Rising interest rates are going to drastically slow down the real estate market for the next couple of years. We have been through this cycle many times before, and we also know that the higher rates will cause rents to rise as well.
It may seem counterintuitive that rents go up as property values go down, but the higher rates push buyers out of the home ownership market, causing a glut of renters in the rental market.
Owner financing may be one solution to this problem as more and more buyers are unable to get qualified for traditional mortgages and sellers are left still wanting top dollar for their properties.
How Owner Financing Works
Owner financing is a way for a home buyer to purchase a brownstone without the help from a lender, as the home seller essentially acts as the lender. The buyer and seller agree on a price and instead of paying with funds from a lender, the buyer simply signs a promissory note agreeing to make payments to the seller.
The note lays out the purchase price, interest rate and other terms of the loan, and the consequences of default. Typically the loans come with a balloon payment after five years. At that time the buyer can either get qualified for a traditional mortgage or agree to new terms with the seller.
Advantages for Buyers
Buyers may like a seller financed property because it allows them to get into a brownstone and start building equity without having to get qualified for a traditional mortgage. Especially with tightening credit requirements, this could be a benefit to a lot of buyers.
The interest rates and sale price are often higher than on properties with a traditional mortgage, but the choice for a buyer usually isn’t between seller financing and traditional mortgage, it is between seller financing and renting another year or two. When compared to renting, seller financing at the less favorable terms is still better than renting.
Advantages for Sellers
While generally a seller wants to get the immediate cash payment associated with a traditional mortgage, there are significant advantages to the seller if they agree to finance the sale.
As higher interest rates push down property values, a seller financed property can still command a higher sale price. Also, the sale can be closed much faster since there is no underwriting or funding process from the bank. In addition, the property can usually be sold in an as-is condition, compared to the needed repairs that a bank will usually demand before the transaction can take place.
If the seller can defer the lump sum of cash until the balloon payment comes due, seller financing can solve the problems that arise in this rising interest rate environment.
Opportunity to Investors
This environment may present a golden opportunity for investors as well. Not all sellers will want to finance their own sales. For cash rich investors, this will be an opportunity to buy up properties at a discount. They can then flip the properties to buyers using the seller financing model.
As is so often the case in real estate investing, those who can stay creative and flexible will always be able to find an advantage.
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Authored by: Stanley Montfort
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