I get lots of calls from people asking about the advantages of investing in mortgage notes. Most of those calls come from landlords who own one or more rental properties, and they share a common dilemma. The reason they bought rental properties was to have stable, monthly stream of income—not because they wanted an endless stream of headaches from tenants.
They want to sell their properties to stop the headaches, but they don’t want to stop to their monthly income. They’re also concerned about paying taxes on their capital gains. So, let’s discuss their options.
One simple option is to sell their properties and invest in mortgage notes with the profits. While I’m happy to sell them notes, I ask them to consider selling the property and “carrying back” the note with seller financing. Then I explain the benefits of this technique, but first we discuss their goals.
Identifying Your Investment Goals
I ask them their overall plan and how this particular investment fits in:
- Is your goal to build your retirement?
- Do you want to create cash flow to cover market cycles?
- What is your time frame?
- Is the income for now or later?
- Have you set markers to gauge your progress?
- What level of risk are you willing to accept?
All these factors must be considered before making the decision to sell a property by offering seller financing to the buyer.
In addition to reviewing your goals, here are some other important aspects to consider.
Seller Financing Consideration
Know Your Buyer
In this regard, there are two key aspects to evaluate: Will the buyer be able (and willing) to make their payments, and will the buyer manage the property to increase (or decrease) its value.
As for ascertaining the buyer’s ability to make the payments, if you sell the property to a reliable tenant you’ll have some assurance from your previous experience with them. If you sell it to someone you don’t know, there are many credit reporting services that give you a clear history of how they’ve paid previous obligations. Just like any bank, you can approve or decline any potential buyer. Since you, as the note holder, would receive the property back if the buyer defaults, it’s important to find a buyer who will take pride in owning their home and has enough margin in their income to pay the taxes and keep the property in good condition.
Maximize Your Return on Investment
Here’s an example to explain this. If you sell a property and have a $1,000,000 gain, the tax most likely will be in the 30%+ range which is $300,000. That must be paid in the same year the property is sold (which is a huge hit). However, if you sell the property and create a note, you can defer the tax by spreading it out over several years, plus get a healthy return from the interest charged to your buyer. By creating a note at say 8%, with a 20-year term you’ll receive an extra $31,123.90 in interest payments. Considering your low risk level and rate of return, that’s much better than many other types of investments.
Increase Your Number of Potential Buyers
By offering seller financing to your buyer, you’ll actually have a larger pool of well-qualified buyers to choose from than traditional lenders have. That’s because many mortgage companies automatically turn down buyers who aren’t US citizens, or they’re self-employed and don’t have W2 income, or the amount they want to borrow is below the bank’s minimum lending limit. (About 35% of well-qualified buyers with good credit scores are being turned down by traditional lenders.) These “penalty box” buyers are often happy to pay more in purchase price and interest, so you’re more likely to get your desired selling price.
It doesn’t take long to see the advantages of owning notes instead of rental properties. If you’ve been a landlord, you’ve grown accustomed to the consistent cash flow provided by rentals. But you also know about the hassles of dealing with tenants, toilets, and turnover. By selling the property and creating a note, you can continue receiving that consistent cash flow without those headaches. Plus, you don’t have to pay property taxes or insurance on the rental property. When you sell you can also defer the capital gains taxes over many years.
We’re happy to answer any additional questions, so if you’d like more information or assistance with creating a note, please call or email us. We can be reached at 800.508.5212 or firstname.lastname@example.org