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When it comes to paying off debt, you have heard all of the usual advice: just choose to stay out of debt; don’t use credit cards; do whatever it takes to pay it off; double-down on payments of the highest interest loan; and the like. This might be sound advice for many people, but the fact is that you may learn these pointers after you already have the debt and your funds for repayment may be limited. For those fortunate enough to have some type of non-liquid assets, there may be some out-of-the-box ways to help you pay off your debt.
An Owner Financed Mortgage
Before explaining how selling an owner financed mortgage may help with debt, here is some important background information about owner financed mortgages. If you are trying to sell your home, have a good amount of equity, and are having a hard time finding a buyer, you may be in a good situation to sell your home by financing a buyer’s mortgage. This means that instead of a buyer getting a loan from a bank, they are getting a loan from you, the owner. The buyer gives you a down payment and then contractually agrees to make monthly payments at a stated rate for a stated period of time until the house is paid off, just as if they were paying a bank. The down payment should be a good percentage of the house’s value (at least 10%) so that the buyer can show with their own cash that they are serious about one day owning the house.
Of course there are some risks. If a buyer is trying to purchase a home by financing the sale through the seller, this often means they may not qualify for a standard bank mortgage. If that is the case, the buyer’s inability to obtain a standard mortgage could indicate a poor credit score due to slow payment history or what is known as a known as a “thin file”. A “thin file” means the buyer may have a very limited or no real credit history, thus the credit file is considered “thin” by lenders. It might also indicate that the buyer is “too new in their employment” or that they have recently started a new business. Lenders may be hesitant to take on these risks. Of course, it could also mean the lender believes the applicant has an unacceptable debt service ratio, which means the lender believes the debt may be unsustainable when considering household income and debt repayment expenses.
If you are considering financing a purchase of your real estate with a seller financed mortgage, make sure you really understand the person and can work well with them. Checking everything a normal bank would do will show you if you can work with this potential buyer. You will be relying on their payments for up to thirty years. Having an attorney draft and record the agreement is critical. Further, you should consider engaging a title company to act as a record-keeper and reporting agent for all payments made by the buyer. For example, you could direct that each of the buyer’s payments go to the title company who would keep track of exactly how much was paid and when. There would be no room for confusion or accusations of being cheated on either side, because a third party is keeping track of payments. The title company could also provide the buyer with an annual statement of interest paid and you, the seller, with a statement of interest earned. These reports are critical for accurate and timely filing of tax returns. Of course, you should always consult your attorney and tax advisor when considering such a sales structure for your real estate.
Selling an Owner Financed Mortgage
If you would like to significantly reduce or eliminate debt, financing another person’s mortgage may seem counterintuitive. If you hold the mortgage and have a good paying buyer, you will get the payment of the principle value of the mortgage plus a lot of interest income. However, you may not be able to wait 10, 15, or 30 years until the buyers have paid you back. You may prefer to receive the equity now and reduce or pay off debts immediately. That is where selling an owner financed mortgage comes in. However, this can be a difficult choice to make. On one hand, you would receive more money over time through the buyer’s payments and so you may prefer to just rely on that money to slowly pay off debt. On the other hand, the money you could get now is likely worth more than if you received the same amount through the next few decades. In addition, the peace of mind you can get when a debt is paid off may be a better choice. Here too, consulting with trusted advisors may be very useful when making such a move.
A mortgage investment company or a wealthy individual investor may want to purchase the mortgage between you and your real estate buyer. Purchasers see owning a mortgage as an investment opportunity.
Let’s look at an example of selling a financed mortgage. The owner has lived in the house for 20 years and has paid off the mortgage in full. The house is worth $250,000 and the buyer makes a down payment of 10% or $25,000. The owner and the buyer have a note that states that the remaining balance of $225,000 will be paid back monthly over the next 20 years at a fixed rate of 6%. Two years into the agreement, the seller becomes ill and ends up owing $40,000 in medical bills. The seller does not have sufficient cash to pay these bills. The doctor and hospital may accept minimum payments paid in part by the monthly mortgage payment of $1,611.97. Or they could elect to sell the financed mortgage. At this point, the buyer owes them $212,615of remaining principal. Perhaps the mortgage owner decides that they want to get out of debt as soon as possible. They meet with investors who judge the value of the property and look at the buyer’s payment history (another reason to work through a title company) to make sure it is a good investment for them. The owner sells the note to an investment company who will pay them a lump sum for what they deem to be the value of the note as determined by their required rate of return. If the investor’s target rate of return happens to be 6%, you should receive the principal balance. Oftentimes, investors want a higher than stated rate of return, so you would be asked to sell your note worth $212,615 at a discount. In this later case, the owner will lose some principal value, but will be able to pay off their medical debts in full and be able to avoid years of potential stress and the payment of a lot of interest to the doctor and hospital.
When a buyer takes the place of the original seller of the real estate as now owner of the mortgage, the investors must honor the note that the buyer and the original seller had agreed to and should notify the buyer that the recipient of the payments has changed. The buyer now pays the investment company until the real estate is paid off. Once more, structuring such a transaction would benefit from professional tax and legal advice.
A Final Thought
Having an owner financed mortgage can help a person who may not be able to sell their house the traditional way and a person who may not qualify for a loan but needs to buy a house. Likewise, selling a financed mortgage can be a winning situation for the seller if they have a more immediate financial need. The buyer still makes the exact same payments to purchase the real estate while you are able to get money up front to pay off debt.