No Interest Real Estate Loans Work For Some Sellers
Posted on November 30, 2007
For the past 30-35 years, the baby boom generation has driven economic trends in this country, and this movement will continue. As the population ages, I predict there will be excellent opportunities for both investors and homeowners to buy properties from aging boomers, and get seller financing at rates as low as zero percent. Many elderly sellers will be moving in with relatives or into retirement communities and will want to convert real estate equities into retirement income.
It’s a sad but true fact that many aging boomers will have little for retirement other than their monthly social security checks and the equity in their homes. Unfortunately, hundreds of thousands of them have had their retirement nest eggs wiped out or severely reduced by the tumble in the stock market a few years ago and by bankruptcies of major companies like Enron and K-Mart. As these people retire, many of them will be looking to downsize their homes and to convert the equity in their existing homes into supplemental income.
Sure, they could sell their properties and invest the cash in dividend-paying stocks, bonds, or certificates of deposit. The problem with doing that is that fluctuating interest rates produce an income stream much like a roller-coaster ride. When interest rates dropped to the historical lows that fueled the real estate boom of the early 21st Century, the rates banks paid for deposits dropped to the point where a $250,000 certificate of deposit produced less than $350 per month in income.
Sellers who had financed the sale of their properties at 8-12 percent interest or higher, and were expecting a nice income stream for retirement, suddenly found buyers refinancing and paying off the notes. Many of them suffered because they were unable to find a place to reinvest the money at a rate even close to the rate they had been getting. Even people with substantial amounts of cash were forced to curb their lifestyles when CD rates dropped from 6-8 percent to under 2 percent.
Financing all or a portion of the sale of real estate at zero percent interest can be attractive for some sellers and here’s why. Instead of taking a big discount to sell a property during a down market, sellers who are able to do so can often get full asking price and more if they are willing to finance at zero percent or very low interest rates.
Suppose a seller has a house listed for sale at $150,000 and an interested buyer who can only afford a $1,000 per month payment. If the buyer plans to keep the house and isn’t just looking to flip it for a profit, what’s the difference between offering $100,000 and asking the seller to finance it for 15 years at about 9 percent interest or offering $180,000 and asking the seller to finance it for the same number of years at zero percent interest? Either way, the payments would be $1,000 per month, but sellers who might be offended by a $100,000 offer may not be by one priced at more than the asking price.
If offered $100,000, the seller would see it as having to discount the price $50,000 and still have to worry about the purchaser refinancing and paying off the loan whenever interest rates fall. By offering $180,000, the seller sees a $30,000 higher price and never has to worry about fluctuating interest rates. Paying off a zero interest loan early would be foolish. For example, if rates dropped drastically after 30 months, it would still take $150,000 to pay off the remaining 150 months of the loan. This type financing assures the seller of a steady income of $1,000 per month for 15 years no matter what interest rates do, and the loan is secured by the real estate. Naturally, sellers, just like banks, would want to check a buyer’s credit history and background in order to feel comfortable doing business this way.
Here’s a tip! Never assume that sellers won’t finance the purchase of their property and never assume that they won’t accept interest rates as low as zero percent. The only way to find out for sure is by making a written offer and asking for what you want.
Zero interest financing may seem impossible to those who think the only way to buy is the conventional way, with a 20 percent down payment and a bank loan for the balance, but I’ve been doing deals like this for years. In real estate, price and value are not the same. When you understand that value is the combination of what you pay and how you pay it, it’s possible to have the same value at many different prices. Both buyers and sellers should consult their accountants or other tax professionals about such transactions, but in most cases the tax impact is negligible.
Here are a couple of other things you may want to think about. As a buyer, you should insist on an assumption clause that would allow you to sell the property and give the new buyer the right to assume the loan. As a seller, you may want to reserve the right to approve any new buyer before allowing the assumption. Another option is for the seller to reserve the right to approve a new buyer, but also include a prepayment clause in the event the new buyer is not acceptable. This prepayment clause could give the new buyer the right to pay off the loan early at its discounted present value based on the number of months remaining and the current rate of interest.
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