Understanding the current market can never be over emphasized when it comes to real estate investments. In today’s unique and slightly confusing marketplace, this is even truer. While every deal has it’s own set of circumstances determining how you need to structure the financing, there are two general and important considerations distinctive to today’s market.
1. Seller’s serious about attracting buyers must consider offering seller financing if they want to attract the highest number of potential buyers. And therefore the highest price.
2. Bank’s will continue requiring large down payments from investors for the foreseeable future. Not a particularly good thing but one that can be worked around with creative financing.
When it comes to financing your real estate investments, seller financing should be your first choice in today’s market. The seller won’t charge points, they won’t require private mortgage insurance, and there won’t be loan origination fees. To say nothing about all of the “garbage fees” like courier and fax charges that banks bring to the closing table.
Another major savings comes from the much lower down payment sellers will accept, especially for a house in less than pristine condition. Often a down payment of 5% or less compared to 25% or more for a bank loan.
While seller financing offers several advantages over a bank loan, there is usually one big hurdle to get over before a seller will commit. Few sellers want to carry the loan for 30 years. They want a balloon payment to cash them out in a few years. This is where sharp real estate investors become creative with their creative financing.
Let’s look at an example of a creative way to structure a seller financing deal for your real estate investments in today’s marketplace. Let’s say you find a nice single-family house in a nice neighborhood with a decent price of $125,000. A seller financed down payment is 5% and comes to $6,250 instead of the $31,250 (25%) a bank requires. In exchange for that down payment, you negotiate a balloon payment as far out as possible. Say 5, 7, or 10 years.
Although you don’t have a crystal ball to tell you what the marketplace will be in coming years, you should have an exit strategy for your real estate investment before you even buy. In this case, you may want to sell the house for a tidy profit before the balloon payment comes due. But you need a plan B in case the market timing doesn’t work for a sale. You’ll need to refinance the loan – probably through a bank.
If nothing else changes in 7 years, with a 5% down payment and a 6.5% seller financed loan, you’ll have 14.24% equity in the property when the balloon payment comes due. If banks still require 25% equity, you’ll need to come up with another $13,450 to qualify for a loan. Not many investors want to come up with another big chunk of money to refinance. However, if you’re into the property correctly, you should be able to pay an extra $125 each month to earn equity faster. With that extra payment, you’ll own 25% equity when the balloon payment comes due.
If you negotiate that 7-year balloon up to a 10-year balloon payment, the extra monthly payment plummets to a mere $45. Giving you the 25% equity needed for a traditional loan.
Always crunch the numbers for multiple scenarios to find the highest possible profit from your real estate investments. Another way to creatively use creative financing is by slowly ramping the payments up (as rent increases) to meet the 25% equity requirement when the seller financing balloon comes due.
Author bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.