Is Seller Financing for You?
Most house sellers aren’t in a position, financially or otherwise, to provide financing to the buyer of their home. So, make sure you’re in a position to seriously consider providing financing.
To consider making a loan against the house that you’re selling, you should be able to answer yes to all the following questions:
- Will you be able to purchase the next home you desire without the cash you’re lending to the buyer of your current house? This issue keeps most sellers out of the financing business. If you need all the cash you have as a down payment to qualify for the mortgage on your next home, seller financing is out of the question. And, if you can lend some of your money to the buyer of your house, don’t make the loan if you then need to borrow more yourself for your next home purchase. Even if you can charge the buyer of your current house 2 percent or more in interest on the money you lend than you’ll pay for the money you’re borrowing to buy your next home, such an arrangement generally isn’t worth the hassle and financial pitfalls.
- Do you desire income-oriented investments? Understand that mortgages are a type of bond. When you invest in a bond, your return comes from interest if you hold the bond to maturity. Unlike investing in stocks, real estate, or a small business, you have no potential for making money from appreciation when investing in bonds held to maturity. If you’re looking for growth as well as income, seller financing isn’t for you.
- Are you in a low enough tax bracket to benefit from the taxable interest income on the mortgage loan? If you’re in the federal 28 percent or higher tax bracket, consider investing in tax-free bonds, such as municipal bonds, and not mortgages, the interest on which is fully taxable. The reason: The interest income from municipal bonds is free of federal taxation and sometimes state income taxation. By contrast, the interest income from a mortgage is taxable as ordinary income at the federal and state levels.
- Are you willing to do the necessary and time-consuming homework to determine the creditworthiness of a borrower? As we discuss in the next section, unless you secure a large down payment (25 percent or more of the value of the property) from the buyer of your house, you need to be darn sure that the borrower can pay you back. If you’re looking for a simple, non-time-consuming investment, look elsewhere. Try mutual funds and exchange-traded funds.
- Can you weather a default? Even if you do all the homework we suggest in this chapter before agreeing to lend money, the buyer/borrower still can default on you just as he can on a banker. Bad and unforeseen events can happen to borrowers. Accept this reality. Ask yourself if you can financially tolerate going without the borrower’s payments for many months during the costly and time-consuming process of foreclosure.