Rapid City financial advisor Kahler writes: Seller financing, a real estate option from the past, may be back
Today’s rising real estate prices and interest rates have sparked memories for me of the 1980s, when I made my living as a real estate broker. Those were the days of 12% mortgages, which put home ownership out of the reach of many. Seller financing, where the seller rather than a financial institution makes the loan to the buyer (often using a sign like the one above from wikimedia commons), was a common way to buy and sell property without involving bank financing. I remember going three years without ever taking a client to a bank.
Today, cash deals have become the gold standard in real estate. I haven’t been aware of a seller carrying back financing for decades. But rising interest rates are giving some sellers an opportunity to have their cake and eat it too.
When someone references selling on a contract for deed, a mortgage, or a deed of trust, these are the legal names of the instruments used in seller financing. The following property owners may be candidates for seller financing:
Those with a lot of equity in their home and no immediate need for the sales proceeds other than investing them.
Those who want a higher rate of return than a bank savings account or CD.
When getting your price is more important than getting cash.
When tax consequences would improve if the purchase price was spread over two or more years.
Those who own unique properties where bank financing is not available, like land or mobile homes.
There are potential advantages to seller financing. One is the ability of the seller to attract a broader range of buyers. Not everyone has either the down payment, credit history, or necessary income to qualify for a bank loan.
Sellers who finance the sale of their property become the lender. They will probably receive a higher interest rate than they would from a bank CD. The regular monthly payments from the buyer can provide a steady income stream. For some sellers, the higher rate of return and predictable cash flow are significant advantages.
They can often obtain a higher sale price when offering seller financing. Buyers are usually willing to pay more for the convenience of not having to secure a mortgage or make a large cash payment upfront.
Carrying back the financing on a sale can also offer the seller potential tax advantages. Depending on your specific situation and the tax laws in your state, you may be able to spread out the capital gains taxes over the life of the contract rather than paying it all at once.
Of course, there are also drawbacks to seller financing. One of the biggest is the risk of the buyer defaulting on the contract. If the buyer stops making payments, you may have to go through a time-consuming and costly legal process to regain possession of the property. You also risk a potential loss on reselling if property values have declined or the buyers left the property in poor condition.
When you sell on a contract for deed, your equity remains tied up in the property. You won't have access to the full sale proceeds until the contract is paid off, which can limit your financial flexibility. You will also have more administrative tasks than with most other liquid investments. You'll need to keep accurate records and ensure the buyer complies with the terms of the contract.
Seller financing can pay both emotional and financial dividends. Yet it is not for everyone. You should carefully consider your unique financial situation first. It’s important to obtain legal, tax, financial planning, and real estate advice to know if this is the right fit for you.
Rick Kahler, CFP, is a fee-only financial planner and financial therapist with a nationwide practice, Kahler Financial Group, based in Rapid City. His co-authored books include Coupleship Inc. and The Financial Wisdom of Ebenezer Scrooge.
