Is Owner Finance a Godsend or the Devil?
We love rentals. If you’ve read a single word I’ve written, you know that. We like flips pretty well but we hate the taxes. Owner finance, however, has always been a problem for me. I heard stories of these “sharks” who sold houses to buyers that couldn’t afford the house and probably shouldn’t own a home yet. The interest rates were high. The seller, in these situations, benefited from a default and taking back the house. Some would admit this. Others wouldn’t. But they would collect a large down payment and were happy to collect this amount again and again by selling the same house over and over.
I have a confession.
We just sold a house on owner finance terms. The interest rate is ten percent! Is that predatory?
Let me tell you why I don’t believe so. But I want your opinion. This house is a three bedroom, one bath house that needs work. The buyer is a contractor who will never get bank financing but who works very hard. He currently rents a two bedroom house for 1,000 dollars per month. He is building no equity in this house.
He just purchased this home from us for 38,000 dollars with a five thousand dollar down payment and financed 33,000 dollars at ten percent. His PITI is now less than his rent was. He builds equity and wealth with every improvement he makes. No traditional bank would loan to him. He has the skills to make the needed repairs. The house is in livable condition already. He plans to pay more aggressively and pay off the loan sooner but it is fully amortized for ten years. The house has a nice back yard for his three kids to play in.
Am I justifying this as a win/win or is it truly a win/win? I now strongly believe that I am not justifying. We need a certain return to make an investment worth our risk and energy. Ten percent is the minimum for us.
What do we give up in this scenario versus keeping the house as a rental? We give up on all future appreciation. We give up on the tax benefit of a rental to include depreciation. We also now pay taxes on the money we make on this financing. We also give up the management responsibilities and expense associated with maintaining a property. Remember we are no longer the owner. You wouldn’t call your bank to fix your faucet, would you? We don’t pay taxes or insurance on this property either. We don’t have an endless stream of income with this model as we do with a rental. There is an end to the income stream.
So what made this a property we decided to sell this way versus keeping it as a rental when we are self-admitted property hoarders? The logic was that this lower-end property isn’t likely to appreciate as much as some of our higher-priced properties. It also would possibly be a tenant class that we don’t want to manage. Not to say that there aren’t great tenants there, it’s just different than our normal model for property management. We have found in the lower-priced properties that we own, that we get a lot of Section 8 applicants. We currently don’t participate in the section 8 program. We have friends that love it and do great with it but it’s not our model at this time. It will generate better returns than a typical rental with no maintenance responsibilities.
What do you think? Good deal? Bad deal? I have certainly changed my opinion of owner-finance as I see this good man and his family getting an opportunity to own a home and have his shot at the American dream. I won’t be surprised if he owns his home outright in five years. How many of us can say that?
I believe we could have sold this home on owner-finance terms at a much higher price but we wanted to feel good about this deal and create a win/win scenario. The buyer is also one of the best contractors we know and has contributed to our business success over the years significantly. Is the buyer happy? Yes! Are we happy? Yes! Was the Seller of the house the we bought from happy? Yes! Is the private lender who funded it happy? Yes! So technically this is a win/win/win/win scenario.
There surely is a point at which this could become predatory, in my opinion. Some say that this isn’t our responsibility. That we aren’t putting a gun to anyone’s head. That the buyer has to choose to take these terms. I’ve also heard that the landlord is the “predator” and that the owner-finance seller is at least allowing the buyer to build equity. I’m curious what your thoughts are. Please comment.
I suggest that we all do have a moral responsibility in whatever business we do. Where we each fall on the continuum from landlord to renter or owner finance buyer to owner finance seller colors our perspectives. Please do business that allows you to hold your head high and that you can be proud of. Try to create win/win situations where everyone leaves the closing smiling. This is the recipe for long-term success by building a positive reputation and good karma.
Leave some comments and let me know your thoughts on this investment model. Do business that creates win/win solutions. You are not responsible for your customer/borrower’s personal finances but don’t set up deals where failure of one party enriches another party and wherein there is a likelihood of that failure occurring. Making money is great but do it with an eye on your morals and ethics to keep yourself in check. We often have more sophistication and education than our tenants, buyers, or sellers. Don’t take advantage of that. Use that to find positive solutions. And above all: always keep the main thing the main thing!