How to Use Hard Money for Seller Financing Deals
As a hard money lender, I often get asked how to use hard money in a seller finance transaction. In this article I will explain two possible scenarios you may come across when using hard money in a seller financing deal. With the right knowledge and funding sources, using hard money in seller financing transactions can be done successfully.
Seller financing can be an attractive option for buyers and sellers of real estate alike, especially when a seller has motivation, a low interest rate mortgage, or a lot of equity. Seller financing can allow real estate investors to purchase or control real estate investments without the need to take out a traditional mortgage loan from a bank. Meanwhile, sellers benefit by getting a higher asking price and earning additional income.
But here’s the thing. Most sellers want you to bring in a down payment on a seller finance transaction. This is the part where many real estate investors don’t know how to proceed because they don’t have cash for a down payment.
Hard money loans are used by real estate investors to fund real estate purchases, so why can’t you use hard money in seller financing deals? Understanding how hard money loans work in seller finance transactions is an essential lesson for newbie real estate investors. Keep reading because I am about to give you a crash course for how to use hard money in seller financing deals.
Using Hard Money Loans in Wrap-Around Mortgage Transactions
A real estate investor offering to purchase a property from a seller may ask if the seller is willing to finance the purchase. When a seller has an existing loan on a property, the seller may offer financing through the existing loan already in place. This type of seller financing is often called a “wrap-around mortgage” because it allows a buyer to control a property while using the seller as the lender. In this scenario, the seller is able to finance the purchase for the real estate investor at a higher interest rate than the interest rate on the underlying loan on the property. This means the real estate investor is able to purchase the property without having to get a bank loan.
However, most sellers want to see a down payment from the buyer of anywhere between 5% to 20% of the purchase price. You can get a hard money loan for the down payment to the seller, however, it needs to be funded by a hard money lender that is willing to take a “junior lien” position behind the seller’s first mortgage. If you go to a hard money lender to request down payment funds on a seller financing deal with a wrap around mortgage, you will be asking for a 3rd position mortgage loan. If this is confusing for you, it will make more sense once you learn how to structure a seller financing deal with a wrap-around mortgage.
Wrap-around Mortgage Example
Let’s consider an example. You find a property listed for $300,000 that isn’t selling and it has been sitting on the market for a long time. So you approach the seller with a full price offer of $300,000, but only if the seller is able to offer seller financing. The seller has a first mortgage loan on the property and wants 10% down payment from you, or $30,000.
You don’t have the down payment of $30,000 so you will need to find a hard money lender that is willing to enter into a junior mortgage position behind the seller’s first mortgage in order to provide that 10%. This means there are three loans. The seller’s existing mortgage is in a first position and the seller’s financed loan is in a 2nd position, wrapped around the existing first mortgage. Then you have the down payment funds from your hard money lender for $30,000 in a 3rd position. This means the hard money lender is in a junior lien position, or a subordinate position to the other financing.
Many hard money lenders won’t go in a junior lien position. This makes it more of a challenge to get the down payment funds from a hard money lender on a seller financed deal with a wrap around mortgage. But there are always hard money lenders out there that will lend in a junior lien position, even though some of them won’t!
What if a Seller Does Not Have a Mortgage?
In this scenario, you approach a seller to purchase a property with seller financing and you discover that there is not a loan on the property. The seller will ask for a down payment, but you don’t have the down payment funds. You may get a hard money lender to loan you the down payment funds to give to the seller. However, the hard money lender will usually want a first mortgage position where the seller’s financing takes a junior position.
Most sellers won’t take a 2nd mortgage position behind your hard money lender, but some sellers will, if it’s a small amount. In this case you can offer your hard money lender a 1st mortgage position with the seller carrying the remainder of the financing in a 2nd mortgage position.
However, if your seller will not take a 2nd mortgage position behind your hard money lender, then you will need to find a hard money lender that is willing to go in a second position behind the seller financing loan.
Let’s consider the same example that we used before. You find a property listed for $300,000 that isn’t selling and has been sitting on the market for a long time. So you approach the seller with a full price offer of $300,000, but only if the seller is able to offer seller financing. The seller does not have a first mortgage loan on the property but the seller wants a 10% down payment from you, or $30,000, in order to seller finance the purchase.
You don’t have the down payment of $30,000, so you will need to find a hard money lender to loan you the down payment funds. You will need a seller that is willing to enter into a second mortgage position behind the hard money lender’s first mortgage. Or, you will need to find a hard money lender that is willing to go into a second mortgage position behind the seller financing. Most hard money lenders will insist on a first mortgage position so it would be easier to find a seller that is willing to go in a second position behind the hard money lender. However, if your seller is unwilling to go into a second position behind the hard money lender then you need to find a hard money lender that is willing to go into a second position behind the seller financing.
Qualifying for a Hard Money Loan
Hard money loans are considered to be much easier to qualify for than traditional bank financing. However, even hard money lenders need certain information from borrowers in order to make an informed decision. Submitting a loan to a hard money lender is easier than you may think. Check out this article where we explain how to make loan submissions to hard money lenders to get a yes or no answer quickly.
Negotiating Terms on Hard Money Loans
When applying for a hard money loan, it’s important to be aware that there may be room to negotiate the terms of the loan. While traditional banks often have inflexible terms, hard money lenders tend to be more flexible on the terms of the loan. This includes flexibility on interest rates, fees, and extension options.
Potential Pitfalls of Seller Finance Transactions
Seller finance transactions can provide buyers a way to purchase properties without having to obtain loans to do so. However, it’s important to be aware of the potential pitfalls involved with such transactions. These risks include: the seller may be behind on loan payments, the seller may have liens on the property, or there may be a divorce in process that is not disclosed by the seller.
Legal Aspects of Seller Finance Transactions
When engaging in a seller finance transaction, both the buyer and seller should be aware of the legal implications. This includes understanding the rights and responsibilities associated with each party, as well as any potential liabilities that might arise during the course of the loan. Each state has its own set of laws and regulations regarding seller finance transactions, it’s important to familiarize yourself with the rules in your jurisdiction before entering into any agreement. This includes information on things like maximum loan amounts, required disclosures, and licensing requirements.
An experienced real estate attorney can provide guidance and help ensure that everyone involved is protected by creating a solid, legal contract. Whatever money you spend on a good real estate attorney is worth every penny to make sure you are getting into a good deal, with a binding contract, that won’t come back to bite you!
Structuring Financing to Meet Your Needs
When financing a seller financed purchase with a hard money loan, it’s important to carefully consider the terms of the loan in order to structure the financing in a way that meets your needs. This includes understanding what types of loans are available, as well as the repayment terms and interest rates associated with each option. It’s also important to consider any potential tax implications of taking out a loan.
Conclusion
Seller financing can allow real estate investors to purchase investment properties without the need to take out traditional bank loans. Getting access to a down payment in a seller financing transaction should not deter a real estate investor from engaging in these deals. If you understand how to use hard money loans correctly to source a down payment, you can make a seller financing deal work for all parties involved.
