Understanding the Seller Financing Interest Rate and Seller Financing Down Payment
Using owner financing to sell your property can be a great way to earn a return on the equity you've built up over the years, offering several passive income and seller financing tax benefits. This return is influenced by the principal amount, initial seller financing down payment, loan term, and seller financing interest rate. Together, these factors determine the monthly payment and the total amount you will receive over the life of the seller financed loan.
Many people assume it's as simple as requesting a high seller finance interest rate and large owner financing down payment from a buyer. However, this is an outdated approach and there are pros and cons, as well as various risks, that should be considered when setting these amounts for an owner financed sale.
In this article, we'll cover what a seller financing interest rate is, if there is an average interest rate for owner financing, how to determine an appropriate seller financing down payment, and the risks associated with these decisions. By the end, you'll have a solid understanding of how to set these parameters for your sale and be ready to structure an owner financed arrangement to sell your property.
While we specialize in purchasing properties with seller financing from owners like you and are familiar with how to structure an owner financing interest rate and seller finance down payment, we are not legal, tax, or finance professionals. Therefore, this information should not be taken as legal, tax, financial, or investment advice. We recommend using this as a general guide to better understand the aspects of owner carry interest rates and owner finance down payments, but always consult with a legal, tax, or finance expert to evaluate your specific situation.
Want a Seller Financed Offer on Your Property? Get an offer from our team. We specialize in purchasing properties directly from owners with seller financing.
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Before We Begin: Understanding the Structure of an Owner Financed Loan
Owner financing, also known as seller financing, is a creative financing process where the property owner acts as the lender and extends a loan to the buyer using the equity in the property. The seller then earns passive income from the buyer's monthly payments until the loan is paid off. For a more detailed explanation of owner financing, you can check out our separate article here.
Just like any other mortgage loan, an owner financed loan is structured with specific inputs that determine the monthly payments owed by the borrower to the lender:
Property Sales Price
Buyer's Seller Financing Down Payment
Owner Financed Loan Principal
Seller Financed Loan Term
Seller Financing Interest Rate
The owner financed loan principal amount is determined by the difference between your property sales price and the seller financing down payment you receive. This principal amount is then repaid over the seller financed loan term with an owner finance interest rate, both of which you decide on directly with the buyer. This flexibility allows you to structure a deal that works for both you and the buyer, unlike traditional mortgage loans where terms are set by the market and then you pay intermediaries like realtors to set a sales price.
The challenge lies in setting these seller financed loan inputs to ensure you get a solid return while minimizing potential risks down the road.
What is a Seller Financing Interest Rate?
The seller financing interest rate determines the return you make on a seller financed loan and this rate is similar to any other mortgage loan interest rate. It is the amount the seller charges a borrowing buyer and is a percentage of the principal. In the monthly seller-financed loan payment, a portion goes toward interest and the other portion toward the principal. The principal amount reduces the loan balance, while the interest amount is your return on top of the principal for lending to the buyer.
Adjusting the seller financing interest rate will change the monthly payment size, your return on the owner financed loan, and the amount of interest you earn each month. The key difference in the seller finance interest rate compared to a mortgage rate is that you set this rate directly with the buyer, without being subject to any set standards.
What is the Average Seller Finance Interest Rate to Expect?
The seller financing interest rate varies based on several factors so there is not typically an average interest rate for owner financing to expect. It depends on your goals, the type of property you’re selling, current market conditions, the type of buyer (retail or investor), and the specific sale terms agreed upon (e.g., loan term length, sales price, owner finance down payment amount). A seller finance interest rate can be lower or higher than conventional mortgage rates that you might see in the market. This flexibility really depends on what the seller is willing to accept and what the buyer is willing to pay.
Why is the Seller Financing Interest Rate Not Just the Same or More Than What a Bank Charges?
There are several reasons for why there are differences in the seller financing interest rate from both the seller's and buyer's perspectives. The seller financing arrangement not only benefits the buyer but also provides numerous advantages to the seller. Let’s explore a few of those:
Benefits for the Buyer:
Seller financing allows buyers to bypass the lengthy and sometimes difficult conventional loan process.
Enables buyers to work directly with the property owner.
Helps buyers purchase a property more easily and quickly.
Benefits for the Seller:
Sellers can delay their tax burden and earn a return on the principal amount in the interim. This typically results in a higher principal amount earning interest compared to the amount after capital gains taxes in a cash sale.
The seller financed loan is secured by the property itself, providing a tangible asset as collateral.
Allows the seller to earn steady passive income without the headaches of property management.
Increases the pool of buyers and helps the sale of properties that might not qualify for a conventional loan.
It's also important to consider the typical buyer who purchases properties with owner financing. These buyers are often either family members or friends, retail buyers who cannot qualify for a conventional loan, or experienced property buyers. For family members and friends, sellers usually offer a preferential owner financing interest rate to avoid overcharging loved ones. Retail buyers who plan to live in the home often choose seller financing because they cannot qualify for conventional loans. And finally, experienced property buyers who make up the majority of owner finance purchases and try to structure the deal to benefit both parties.
As a benchmark, if current conventional mortgage rates are around 6-7%, a seller financing interest rate might range between 3-5% on average. This range typically still benefits the seller by accounting for tax advantages, ensuring long-term passive income, and reducing default risk through manageable monthly payments.
Ultimately, these rates are flexible so you should set a rate that works for both you and the buyer. The goal is to find a seller financing interest rate that provides a solid return on your investment while still remaining attractive enough to secure a reliable, low-risk buyer.
What Are the Risks of a High Owner Finance Interest Rate?
It's easy to focus on securing the highest owner finance interest rate to maximize your return. However, this can lead to significant risks that are often overlooked. When you offer owner financing, you rely on the buyer to repay you. If they fail to do so, your primary recourse is to foreclose on the property – just like a bank. This is far from ideal and should be avoided whenever possible.
A high owner finance interest rate increases the buyer's monthly payment which can lead to the following risks:
Early Payback to Avoid a High Seller Finance Interest Rate
The goal of seller financing for most is to receive steady passive income over the life of the owner financed loan and delay a cash-out situation for the property (e.g., passive retirement income). A high seller finance interest rate incentivizes the buyer to refinance as soon as they can secure better rates elsewhere. If you were expecting steady monthly income for many years and the buyer refinances early, paying you off in cash, you lose the tax advantages of this method and your remaining capital gains burden on the sale become due.
While this might seem like a good outcome if you want to be paid back quickly, it introduces another major risk.
Buyer Default Due to a High Owner Finance Interest Rate
Higher monthly payments make it more challenging for buyers to pay the debt. This is why it’s not always wise to lend to someone who cannot qualify for a conventional loan. If a bank, whose business is to make loans to qualified borrowers doesn't think a borrower can repay, it's risky for you to lend to that same borrower at a higher rate. If they couldn’t afford the bank's rate, they likely can't afford your higher owner finance interest rate either. They may also struggle to refinance when the loan comes due if you have a shorter payback period with a balloon payment.
This significantly increases the risk of buyer default because you're lending at a rate higher than the market. The goal is to ensure the loan can be repaid regularly over its entire term regardless of unforeseen market cycles. That way you have a reliable and low risk loan to manage.
That's why, when we purchase properties with seller financing we perform due diligence to ensure the monthly payment doesn’t only provide the seller with a great return but it is also affordable for the long term. We consider local rental rates and other factors to make sure the loan can be serviced regularly which allows you to enjoy passive income without worry.
What is a Seller Financing Down Payment?
A seller financing down payment is essentially the same as any other down payment a buyer makes when purchasing a property. It is an initial payment covering a portion of the purchase price. The key difference in seller financing is that you, the seller, receive this portion in cash while the remaining amount of the sale price is financed to the buyer through an owner financed loan provided by you.
Adjusting the seller financing down payment affects several aspects of the property sale:
Seller Finance Loan Amount: The size of the seller financed loan changes with the owner finance down payment amount as it represents the remaining purchase price after the down payment.
Monthly Owner Finance Payment: Since the loan amount changes, the monthly payment the buyer will pay will also adjust accordingly.
Capital Gains Taxes: The seller financing down payment amount can influence the capital gains taxes you might need to pay in the year of the sale because you are not spreading this portion of the sale over multiple years.
How Do You Determine an Appropriate Owner Financing Down Payment?
Setting an appropriate owner financing down payment, like the seller finance interest rate, is a flexible process you can decide on directly with the buyer. There are no set standards or requirements and in some cases you might choose not to require a owner financing down payment to maximize tax advantages and increase your monthly passive income. Unlike the 5-20% range commonly associated with conventional loans, seller financing allows for more personalized terms that work for both the seller and buyer.
You should consider the following factors when determining an appropriate owner finance down payment:
Manage Risk Tolerance with an Owner Financing Down Payment
A down payment could reduce your risk by providing upfront cash and may help ensure the buyer has a vested interest in the property. However, it’s important to balance this with what is needed to attract a solid buyer.
Seller Financing Down Payment’s Impact on Loan Terms
The seller finance down payment directly affects the initial loan amount and the size of the monthly payments. It’s important to make sure the loan remains profitable for you while being manageable for the buyer. Feel free to check out how this changes the terms with our seller finance calculator.
Owner Finance Down Payment’s Tax Implications
A owner finance down payment can have immediate capital gain tax consequences so it’s a good idea to understand these implications before deciding on an amount. You can learn more here about seller financing tax implications.
By carefully considering these factors, you can determine the ideal owner financing down payment (if any) for your seller financed sale. However, you’ll also want to also consider any pros or cons of each factor before you set a large seller financing down payment.
Pros and Cons of Setting a Large Seller Finance Down Payment
The decision for if you should set a high seller finance down payment mainly involves weighing the pros and cons related to risk tolerance and tax implications.
Pros of a Large Seller Finance Down Payment:
Ensures the buyer has “skin in the game”, possibly reducing the likelihood of default since they risk losing a large upfront payment.
Provides immediate cash in your pocket which can be a huge plus in certain situations.
Cons of a Large Seller Financing Down Payment:
You might see immediate capital gains tax consequences due to the large upfront cash received.
You may see lower returns with a large owner financing down payment. Less cash upfront can be beneficial if your goal is to maximize returns and increase monthly income, as it results in a higher loan amount that accrues interest.
Ultimately, there is no set amount for a seller finance down payment and your decision should align with your financial goals and the specifics of your property sale.
Seller Financing Offer & Tools
Seller financing requires a clear understanding of the process and the right buyer. We specialize in purchasing properties with seller financing for our portfolio and can provide you with a Seller Financing Offer. Alternatively, you can leverage our Owner Financing Tools and Contract Templates to navigate the seller financing process on your own.
Additional Seller Financing Resources You’ll Love
Our Owner Finance Contract Template
What Is Seller Financing?
Understanding Seller Financing Tax Benefits and Seller Financing Tax Implications
Checklist And Paperwork for Selling A House Without A Realtor
How to Retire with Seller Financing
Strategic Ways of Transferring Ownership of Property from Parent to Child
Seller Finance Calculator
