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5 Considerations Before Becoming A Lender In Owner Financing
Owner financing has long been a practice of real estate investors when dealing with desperate sellers.
Sometimes property owners are just so desperate to let go of their assets that they are more than willing to help assist the sale by financing the buyer.
It is something that is often talked about from the perspective of the buyer.
But owner financing can actually be a secret weapon of a seller when dealing with potential buyers who are just unable to obtain any credit from traditional lenders.
If you no longer want to be associated with a particular property, and have a serious buyer on hand, why let the deal slip away if you don’t see any cash flow problems on the horizon.
On top of that, you can boost the bottom line by not just profiting from the proceeds of the sale, but from interest charges as well.
Selling financing can be a very attractive proposition to buyers with a tight budget.
Not only will they save a lot of money from loan application fees and points, they don’t have to go through the typical credit assessment process that be both hideous and time consuming.
And there cannot be any assumption that their mortgage applications will be approved.
In reality, there is a huge market for home buyers who are just unable to obtain a traditional mortgage to buy their dream homes.
Various reasons include:
- Too low a household income to qualify for a big loan
- Previous brush with lenders regarding bad debts
- Recent late payments towards credit card bills
- A spouse with undesirable credit record
While major lenders would scratch off such borrowers due to their stringent criteria. There can be opportunities to lend to perfectly good borrowers if issues are given a deeper look on a case-by-case basis.
Yet before you declare yourself a seller willing to bestow owner financing to the lucky buyer, here are some serious thought to think about.
1) Can you afford it?
The most basic question to ask first is whether you can afford to extend owner finance.
The number one reason why the majority of real estate transactions don’t have owner financing is because the seller needs the proceeds from the sale to close the purchase of a new house.
Where else are you going to get the money for the new place unless you have built up a beefy bank account over the years?
If you feel that being benevolent to the buyer will give you good karma, and you can always take up a bigger loan for the new purchase, please think again.
That is taking on too much risk on your side of the table.
Which leads to the second point…
2) Can you financially withstand a default?
Even a borrower with a credit score glowing like a supernova has the potential to default on a loan.
It’s just the way life is.
Sometimes, shit happens. And a family who have never had to worry about money can start to spend every minute of every day counting spare change.
How much of your lifestyle depends on the repayment terms of the loan you have given to the buyer?
If for example, you cannot see yourself going 3 months without repayments, then you are absolutely not ready to take on such a risk. Even the process of foreclosure can take too long to save you.
It’s not that default are very likely to happen. It just that a small matter like this can send you into financial turmoil… or even worst as the dominoes fall…
This is why it is critical whether…
3) Determine creditworthiness of borrower
You can’t just approve a borrower from a snap of your fingers. This is thousands of dollars we are talking about here. Your money.
Since you are the lender, you will be the one to determine if someone is legit, credible, and will move mountains just to pay you back.
You can’t base this decision on a “good feeling”.
Some of the information you might want to use to assess an individual’s creditworthiness are:
- Credit history report
- Interview with previous landlord
- Proof of current household income
- Whether they are up to date with current obligations like car loans
If you have absolutely no idea how to go about this, or if the buyer is not cooperative in providing documentations to state their case, it’s better to err on the side of caution.
4) Is lending something that fits into your investment philosophy?
If we just zoom out for a moment and look at the big picture, lending to a buyer is basically the same as investing in financial products like a treasury bond. Expecting to collect interest over time up till maturity.
There is no potential for appreciation or growth.
Is your investment philosophy in line with such investment vehicles?
While allowing your money to make money by itself this way sure beats keeping them in the bank, a lot of people prefer investment vehicles with a higher potential reward and returns.
This is why the majority of people prefer to put money in stocks, real estate, new businesses, etc.
5) Are you at a higher tax bracket?
If you are a high income earner, you are playing the tax game on a different league compared to the average person.
Take note that interest income arising from mortgages are taxable as ordinary income.
There are other investment vehicles that are free of tax… like municipal bonds.
If you are concerned about tax implications do speak with a local CPA to learn about the ins and outs of what you are walking into when you enter into the arena of lending.
Finally, if a buyer meets all your screening criteria nicely, don’t let this being a new thing to you stop you.
You could very well be entering a new world of new discoveries that can take your investing activities to a whole new level.