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?


Ben Frederick Realty

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