Now that we have explained the benefits and told you how owner financing works, let's talk about making contact with a contract buyer, with the idea of selling a newly created contract from the sale of your home.
The contract buyer will want several pieces of information from you. They will suggest the terms you should put in your contract, which gives it the highest cash value when selling it. They can suggest the amount of down payment you should try to get from your buyer, how many years the contract should be written for, plus the right interest rate you should charge. The contract buyer will also ask you about your cash needs from the sale. This is something you shouldn't be afraid of. They're not trying to pry into your personal affairs. The contract buyer's goal is to construct an offer to fulfill your cash needs. Depending on your cash needs, there may be times when it is best to sell a part of your contract, rather than the whole thing. This method could give you a gigantic lump sum of cash when the sale closes. We'll explain how selling a part of the contract works in a few moments. Disclose all the information you can with the contract buyer. Explore all your options with them. They will assist you in constructing a plan that lets you win from your home sale. Your goal is to create a contract that has high cash value that you can easily sell.
Let's see what a high cash value contract should look like. We will call this Example One:
THE QUALITY CONTRACT
Let's pretend you have a home you're going to sell for a market value of $100,000.00. Let's say you find a good buyer who can put down $20,000.00. The buyer is going to have a 20% equity position at the very beginning. A contract buyer likes to see that. The more equity your buyer has at the start, the better for you when you sell the contract. Lets assume the interest rate you charge on this contract is 10%. Market rates could be lower or higher, at the time you're reading this manual. The 10% rate is only an example. The remaining balance of $80,000.00 is amortized over 15 years. This means the buyer will be making monthly payments for 15 years of $859.68. Here's what the contract will look like.
Sales price of the house: $100,000.00
Down payment: $20,000.00
Remaining balance: $80,000.00
Interest rate: 10%
Monthly payment: $859.68
This represents a good quality contract. The home is selling for market value. The buyer made a good down payment, giving them decent equity at the start. The contract has a reasonable pay back term of 15 years.
Lets see what a contract that would be low in quality would look like. We'll call this Example Two:
THE LOW QUALITY CONTRACT
Let's say we're going to sell the house again for $100.000.00. This time the buyers are only putting down $5,000.00. The contract will be amortized for 30 years with an interest rate of 10%.
Monthly payment $833.69. Here is what it looks like.
Sales price of house: $100,000.00
Down payment: $5,000.00
Remaining balance: $95,000.00
Interest rate: 10%
Monthly payment: $833.69
This contract is low in quality because the buyer is not putting much cash down. The pay back term of 30 years is very long. When comparing these two examples, you want to remember that contracts with shorter pay back terms, and good down payments always give you the highest cash values. Another way to measure the cash value of a contract is to calculate the loan-to-value on the home. You do this by adding up the total loans on the home. Then you compare that figure to the price or cash value of the home. In our first example of the quality contract, the loan amount is $80,000.00. The sales price is $100,000.00. That gives the home an 80% loan-to-value ratio. A contract buyer would be comfortable with that ratio. The low quality contract has a 95% loan-to-value ratio. Much too high. However, there is a way to make the low quality contract into a workable deal. We'll show you how that works in a few moments.
Loan-to-value is very important to you. Do your best to create a contract that has the right ratio. If you're selling other property like apartments or commercial real estate, a contract buyer would want the following ratios:
Multi-family units and apartments need to keep the loan-to-value at about 65% maximum. It can go lower but 65% is acceptable to a contract buyer. If you're selling commercial property, your loan-to -value should be around 60%. For vacant land, or lots, loan-to-value should be no more than 50%.
O.K., you've seen what a quality contract looks like. You should now have a working knowledge of loan-to-value. Its time to answer the major question you probably have at this point. How much money would the home seller receive if they sold these two contracts?
Let's review the first example of the quality contract. The home is selling for $100,000.00. The buyer is putting down $20,000.00. The balance of $80,000.00 is paid over 15 years at 10%. Monthly payment will be $859.68. How much will the contract buyer pay the home seller for this contract? As far as this deal goes, we would say around $72,000.00. When you add up the down payment of $20,000.00, plus $72,000.00 from the contract buyer, the home seller ends up with $92,000.00 cash. That's $92,000.00 they won't have to wait 15 years to get.
Your questions regarding the discount will be answered later in the section entitled:
"UNDERSTANDING A PRIVATELY HELD CONTRACT AND NOTE"
This section has good information for people creating contracts from a home sale. If you already own a contract you'll discover some vital facts you may not be aware of. We encourage you to study section three carefully.
Let's see you how the home seller could do even better in our example.
The seller is coming out with $92,000.00 cash they won't have to waiting 15 years to collect. Lets make some changes that could make things better for the home seller. Lets pretend the seller doesn't need all cash when they sell. What they really want right away is the large down payment.
A second offer could be made.
OFFER TWO
The contract buyer suggests the home seller could sell part of their contract, rather than the whole thing. The contract buyer offers $39,000.00 for the right to receive the first 60 payments of the contract. When the 60 payments have gone by, the contract will be returned to the home seller with a balance remaining of $65,053.30. The home seller will then start to receive the monthly payments. This method gives the home seller a gigantic lump sum of cash immediately with payments to follow.
Let's review Offer Two:
Home sells for: $100,000.00
Down payment: $20,000.00
Contract buyer purchases first 60 payments for: $39,000.00
Total cash to home seller at closing: $59,000.00
After 60 payments the contract is returned to seller with a balance of: $65,053.30
Home seller begins to collect monthly payments.
Think about this. When you add up the $59,000.00 the seller received at closing, plus, the $65,053.30 remaining after the 60 payments go by. The seller ends up with over $124,000.00 plus interest on the balance remaining. Remember the home sold for $100,000.00. Not bad. The home seller comes out better when a part of the contract is sold versus the whole thing.
Lets assume the homebuyer needs a lower monthly payment. This is simple to solve. Write the contract with a 30-year pay back term. The monthly payment is then lowered to $702.06. We've accommodated the buyer by lowering the monthly payment. Now, in exchange, we can require that a balloon payment be placed in the tenth year. This makes the contract pay off in ten years instead of thirty. Now, our contract buyer can make a third offer.
OFFER THREE
The contract buyer will purchase the ten years worth of payments from the home seller, for $49,000.00 cash. After the ten years go by the balloon payment comes due. This goes directly to the home seller. In ten years, the value of the balloon payment would be $72,750.42. Let's see how this offer looks.
Home sells for: $100,000.00
Down payment: $20,000.00
Contract buyer purchases the first ten years worth of payments: $49,000.00
Total cash to home seller at closing: $69,000.00
Balloon payment comes due in ten years and goes directly to the home seller: $72,750.42
The home seller does well with this offer. They get $69,000.00 when the sale closes. Plus, the balloon payment of $72,750.42 for a total of $141,750.42. Contract buyers can also come up with other offers and combinations. The next two sections in your manual will give you more ideas. Contract buyers don't offer a set price for a contract. They're all different. The values have to be measured on the individual merits of each contract. Remember to completely discuss your needs with the contract buyer. They'll do their best to come up with the right plan that works for you.
Now, let's talk a bit about The Low Quality Contract. Let's see how an offer could be made for this one. This contract was set up on a long pay back term of 30 years. The down payment was low at $5,000.00. The contract buyer would probably offer around $71,000.00 cash for the whole contract. The home seller would only get around $76,000.00 when everything settles. The seller would certainly want to do better. Let's make an alternative offer. The contract buyer could purchase the first ten years of payments from the home seller, for $53,000.00 cash. After ten years, the contract would be returned to the home seller. The balance owed would be $86,391.12. The home seller will start to collect the payments from then on. Let's see how this looks.
Home sells for: $100,000.00
Down payment: $5,000.00
Remaining balance: $95,000.00
Contract written for 30 years at 10%
Monthly payment: $833.69
Contract buyer purchases first 10 years of payments: $53,000.00
Total cash to home seller at closing: $58,000.00
After ten years, contract is returned to home seller with remaining balance of: $86,391.12
We have turned a low quality contract into a deal that can work for the home seller. They get $58,000.00 cash at the start. Plus the $86,391.12 remaining after ten years, including interest. Not bad for a house that only sold for $100,000.00.
If a new contract is set up on a long-term pay back with a low down payment, your best strategy is to sell a part of the contract versus the whole thing. The contract buyer might suggest placing a balloon payment in the tenth, or possibly the fifteenth year. You could use the same strategy we used before. Sell the payments only and keep the balloon for yourself. Contracts that are low in quality can be made into deals that work for the home seller. There are other offers and combinations that can be made. Every situation is different. Remember, discuss everything in detail with the contract buyer.
Let's talk about selling a house that you don't own free and clear. You have a first mortgage that money is still owed on. Contract buyers can help you if you've got enough equity in the home. If your home is selling for $100,000.00 and you still owe $40,000.00 on a first mortgage, you have a 60% equity position. This is very good. Let's say you still owed $80,000.00 on the first mortgage. Your equity is only 20%. This would not be good. The contract buyer would have a hard time working with something that small.
Let's see two examples on how this works. What we're talking about is the creation of a second mortgage that you would sell to the contract buyer.
EXAMPLE OF A QUALITY SECOND MORTGAGE
Selling price of home: $100,000,00
Down payment: $20,000.00
Home seller still owes on a first mortgage with a remaining balance of only: $40,000.00 (60% equity)
Home seller creates a second mortgage with a five-year pay back at 10%: $40,000.00
Monthly payment: $849.88
Contract buyer purchases second mortgage from the home seller for: $35,000.00
Cash to home seller at closing: $55,000.00
If you owe on a first mortgage that cannot be assumed by your buyer, a contract buyer can solve that problem for you. When you close the sale on the house, draw up a new mortgage for the entire cash amount owed on the house subtracting the down payment. In the case of our example, this new mortgage would be for $80,000.00. When the contract buyer purchases the deal from you, they'll use part of the cash proceeds they pay for the contract, to pay off the $40,000.00 balance owed on the first mortgage. The cash that's left goes to the home seller. So, loans that aren't assumable are no problem for contract buyers. They simply pay off any senior mortgages from the cash proceeds when the deal closes. Now, we'll show you a second mortgage that would not be as good.
EXAMPLE OF A LOW QUALITY SECOND MORTGAGE
House sells for: $100,000.00
Down payment: $5,000.00
Seller still owes on a first mortgage with a remaining balance of: $85,000.00 (equity only 15%)
Home seller creates a second mortgage with eight-year pay back term at 10%: $10,000.00
It would be very hard to get a fair price from a contract buyer for this second mortgage. The first mortgage still owed on the house has a huge balance of $85,000.00. Let's say a contract buyer bought this second mortgage. Six months later it goes into default. The contract buyer would either have to make the payments on the first mortgage, or pay it off to protect their investment. This would not make financial sense for the contract buyer. There is too little money invested to take on the financial responsibility of the first mortgage. Remember it's hard to do well selling second mortgages when the equity in your home is low. Each case varies. Talk the situation over with the contract buyer.
If the equity is low in your home at this time consider waiting awhile before selling. Your equity will get better as your home goes up in value. Plus, you'll owe less on your first mortgage. The information in this article will work just as well in the future as it does today. Keep it handy and review from time to time. We've covered a lot of information. We hope you're convinced that owner financing dramatically increases your ability to sell your home quickly.
