Selling a rental property with owner financing

Why landlords look at owner financing

Some owners want to keep a stream of income without the late-night maintenance calls. Others have a property that is hard for a typical bank-financed buyer to purchase, perhaps because of its condition, its mix of units, or a rent roll that does not satisfy a lender. Offering financing can widen the pool of buyers who are able to make an offer.

There can also be tax timing reasons, because payments received over several years may be reported over several years under the installment method. That is a topic for your tax professional, and the depreciation you claimed as a landlord changes the picture, which we cover in a separate article.

The trade-off is that you stop being a landlord and become a lender. Your money is tied to a buyer's ability and willingness to pay, and the property you sold is now the collateral that protects you.

How the paperwork usually fits together

In a common setup, title passes to the buyer at closing. The buyer signs a promissory note promising to repay the balance, and a mortgage or deed of trust that gives you a lien on the property if the buyer does not pay. Which security instrument is used depends on the state.

Another structure is a contract for deed, sometimes called a land contract, in which you keep legal title until the buyer finishes paying. It looks simpler, but the rights of each side on default vary a great deal from state to state, and some states regulate these contracts closely.

• Down payment: how much the buyer has at risk from day one
• Interest rate, payment amount, and amortization schedule
• Any balloon payment, and what happens if the buyer cannot refinance
• Late fees, default terms, and who pays taxes and insurance
• Whether a professional loan servicer will collect and track payments

Selling with tenants in place

In most places, a sale does not end existing leases. The buyer generally steps into your shoes as landlord and takes the property subject to the tenants' rights. That means the buyer inherits the leases, the security deposits, and any obligations under state and local landlord-tenant law.

Before closing, gather the current leases, a rent roll, deposit records, and any written side agreements. Many buyers ask tenants to sign an estoppel letter confirming their rent, deposit, and lease end date, which reduces arguments later. Security deposits usually need to be transferred or credited to the buyer, and tenants often must be told where to pay going forward. State and local rules on notice, deposit handling, and rent regulation differ, so check yours.

Small multifamily: underwrite the buyer and the building

With a duplex, triplex, or fourplex, the rent from the units is often how the buyer plans to pay you. If vacancies rise or a major repair hits, your payment may be at risk. It is reasonable to ask for the buyer's experience managing rentals, a credit report, proof of the down payment, and a plan for reserves.

Remember that the building is your collateral. If the buyer neglects it, lets insurance lapse, or falls behind on property taxes, the asset protecting your note loses value. Many sellers require proof of insurance naming them as mortgagee or loss payee, and require the buyer to keep taxes current, with the right to see proof.

Your own mortgage and the due-on-sale clause

If you still owe money on the property, read your loan documents before offering financing. Most mortgages include a due-on-sale clause that lets the lender demand full payment if the property is transferred. Federal law, in 12 U.S.C. 1701j-3, generally allows lenders to enforce these clauses and lists only narrow exceptions, such as certain transfers to a spouse or into a living trust.

A wraparound arrangement, where you keep paying your loan while the buyer pays you, does not make the clause disappear. If the lender calls the loan, you may need to pay it off quickly. Talk to a real estate attorney before relying on any structure that leaves your loan in place.

Rules that may apply to you as the lender

Federal consumer lending rules are aimed mainly at consumer credit. Credit used to buy rental property the buyer will not live in is often treated as business-purpose credit, but if the buyer plans to occupy one of the units, consumer rules can come into play. Regulation Z, at 12 CFR 1026.36, contains narrow exclusions for people who finance the sale of a small number of their own properties, with conditions on the loan terms.

States add their own requirements, including licensing rules and limits on certain loan features. Some sellers hire a licensed residential mortgage loan originator to set up the terms. A local real estate attorney can tell you which rules apply to your property and buyer.

Where a direct buyer fits

Owner financing is one option, and a full cash sale is another. Prominent Cash Offer buys houses nationwide for cash in any condition, including occupied rentals. On cash purchases there are no fees or commissions, Prominent pays the closing costs, you choose the closing date, and the offer comes in writing with no obligation to accept.

Cash is Prominent's primary path. Flexible arrangements are evaluated case by case, and not every property, seller, or state qualifies. Whatever you consider, compare the written terms side by side and have an attorney and a tax professional review anything that involves you carrying a note.