Seller Financing

I was asked, “What is the advantage for a seller to take-back financing?”

In most cases, the seller can earn a higher monthly income taking back financing than selling the property, paiying the taxes, and putting the balance into a savings account.

Selling and paying the capital gains tax, leaves me with less money to reinvest.  Holding  financing, (a) I delay paying capital gains taxes until the future and (b) I can usually earn a higher rate of return on a mortgage than I could putting the money into a certificate of deposit at the bank.  The advantage is (1) earn a higher rate of return, and (2) earn that higher rate of return on a larger amount of money.

When a property is sold, the gain must be computed.  In this example, my property sells for $300,000.  I pay 8% in broker fees, transfer taxes and other closing costs, netting $276,000.  I purchased the property many years ago, so by taxable “cost basis” is very low, at only $50,000.  Take the sale price, minus the selling costs and minus the cost basis to compute the “taxable gain”; that is, the amount subject to capital gains taxes.  A 20% Federal Capital Gains Tax Rate and a 7% Maryland Capital Gains Tax Rate makes for a total tax bill of $61,000 leaveing me with $215,000 to invest.

$300,000 Sale Price
– 24,000 Selling Costs (transfer taxes, broker fee, etc)
50,000 cost basis
226,000 taxable gain
    27% capital gains tax rate (20% federal, 7% state)
61,000  capital gains tax
215,000 = Sale Proceeds After Taxes (sale price, less selling costs, less capital gains tax).

Investing $215,000 into a 5-year certificate of deposit at the bank yields 2.5% per year, or $450 monthly interest income.

Electing Seller Financing, let’s say the buyer puts 20% down and I hold a first mortgage at 5% interest, amortized over 30 years, with a balloon payment due in 5 years.  Now, I get $36,000 in cash at closing, after paying broker fees and closing costs, and holding a $240,000 mortgage.

$300,000  Sale Price
–   24,000  Closing Costs
– 240,000  Seller Take-back Mortgage
=$36,000  cash at closing

$240,000 at 5% amortized over 30 years is a $1,288.37 monthly mortgage payment, of which about $1,000 is interest and the principal is just under $300 per month.

In retirement, which would I rather have:  $450 interest payment from the bank CD or a $1,288.37 monthly mortgage payment that I collect from the buyer?

Concerned about risk?  Nationally and historically, only about 5% of seller-held mortgages go into default.  Would it be so bad if the worst case scenario were foreclosing and taking the property back, only to sell it to someone else?

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