WHY NOT??? - Posted by JohnBoy
Posted by JohnBoy on November 17, 2000 at 16:55:00:
Why wouldn’t you sell owner financing because you might have to pay taxes on any interest you make??? That would be taxes on the interest, which is additional profit. I don’t see that being a concern at all.
You have up to three years to sell the property after you move out of it and still get the tax free deduction on the gain from a sale for a property you lived in as your personal residence. It’s if you lived in the property 2 out of the last five years at the time you sell it, you get to take the deduction. So she could make MORE money off this for up to 3 years until she needs to sell it and still keep the tax deduction.
She could L/O this for about 10% ABOVE RETAIL MARKET VALUE giving a one or two year option, get anywhere from 3% - 10% down as NON-REFUNDABLE OPTION CONSIDERATION and lease the property for up to $200 per month ABOVE the market rent going for rental property in the area depending on the price bracket of the home, and end up making a whole lot more money off this deal! Meanwhile her $40k equity is in one of the SAFEST places to be. In real estate!
If her tenant/buyer doesn’t exercise their option then she can get a new tenant/buyer and start over again with more option consideration, higher rent and a higher option price after each year!
She doesn’t say what her home is worth or what market rents are in her area for a house simular to hers. So lets use an example to get an idea of what she could make using a home worth $100k today with market rents at $1,000 per month?
She could offer that on a L/O for $110k, get $5k down as non-refundable option consideration and lease it for $1200 per month, for ONE YEAR.
At the end of one year she will have made $5k cash up front plus $200 per month cash flow ABOVE market rent for a profit of $2400 in cash flow plus the $5k option consideration. If her tenant exercised the option she would get $105k at closing which is $5k above what the market value was a year ago! Since she said she has $40k in equity and assuming this house was worth $100k, that would mean her mortgage balance is about $60k. So we could safely assume for this “example” that her mortgage payment is around $600 per month.
That means her total cash flow would be $600 per month leasing it at $1200 per month for a total cash flow of $7200 over the first 12 months. $7,200 plus the $5k option consideration = $12,200 profit in one year so far.
If the tenant exercises their option they would owe $105k. $105k plus the $12,200 profit = $117,200 she would end up getting for the property after one year. Instead of cashing out for the $40k equity TODAY, she now has made $57,200 instead of just $40k. An additional $17,200 profit and NO real estate commission to be paid! That would have given her a 43% return on her $40k by leaving it in the property.
Assuming the tenant didn’t exercise the option, she starts the process over again the second year getting another $5k option consideration and leasing the property for $1250 per month with an option price of $112,500 (assuming values have continued to go up in the area).
So during the second year she makes a monthly cash flow of $650 for 12 months = $7,800 plus the $5k option money for a total profit of $12,800 in year two!
If the tenant exercises the option this time around they would need $107,500 to buy the property. $107,500 plus $12,800 = $120,300 for the property the second year. Her $40k equity left in the property would have earned her a 51% return for this year.
If this tenant doesn’t exercise then she starts over AGAIN and gets a new tenant with another $5k option money and leases it for $1300 per month the third year with an option price of $115k.
This time around she makes $700 per month cash flow for 12 months for a profit of $8,400 plus the $5k option money for a total profit of $13,400.
If this tenant exercised the option they would need $110k at closing to buy the property. $110k plus $13,400 = $123,400 for the property. She would have made $63,400 instead of just $40k. Her $40k would have made her a 59% return in the third year.
So lets see. After three years assuming the third tenant exercised the option, she would have made a total profit over three years of:
1st year = $12,200 cash flow
2nd year = $12,800 cash flow
3rd year = $13,400 cash flow, plus $110k at closing minus her $40k equity minus her $60k mortgage balance = $10k additional profit for a total profit of $22,800 the third year IF the option was exercised this time around.
That a total profit of $48,400.00 over 3 years in ADDITION to her $40k equity she has now. That’s a total return of 121% on her %40k equity over just three years!!!
Ahhh! But you say, what if the third tenant doesn’t exercise their option, then she loses her tax free deduction on the $40k! Simple! The FOURTH time around, instead of selling on a L/O, sell it on a contract for deed! That’s a sale and would qualify to keep the deduction.
Now you sell on contract for deed for $120k and get $10k down, carry the contract for 3 years amortized over 30 years at 12% interest.
That means you collect principle and interest payments of $1131.47 minus the $600 mortgage payment on the underlying loan for a monthly cash flow of $531.47 for three years.
After three years she would make 36 months x $531.47 = $19,132.92 in cash flow plus the $10k she got down for a profit of $29,132.92 over three years.
At the end of three years the contract balance owed would be about $108,644.37. After deducting the $60k mortgage balance and her original $40k equity that leaves her with another $8,644.37 profit plus the $29,132.92 cash flow and down payment money she received for a total profit of $37,777.29 over three years.
Now lets see what that $40k equity made her after 6 years?
1st year = $12,200
2nd year = $12,800
3rd year = $13,400
4th - 6th year = $37,777.29
Total profit = $76,177.29 over 6 years!
After the 6th year when her buyer is required to refinance and pay off the contract for deed she will walk away from closing with $48,644.37.
So instead of taking $40k now, she turns it into getting $116,177.29 instead by selling on terms and leaving the $40k in the property over 6 years.
Where else can you put $40k today where it is 100% SAFE, and turn into $116,177.29 over 6 years?