The terms of a seller-financed transaction have a dramatic impact on the price an investor will pay should the seller ever decide to sell their note, mortgage, trust deed or contract. Here are the key elements of a seller-financed transaction that will ultimately determine its fair market value.

• Down Payment – The general rule is “more is better.” The more a buyer has invested in the property from the start, the less likely they are to stop paying, go into foreclosure, or just walk away from the property. A down payment of 20 percent of the sales price is ideal (more if you can get it), and a 10 percent down payment should be the minimum accepted in most situations. The down payment creates immediate equity which is a key element in the pricing equation should the note be sold a year or two down the road.
• Credit Score – The credit report reflects the buyer’s past payment habits, making it a generally reliable indicator of how timely they will pay the seller. The buyer’s credit score should preferably be above 625, with an ideal score of 675 or higher. Note buyers will discount the offer price for notes where the borrower has a lower credit score since this increases the investment’s risk.
• Interest Rate – The ideal interest rate for a top-dollar seller-financed notes is currently in the 8% to 10% range. Notes with a lower interest rate will require a larger discount when sold. For example, a note written at 4 percent interest might only be worth half of its unpaid balance to an investor. Be careful to follow current mortgage laws when deciding what interest rate to charge. Keeping the monthly payment in line with market rents for a comparable home may also be a factor when deciding on the interest rate. Don’t even think about offering an interest-only mortgage loan.
• Term – Note buyers generally like shorter terms and amortizing payments. However, there’s always a dance between sales price, interest rate, monthly payment amount and term (length) when crafting a seller-financed transaction. Traditionally, a 360-month amortizing loan with a 5-7 year balloon payment was considered a good balance, keeping the payment reasonable for the buyer while also minimizing the discount should the note ever be sold to an investor. However, federal legislation enacted after the 2008 housing crisis has placed some limitations on the use of balloons for owner-occupied home sales. Be sure to know and follow all applicable laws when designing the seller-financing terms.

Unlike when dealing with a bank, a distinct advantage with seller financing is that the terms are negotiated and agreed upon by the buyer and seller. When selling a property with seller-financing, just keep in mind that if the buyer gets everything they ask for then the seller will most likely pay with a larger discount should they decide to sell their note.

Think of the negotiation process as an attempt to balance the scales. If the buyer is willing to come up with a larger down payment, the seller might reciprocate by lowering the interest rate. If the buyer’s credit is less than desirable, then a higher down payment and interest rate might be appropriate.

Whatever you do, don’t be the seller that ends up with a zero-down, interest-only, poor-credit note. If you are that seller, then you’ll be hard pressed to find an investor even willing to make an offer on your note. In fact, notes structured heavily in favor of the buyer are statistically much more likely to result in default and foreclosure, an outcome that nobody wants.

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