Have you ever heard of these terms or these phrases before when you’re looking on LoopNet or online listings or getting things from brokers or even sellers? If you’ve heard this before: “seller may carry a small second to help get the deal done”. How about “seller may hold a second” or “owner may carry some paper”? How about “owner may carry”? How about the emphasis “owner financing possible”? I’m sure some of you that are active in the market have seen these terms someplace somehow.
What does this all mean? This is actually code language telling you, “Here’s an open door, an open window for you to explore creative financing.” You just have to know what to do with it. Why seller carry second mortgages? Being creative allows you to close on more deals and make more money. That’s the bottom line.
Why Second Carry Mortgages?
Seller Carry Strategies Assist You in Leveraging for Example:
- Lowering your down payment amount.
- Helps you increase your cash and cash return or ROI immediately and immensely,
- Makes your deals very attractive and unique.
- It allows you to take advantage of motivated sellers where loan assumptions are available.
- You’ll be able to overcome financing obstacles that normally the average person would walk away from, but not you, after this training here.
Seller Carry Second Mortgage Example
Understanding seller carry second mortgages is an absolutely important tool to have in your arsenal of deal making tools. Let’s do a quick example. Quick and easy, okay? I know you guys can’t see the number but just try to follow me along in principle. Let’s say the purchase price of an apartment building is $500,000, and the down payment is 25% or $125,000, but you only have $75,000 so you only have 15%. There’s a 10% shortage.
Here’s how seller carry mortgages can help. In order to satisfy the down payment requirement of the lender, which is 75%, the seller may agree to hold a second mortgage against the property for the remaining $50,000 or 10%. That’s called a seller carry second mortgage. Now, if agrees to do that, everyone is happy. The seller gets to sell the property. You get to buy the property. Lastly, the lender’s equity requirement, a 25% down payment is satisfied. In a nutshell, that’s what a seller carry second mortgage is.
You’re going to have two mortgages. You’re going to have to pay the first mortgage and the second mortgage. You’re going to have to evaluate this and figure your cash flow out by subtracting two mortgages from the NOI.
How does this affect cash in cash return if you don’t do a seller carry second mortgage?
If you don’t do a seller carry second mortgage in this case, you have to come up with the entire 25% or $125,000 instead of $75,000. You’ll be only taking care of the first mortgage. You know, that can have a huge difference on your cash and cash return. Now, in the first case, you have a seller carry second mortgage. You have a certain cash in cash. In the second case, there’s no seller carry. You’re putting down the entire down payment. There’s a certain cash in cash there. The difference is you putting 15% as opposed to 25%. That’s over a 30% improvement on your cash in cash return.
If you can organize a small seller carry of 10%, your cash in cash return can potentially be over 30%. It can be a 30% difference there. For example, let’s you’re able to produce a 25% cash in cash return with the seller carry second mortgage. That’s if you don’t have a seller carry second mortgage. It can be 15-17%. You can go from 15-17% up to 25% with the seller carry second mortgage so that’s huge.
Seller Carry Second Mortgage Assumption Example
Let me go over a second situation with you. Let’s say we have the same apartment building at, $500,000 purchase price. The seller this time has 4 years remaining on a current loan in the amount of $300,000. The buyer must assume the loan because the seller has a large prepaid penalty if the loan is paid off, so he can’t just sell it to you.
You have to assume the loan, but there’s a gap there right? He owes $300,000, but the purchase price is $500,000 so there’s a $200,000 gap there to cover, but again you only have $75,000 so there’s a $125,000 shortage. The question is what do you do? How do you buy this deal?
Here’s what you do: Again, this is about seller carry second mortgage. You’re going to take your $75,000 and you’re going to apply to the gap of $200,000, and then the seller is going to carry a second mortgage for the remaining $125,000. Okay? You got it? You’re going to put down your $75,000 to the bank. The seller’s going to take out a second mortgage against the property for $125,000 so that gap is covered now. You become the owner of that property, but, guess what? You again have to take care of the first mortgage and you have to take care of the second mortgage. Basically, you’re assuming the seller’s loan with the current terms, and by the way, it’s going to cost you about 1% a loan amount to assume it, plus closing costs. Again, you’re assuming the seller’s loan.
What is a Loan Assumption?
That’s what a loan assumption is. When you hear the term “a loan assumption“, this is exactly what it is. You’re going to assume the seller’s loan, the $300,000 so you’re making payments on the $300,000 plus you need to service the $125,000 second mortgage. That is what we call a loan assumption with a seller carry second mortgage.
What would the cash in cash return be without assuming a loan and not taking a seller carry second mortgage?
This is even a more drastic change. In this case, Let’s say there’s no assumption so you’re going to cover the $200,000 difference just out of your pocket. Boom. Down payment, $200,000. Your cash in cash is going to be X-ed. Now, let’s say that in case B, you only have $75,000 so you’re going to apply the $75,000 and he’s going to do a seller carry of $125,000. There’s a huge difference there in the cash in cash return. Guess how much? 50%, over 50% in this case, in the difference in the cash in cash return. If your cash in cash return, without the assumption, you plop down $200,000 as 10%, for example, your cash in cash return with the assumption can be over 25% so that’s over 50% there.
We saw the huge problem. The huge problem was the seller wanted to sell. He has a loan assumption with a large prepay penalty. You don’t have all the equity so the solution is a seller carry second mortgage.