate and make passive income that way.  Assuming I didnt want to rent that house out.

We've thought of it. We have a long term tenant (5+years) who has expressed interest in buying the property. She doesn't have the savings for a down payment/conventional mortgage. I tried to work the numbers but couldn't really figure out a way to make it work in a win-win situation.

[zephyr911]

Typically, rates on owner financed notes are significantly higher then conventional mortgages.   I would only attempt to get an owner financed loan if I had no other choice.  Whether its a primary residence or rental.  Conventional is the way to go if you can do it.

Granted, you're right about "typically". But there are legitimate exceptions.
I'm looking at 15% down and 4% simple interest. As a new partnership we've never gotten below 20% and 5.875%. Dramatic difference in total return on cash.
Unless it turns out this is just a ploy to get us to bite on an overpriced investment, we may bite.

We've thought of it. We have a long term tenant (5+years) who has expressed interest in buying the property. She doesn't have the savings for a down payment/conventional mortgage. I tried to work the numbers but couldn't really figure out a way to make it work in a win-win situation.

It's pretty hard to do. Which is why most of the deals offered are suckers' bets.

[jeromedawg]

Thanks guys for all the input! So this got me thinking about the property my inlaws are in right now in Southern Cal. They took a mortgage out on it back in 2004 and got it refinanced a few years ago amidst the housing crash. It's not as HCOL an area as we're in currently but I would still consider it HCOL in general (Chatsworth area). It's a 3 bed/2 bath single family home (1771sq ft and roughly 7500sq foot lot overall with decent sized back and front yards). There's a den/office with opening to the master bedroom that could be converted to a fourth bedroom (albeit a small one) so technically it could be a 4/2. Her parents have had a good amount of work done on remodeling: installed hardwood floors through the remainder of the house with the hallways and bedrooms, and renovated both bathrooms. The neighborhood is decent too - it's close to a school and park (which is pretty busy every Saturday with kids baseball/softball games being hosted there). I think there's over $200k left on the mortgage currently and I'm pretty sure her parents aren't planning to pay it all off (they took a 30 year mortgage out in 2004 and are in their 70s now...). At first they were talking about how they want to pass the house on to us as an "inheritance" - I was very hesitant about this but now that I think about it, that might not be such a bad idea assuming we just rented it out. I have to check rental prices around the area, but I think we could probably rent it out for more than the mortgage...although, not sure if it would meet the 50% rule.

EDIT: I think the current mortgage is in the ballpark of around $1900-2000. Rentals in this around go for an average of $2500 it seems...

If we did accept the inheritance and take on the mortgage, could we refinance again and negotiate a potentially lower rate (since there's less left on the mortgage)?

What do you guys think about this?

[jeromedawg]

Thanks guys for all the input! So this got me thinking about the property my inlaws are in right now in Southern Cal. They took a mortgage out on it back in 2004 and got it refinanced a few years ago amidst the housing crash. It's not as HCOL an area as we're in currently but I would still consider it HCOL in general (Chatsworth area). It's a 3 bed/2 bath single family home (1771sq ft and roughly 7500sq foot lot overall with decent sized back and front yards). There's a den/office with opening to the master bedroom that could be converted to a fourth bedroom (albeit a small one) so technically it could be a 4/2. Her parents have had a good amount of work done on remodeling: installed hardwood floors through the remainder of the house with the hallways and bedrooms, and renovated both bathrooms. The neighborhood is decent too - it's close to a school and park (which is pretty busy every Saturday with kids baseball/softball games being hosted there). I think there's over $200k left on the mortgage currently and I'm pretty sure her parents aren't planning to pay it all off (they took a 30 year mortgage out in 2004 and are in their 70s now...). At first they were talking about how they want to pass the house on to us as an "inheritance" - I was very hesitant about this but now that I think about it, that might not be such a bad idea assuming we just rented it out. I have to check rental prices around the area, but I think we could probably rent it out for more than the mortgage...although, not sure if it would meet the 50% rule.

EDIT: I think the current mortgage is in the ballpark of around $1900-2000. Rentals in this around go for an average of $2500 it seems...

If we did accept the inheritance and take on the mortgage, could we refinance again and negotiate a potentially lower rate (since there's less left on the mortgage)?

What do you guys think about this?

The other thing I wanted to take into consideration was my in-laws' situation. They don't really have any savings from what I know (just cash stockpiles...they're old-school Asian and love hoarding cash rather than investing it). Not sure how much they have but presumably the house would be handed off after they retire and *if* they decide they want to move closer to us. Realistically, I'm not sure this would happen anytime soon... they run/operate a restaurant and I just don't see them quitting from it. The good news is that they are on a month-to-month lease now and out of the ridiculous contract they signed themselves into years ago and rent there is pretty affordable. I think they're turning a decent profit with the restaurant but we see how it's taking a toll on them and I foresee the only thing stopping them being severe medical issues. Anyway, once they do decide to retire and if they want to move closer, we'd probably have to help them find affordable housing close by. Furthermore, they'd only be getting social security, so we have talked about taking a portion of whatever profit from the potential rental of their former home to help supplement cost of living for them (of course, it would have to be within reason and not according to the lifestyle they might want but can't afford).