If you are a real estate investor, you know all too well that the mortgage industry has suffered from a major meltdown. Lending institutions are folding, foreclosures are reaching record highs, and subprime lending has caused a catastrophe for property sellers, buyers, and lenders alike. As a result, there’s a limited pool of qualified buyers and a shrinking supply of conventional lending sources. In addition, there’s an abundance of properties on the market at low prices. Seller financing is filling the void created by the mortgage crisis, offering an alternative to those hard-to-come-buy conventional loans. It moves property, more quickly and at higher prices.
Seller Financing Goes Mainstream
After the high-interest rates of the 1980s, seller financing became a specialty niche among real estate transactions. The upheaval in the housing market, however, is now creating an extraordinary demand for this alternative financing method. Two years ago, seller financing accounted for about 1 in every 400 real estate transactions. Today, it accounts for 1 in every 50 transactions. Some experts predict that it will soon become the financing vehicle for 1 out of every 10 real estate transactions.
What does this mean to you? Seller financing provides you the opportunity to sell your properties to quality buyers—at the full retail property values and more quickly—for a substantial and steady income stream.
For Quality, Qualify
Qualifying for a conventional mortgage today is much more difficult than it was just a few years ago. More restrictive underwriting criteria disqualify countless candidates who have both a willingness and the ability to meet the requirements of the loans. As a result, as many as 50% of the people who would have qualified for a conventional mortgage just two years ago no longer do. Since the shakeout in the lending industry, many good candidates are being denied the opportunity to borrow money.
Seller financing is the ideal solution for these people and investors alike. To avoid the same pitfalls that brought down many lending institutions, however, the investor must weigh the risk of each loan, and proceed only with those that present a high likelihood of success.
From This Day Forward . . .
Most people enter into seller financing contracts with the same enthusiasm with which they enter into marriage. They’re as happy at closing as newlyweds at the altar. But if the commitment is based on blind faith, the relationship may dissolve faster than ice in the punchbowl.
No investor finances his property for a buyer with the belief that the arrangement will turn sour. At most, it’s considered a remote possibility with tolerable consequences. If the buyer defaults on the loan, the investor assumes that he can simply annul the deal, repossess the property, and avoid any loss.
But the buyer has likely occupied the property for months, perhaps years. What condition is it in now? Have the taxes and insurance been paid? Have needed maintenance and repairs been done? Has the buyer trashed the place and fled? Has the equity disappeared? The seller/lender could get stuck with unpaid bills and costly repairs. The honeymoon is over.
Like fiancés, borrowers are emotionally involved with the transaction and might not view their financial situation objectively. Equally excited about closing the deal, the seller might also be blind to the risks in doing business with a particular buyer. Other investors recognize the risks but believe they can sidestep a foreclosure action by having the buyer pre-sign a deed back to them at closing. However, the buyer cannot waive his future rights. There’s no protection for the seller if the arrangement goes sour. Seller financing doesn’t come with a pre-nup. Clearly, the smart approach is to learn all you can before you’re heavily invested in the relationship.
A Safe Bet
How risky is seller financing? The risk is much lower than it used to be. That’s because it used to be easy, too easy, to obtain a conventional loan. People who failed to qualify for traditional mortgages were, by definition, the riskiest borrowers.
Lending institutions have since tightened their criteria, making it far more difficult for would-be buyers to borrow money. Many are “just missed” borrowers who now fall narrowly outside the newly tightened criteria of lending institutions. These are reliable, low-risk prospects who show every intention of meeting the terms of their loans, and have the ability to do so. They simply no longer “measure up” on paper. What the savvy investor must do is differentiate between these deserving buyers and the risky ones.
I Do Diligence
Approving your seller-finance candidate is like choosing your life partner. During that first encounter, your date presents him or herself in the best possible light. He appears honest; she seems responsible. You like what you see and you want this to work. You make plans.
Smart couples conduct due diligence before saying their “I do’s.” They learn their fiancés’ background, character, values, strengths, and weaknesses. Many singles even hire private investigators to do a background check on their potential mates.
Likewise, real estate sellers should carefully analyze their seller-finance candidates, using disciplined underwriting. The primary variable that affects the cash value of their note is the buyer’s credit. Thus, not only does good underwriting mean a more trouble-free loan, but you also create a more valuable, salable loan. As Ronald Reagan said, “Trust but verify.”
Seller Financing: It’s a Good Thing
You can be extremely successful in this business, if you use a methodical approach that calculates the risk and weighs the benefit. Plus, it’s much more profitable than sitting on an unsold property. With due diligence, good judgment, and some common sense, you can become very successful with seller financing. And the timing couldn’t be better. In addition to your own success, you can provide a much-needed service to people who deserve the opportunity to own their own homes. Are you ready to say “I do”?
By W. Eddie Speed
Eddie Speed, Founder of Note School®, has purchased more seller-financed notes than anyone else in the business. With a lifetime volume of seller-financed notes topping half a billion dollars, Eddie has seen just about every scenario. He is also an acclaimed instructor, mentor, and recipient of the industry’s most prestigious award.
Eddie will be a speaker at Entrust California’s “Creative Lending & Financing” Workshop on May 21. Click here for more information, or to register for the event.