Banks and mortgage companies are in the business of loaning out money and collecting interest. That’s why so many of them will tell you that any other type of financing is very risky and should be avoided.
The truth is that traditional mortgage loans are very low risk – for the banks! They do their best to make sure their risk is as low as possible. They put all the risk on the borrower. It is the borrower that will most likely be in trouble if they default. The only way the bank will lose (other than fees to foreclose) is if property values drop drastically such as they did in 2008. Even then the borrower will lose more than the bank.
Owner financing, on the other hand, keeps the risk with the original borrower (seller) and the bank. As an investor, you carry very little risk. The loan will still be in the seller’s name, and the bank will only go after the seller if you default.
Risk mitigation is the big reason for trying to negotiate seller financing. There are other reasons as well:
1. You don’t need great credit to obtain seller financing
2. You can buy as many properties as you can find and negotiate
3. You can obtain seller-financed properties with little to nothing down
Buying properties ‘subject to’ the existing financing has the potential for being a low-risk method for purchasing properties, while achieving high returns, from motivated sellers. Make sure you can review the mortgage documents with the seller before you buy, and understand that there are still risks involved.
Probably the biggest risk with seller financing is the ‘Due on Sale’ clause. This clause says that if the seller sells the property, the lender can demand that the mortgage is paid immediately. The borrower doesn’t have to pay the mortgage off on the sale, but the bank can demand it. The clause became popular in the 1970’s when interest rates were spiking and banks didn’t want to be stuck with low-interest rate mortgages.
These days the interest rates are low. Banks are much more interested in receiving regular, monthly payments than they are in earning higher interest rates. If you find someone who is having trouble paying their mortgage, and you start sending in payments like clockwork, there is an extremely good chance the bank will not exercise this clause.
It can also be worth accepting a higher purchase price for the property in order to receive seller financing. Many investors will make three offers to a motivated seller:
1. A very low offer, paying all cash
2. A high offer with very favorable terms to the buyer (long payment period, low interest)
3. A combination offer – purchase price between the first two options, with some money down and some owner financing
Remember that the interest rates that come with hard money lending are typically very high. So the money you save with a lower, all-cash offer may be made up in higher borrowing costs – especially compared to owner financing.