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Have you ever thought about owning rental property?

Perhaps you’re interested, but you’re worried about high maintenance costs and destructive tenants.

That’s a common thought and a common worry. And there is a way around it.

Yes, you can invest in income property without actually being a landlord.

It’s called seller financing and it could work for you as a seller or a buyer…

What is Seller Financing?

It’s pretty simple. It’s the process of the seller handling the financing of their home, instead of a financial institution.

It eliminates the 3rd party and allows the buyer and seller to work together directly. It’s also referred to as “owner financing”.

For example: I am selling a home for $200,000. You want to buy my home, but your either can’t get financing or you can’t get a decent interest rate. You then ask if I would be interested in financing the house, instead of using the bank that apparently didn’t like you. I agree to it, we fill out the papers and the house is yours. I lock you in at a 5% interest rate and we both win. I have a steady 5% return on my investment and you have a home.

Seller financing is great for buyers and sellers. Here are the 2 most likely reasons:

  • Sellers: You want to earn a steady (but not amazing) return on your investment for many years to come.
  • Buyers: You are unable to get financing for some reason or you are looking for a better interest rate.

Let’s talk about it as a seller first…

Seller Financing as the Seller

If you’ve ever thought about owning (or if you do own) rental property, you may be interested in seller financing some homes.

When you buy a home and finance it to someone, you are essentially a landlord that doesn’t have to worry about repairs and maintenance issues.

And that’s the main reason I hear for why people don’t own rental property…

“I don’t want to have to deal with fixing leaky toilets or replacing expensive appliances.”

That’s fine, because with seller financing, you don’t have to worry about that at all.

Your only concern is the buyer making the payments. Not only are you getting a monthly payment, you’re also getting interest on that payment.

Then again, there is always the possibility that the buyer will default and not pay the loan. That’s fine too! In that case, not only did you just receive income from the buyer for however long they paid, but you also get to take the house back and sell it to someone else. Sure, there may be some repairs to do, but that’s why you have your emergency fund ready to go.

Before we go on, we need to address a major concern that you may have. If you’re dealing with a home that still has a mortgage, you may be wondering how you would be able to finance a house to someone else that you don’t fully own. That’s a good point! Here are some things you should know…

The Due On Sale Clause

Most mortgages have a due on sale clause. It basically states that, if you ever sell the home before the mortgage is paid off, you will pay the mortgage off in full.

This is usually done practically automatically, since you would pay the mortgage off with the money you get from the sale. Obviously that’s not an option here, so you have a couple choices:

  1. Pay cash for your properties. This is ideal, but it may not be realisitic for you right now. If you’re interested in pure-cash real estate investing, it’s fairly simple, but it’s a process that requires patience. The first step is to make sure all your consumer debt is eliminated. Then begin investing to create a large reserve. Index funds work great for that.
  2. Find a mortgage without a due on sale clause This would let you finance a home and then turn around and finance the home to someone else. This means that you would be paying your mortgage payment with the payment you’re receiving from your buyer. Think: rent-to-own. This is a somewhat…shady option, but it is an option in some cases.

You might just want to rent out your properties until you pay them off, then you can seller-finance them.

Seller Financing as the Buyer

As a buyer, you should always look at seller financing, if it’s an option, because the rate may be better than the current market rates.

Seller financing is also a great way to get financing if you’re unable to get it elsewhere. Banks, credit unions and mortgage brokers look at your credit and your background history, but many home owners will also use their own judgement.

For example: If you had something go seriously wrong in your past, you’re financial history could be a mess. If there is a reasonable explanation behind it, an individual may be willing to listen to you and work with you, whereas a financial institution may not.

Just remember, your interest rate will be based on several things, including your perceived risk level. So you may be able to get a loan through owner financing, but it could come with a high interest rate.

Seller financing could also be an option if you don’t have enough money for a down payment. Some seller financing requires a down payment, but most people will work with you.

You may be interested in taking advantage of seller financing, as the seller, to make money. If you are, be sure to check out my article coming in January on how to buy rental properties, pay them off quickly and sell them with owner financing.

Photo Credit: Gabriel Santiago

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