Hello my friends and welcome to another episode of Ask Marco where I answer your investing related questions.
Today’s question comes from Alan and he says, hi Marco. I have seen on the MLS a house for sale with owner financing. I know houses on the MLS are listed at or near their max value and everyone says you make your money on the buy. My question is, would you pay full price for a house with owner financing if it meets the 1% rule and still makes some cash flow? Also, do you have to tell the bank about this owner financing deal when trying to buy another property using conventional financing? Thanks Allan.
Thanks for your questions Allan.
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So essentially your main question here is about buying an owner finance property. So let’s break this down. So first of all, to your first comment, you don’t always make money on the buy.
I know a lot of people say that, but that comment is especially true for someone who is more of an active real estate investor, or let’s just call them a flipper or someone who buys fixes and then keeps the property because you obviously want to get the best price possible on the front end so you can budget for renovations and contingencies and hopefully some equity in there, which is your forced equity, meaning the profit or the value that you build into the property. If you can find a nice rent ready property or a turnkey rental or a property that is essentially a performing asset, meaning it’s leased and generating income, and you can get at a discount for whatever reason, great. Uh, and that’s just a better deal because you’re not only getting the property you want with positive cash flow, but you’re getting some equity as a kicker on the front end, but you don’t always make your money on the buy.
In fact, if you look at most investments in prudent markets, you will find that the appreciation and equity growth in that property over time is really where you have your greatest gains. If you get that on the front end as a kicker, that’s fantastic. Call that icing on the cake or a bonus, but your wealth has created over time as the equity grows in your property. I could do an episode on that alone, but I just wanted to comment on that while you brought it up. So your question about would you pay full price for house with owner financing? My answer is yes. It depends what I mean by that. Is the owner financing a first or a second? Assuming that it’s a first, the question is how much of a first, is it a hundred percent financing, 80% financing, like a conventional mortgage where maybe they’re only offering, let’s say 50 or 60% owner financing and then you have to come up with the rest and that’s, you know, a sizable down payment compared to your other options, like getting conventional financing or some other mortgage financing that allows you to finance up to 80% but let’s just assume it’s a first.
So if the seller is willing to finance 80% or maybe even 90 or 100% of it with no down payment, fantastic. As long as you’ve got positive cash flow or ideally close to positive cash flow. I mean, if you’re getting a hundred percent financing, meaning full leverage, no down payment, um, and it’s a break even and there’s no deferred maintenance, well, what is your return on zero down when you have positive cash flow? Well, the answer to that question is your rate of return is infinite. You put nothing down. So it’s not that it’s 1% or 5% or 10% or 100% it’s infinite and so that is the ultimate leverage. However, just be careful because with a hundred percent financing, if you’re buying at full price, you have you know no equity there. If you are forced to sell or you need to sell, it is what it is. It’s just a house with no equity generating income.
But if you’re keeping it for a longer period of time, let’s say three, five, seven, 10 years or more, that equity will come in time. Now if you are actually finding a property that is close to 1% meaning it rents for 1% of the purchase price per month and you can get owner financing and let’s say that owner financing is 80% or better or higher, that’s an unusual, not a bad deal. Unusual in the sense that you don’t typically find those very often. Typically it’s going to be a motivated seller or someone who is looking to defer the tax impact of selling that property and paying capital gains on the gains that they made on that property. On the net proceeds of the sale. But if that’s what you’re finding, fantastic that you’ve got asked the question, you know, why is there seller financing? It could be a very strategic move on the seller’s part where they’re looking to defer taxes and that’s great cause that’s a win, win, win for him or her and a win for you.
So you got to ask whether it’s a first or second, how much, how high is the loan to value, why are they seller financing it? Because you want to know what their motivation is. It could be something that is very good for them and very strategic and you can work with them or maybe even make the deal better. And these types of deals typically come down to price or terms. You know, why would someone sell with owner financing? If you’re questioning whether it’s a good deal by painful price, you have to again, put it in perspective. If you’re putting little to nothing down, you’re getting terms, you’re getting favorable terms. So the given the take is that you’re going to give up on the price, you’re going to pay more or be at least willing to pay more in lieu of the down payment. I guess what I’m saying is if you’re getting better terms, meaning a lower down, you’d be willing to pay a higher price.
In fact, I’ve actually paid more for properties in the past. Then the seller was asking because he was giving me seller financing and in fact I was able to get very favorable terms on interest rates in exchange. Plus it was also a bit of a competitive situation where I was told can’t prove it. I was bidding, um, or competing against some other prospective buyers for the same deal. So I was willing to give a little more in an effort to win the purchase. Bottom line here is this is a math question, a finance question. We’re assuming that the property is in good condition, requires little to no maintenance or at least immediately it’s in a good area, good neighborhood. You’ve done your due diligence things check out. This is really a math question. You’re looking at cash flow. Just run your numbers and be realistic. Make sure you’re budgeting for vacancy and you’re budgeting for maintenance and repairs.
Lastly, here you have a question. Do you have to disclose this to the bank or your lender if you have owner financing on this particular deal? The answer is you don’t have to. It’s up to you if you want to. That may be a good thing or it may be a bad thing, but if it’s not recorded in public record, if there’s nothing in the public records to show that you have mortgage and it’s not on your credit report, it’s not going to hurt you not to disclose it. You can just keep that in your pocket and bring it up if it ever comes up, but I don’t think there’s any requirement for you to disclose that. If it’s on public record and they could look it up, which is highly unlikely because they have to have a way to trace it back. But really where a lender would find out about things like this is if it’s recorded on your credit report and the odds of seller financed mortgage loans being on your credit report are virtually zero because you have to physically have that reported you or the seller, so that’s it.
I hope that helps. If you have any other questions about seller financing, let me know. It’s great when you can find a good deal with seller financing that’s favorable. Otherwise, I guess what are you’re comparing it to? You’re comparing it to existing mortgage financing that’s out there, which for many people is 80% loan to value at very favorable rates and we call those our conventional loans conventional financing. All right, that’s it for today. If you have any question about real estate or investing or finance that you’d like me to answer, just go to passiverealestateinvesting.com click on Ask Marco, submit your question and I will cover that ASAP. If you haven’t already, remember to subscribe, share the show with your friends. We love getting this information out to more and more people and thank you for listening. I will see you on our next episode.
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