In challenging economic times, much like today, businesses and people are forced to get creative when it comes to financing options. Increased Libor and Unemployment Rates are the ‘war drums’ for banks to tighten lending standards and raise borrowing costs, but alas this can make for some heavy Opportunity Costs for banks in the way of missed opportunities on some really profitable risks.
In a knee-jerk reaction to an economic downturn, banks often take a ‘throw the baby out with the bathwater approach’ when evaluating risk. But, when the ‘smoke clears’ and ‘easy money’ becomes the norm again, and it will….They will loosen their risk standards.
The Opportunity Cost for banks happens because tightened lending standards ‘opens the door’ for alternative lending options. Things like; seller finance, wraparound loans, and seller carry-back notes have a keen way of being exposed to a larger market during times of economic hardship..
How did this happen-The Gravy Train with Biscuit Wheels
One of my favorite lines in the movie Kingpin is when Ernie McCraken (Bill Murray) tells Roy Munson (Woody Harrelson) that he’s ‘on a gravy train with biscuit wheels’ because he’s just shattered Ernie’s record, in monthly sales.
Of course this was a ploy to convince a pair of unsuspecting bowlers that Ernie and Roy were really Dictionary Salesman, just before those bowlers were about to get ‘rolled’.
Well, the U.S. for many years has been on an Economic Gravy Train With Biscuit Wheels, and now the biscuits don’t have enough lard to hold it together any longer.
How The Gravy Train lumbered down the tracks for years.
Easy money was the way of the world, as long as you were able to service your debt. We mortgaged our futures for houses, cars, consumer stuff, higher education, even payday loans! However, the dark and seedy downside has become Financial Indentured Servitude, and now we’re paying the price in higher debt service costs.. Check out this graph from the Federal Reserve Bank of New York.
In 18 years ‘Non Housing debt’ has doubled, and now equals 16 Trillion, that’s not even counting mortgages. Let that sink in!
And for a little more perspective,
Housing Debt from 2004 until Q2 2022, has increased by nearly 4.75 Trillion!
But the population has only grown by 15% during the same time period. Eeek!!
This equates to an increase (per new person) of mortgage debt to $107,124. Simply unsustainable!
BUT tough economic times often usher in ‘economic re-calibration’.
One thing about a challenging economic environment, is it forces you to think differently, to evaluate what’s really important. And, a new way of thinking may lead you to the conclusion that servicing debt on an oversized house in the ‘Burbs’, has simply dropped a few rungs in the importance hierarchy.
My ‘Economic Re-Calibration’ …Entertaining a Seller Finance option
I just had a conversation with one of my tenants and it reminded me of a great post from Mr.1500 Days when he went to talk to students at the University of Colorado about what he wish he would have known when he was their age…
It felt like I too, was educating the younger generation.
The conversation went like this:
(IS) Melissa, would you have any interest in buying the house you’re renting?
(Melissa) We would, but as you know our credit isn’t ideal and neither are mortgage rates right now.
They have sub-par credit, mainly due to ‘living large while in college”. That said, they’re great renters, just like this renter….They’ve never, not once, paid later than the 2nd day of the month, in 4 years. They’re a good risk, I can attest to it, but the bank wouldn’t know that from the financial statement they would fill out to get a loan.
(IS) What if you bought it through a seller finance option?
(Melissa) Huh? How does that work?
(IS) First off, we’d agree on a price, then have an attorney write up a sales agreement, and list all the actionable steps to follow in order to validate the seller finance agreement.
(IS) You would make a NON-REFUNDABLE down payment of say $7500 which would be placed in escrow for an agreed upon time period, lets just say 18 months.
During this time period you would continue to make ‘rent’ payments as usual. However, $200 per month of your rent payment would go toward principal pay-down.
If we agreed on $160,000 for the house, with a ‘Specified Time’ period of 18 months, and you fulfill the terms of the Seller Finance Agreement you will have paid $3600 at the end of the 18 months.
Then, the $7500 down payment and the $3600 would be applied to the $160,000 sales price, bringing the mortgage balance down to $148,900. You would then get a bank loan, personal loan, or use lottery winnings to pay off the $148,900, and become rightful owners of the house.
(Melissa) This is possible?
(IS) Sure, as long as the terms are listed in a sales contract, and an attorney signs off on it. That’s the beauty of Real Estate, it’s multi-dimensional.
(Melissa) I’ll talk to Jacob about it and get back to you!
Why would I offer to seller finance my property
First, there’s the opportunity cost. They’re obviously in the market to buy, even if they can’t get the best of terms. So, if they can’t buy my rental property, then they may look elsewhere, which means I could potentially lose a good tenant.
Second, I’d like to sell for a certain price, and if I were to ‘seller finance’ for them, I could get that price, and avoid paying any fees to a real estate agent.
Lastly, they would become ‘homeowners’ in their eyes, which means they would assume responsibility for the maintenance, and have a more ‘permanent outlook, and therefore treat the house as if it were theirs.
Using seller financing as a Call Option..
By purchasing my rental through seller financing, the tenants are essentially buying a Call Option, or the right, but not the obligation to buy the property at a certain price, some time in the future.
By buying this ‘Real Estate Call Option’, they are betting that the price today is lower than if they waited 18 months. By executing their option, they are getting 2022 prices and not 2024 prices.
They will also secure a bank mortgage with conceivable lower interest rates, once 2024 rolls around.
That said, there are still good loan terms available today, so it’s not all doom and gloom. Sam over at Financial Samurai wrote about this in a previous post, and it’s still applicable today.
There is likely more benefit for Melissa and Jacob, then there is for me, if I were to seller finance the house. But, if they fulfill the terms, the benefit to me is; I sell the house for a price I’d be happy getting, and without paying the astronomical real estate fees. Not to mention, it would be helping a young family at a chance of putting themselves in a better financial position for the future. Ain’t that what life is all about?
Anyone have experience with Seller Financing?
Jim started his real estate investing career in 2005 and enjoyed 3 good years before the Financial Crash of 2008. Jim’s been a steady equities investor for over 20 years, but really didn’t realize the power of dividends until 2015. Since then, he’s adopted an ‘if it doesn’t produce income, its not worth investing in” motto. Jim works in a sales and marketing position and has knowledge in SEO, Blog Writing, Website building, and growing a digital brand. If you’re looking to build your online presence, feel free to reach out to Jim.