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I’ve accepted the fact that whenever I point out the history of the “subject to” approach to purchases, investors who love ‘em lose their minds. At some point those with many props acquired using that method will face a market with interest rates substantially higher than the loan they took over.

Remember, most of the subject to sales in the last several years have been engineered purposefully to keep the lender in the dark. Sharon Vornholt, a pro’s pro, does it the right way, which is why I admire and respect her as much as I do. Simply put, Sharon gets the lender’s okey dokey in writing. Who knew that would work?

For those who scoff at my thinkin’, ask yourself what you would do if you were the lender with a huge portfolio of loans with 3-4% rates having been taken subject to in the dark, while the current market is 6% or higher? Would you demand payment for contract violation? Or would you just kick the dirt with your toe, and say, “Oh those clever real estate investors. What’ll those smartypants think of next?”

Here’s a solution allowing all players to win. Let’s set the table.

You wanna sell a property acquired long ago. It’s worth $200,000, sporting a loan balance of around $100,000. The interest rate is 4%. The payments are $573 monthly. It has a little over 22 years to go.

Related: The Definitive Guide to Using Seller Financing to Buy Real Estate

The buyer is putting 10% down, which makes you a bit queasy, but you’re biting the bullet on that one for your own reasons. You’ve agreed to carry the entire 90% for 6% interest, amortized for 30 years, due in 10. You’ve already obtained written approval from the lender, who at this point just wants the payments made.

So, how does all this work out?

First off, the buyer gets a loan that’s comparable to what portfolio lenders offer, except for the minor point that they generally want double to triple this down payment. The buyer is only responsible for the seller’s note, as the seller will continue making payments on the original loan.

The property cash flows, showing an acceptable cash on cash return. In other words, the buyer’s all in on this.

What’s the bottom line for the seller at the end of 10 years when the note pays off in full?

Let’s first talk about what he decided to do with the leftover dollars he had after receiving the buyer’s monthly payment and paying the underlying loan payment. He looked at the pathetic 1% or less his CDs were making and decided that applying all or most of the carry back payment to the original loan made sense. His logic was that OldSchool arithmetic says 4% is roughly 4 X better than 1%.

Again, who knew? Brilliant, right?

May the gods be praised — what happened when he did that?! The underlying loan was paid in full over a half year before his carry back note was due. He then changed the formula and added only that amount that would pay off his original loan more or less simultaneously with his carry back loan. This didn’t take all of the carry back payment amount.

The result of that strategy?

He pockets just over $150,600 when the buyer pays off the loan.

If he’d not applied the extra payments to the original loan each month, his net payoff woulda been around $64,700. But wait, there’s a possible glitch in that thinkin’. If over the 10 years he’d kept the difference between the two loan payments — roughly $506 — what would he have had over the 10 years?

The short answer begins with, “Is your crystal ball back from the shop?”

Why? Cuz it’s silly to assume he’s gonna average a 1% return from CDs for all 10 years, right? Isn’t it just as foolish to assume he’d average over 4% too? An easier way to put this is that 4% is his opportunity cost. When the first 1-3 years your return is just 1%, imagine how high the CD interest must increase in order to average MORE than 4% for the 10 year period.

All our seller knows for sure is that putting most or all of his carry back payment into the other loan will definitely earn him 4% compounded interest. Remember, every dollar the loan is paid down is a dollar he won’t be payin’ at 4%. See how this can sometimes make ya crazy? It’s always simple as pie ’til we do the analysis.

Which approach is better?

That depends on multiple factors — not the least of which is the tax impact.

The interest he receives, which is the difference between interest paid AND received, is taxable each year at “ordinary” rates. Interest is taxed as if it’s pay from another job. Cap gains rates are much lower, generally speaking, which would have some conclude that sooner’s better than later, right?

Well, yeah, sometimes. What if the seller’s income is high, but will go down precipitously just before or in the 10th year? That could very easily result in fewer taxes paid in terms of dollars. This is especially true when incomes, counting ALL sources, exceed around $450,000 in the year the capital gain is realized. So it’s not as easy to plan as some may think.

Related: Seller Financing: What it Is and How to Use it To Invest in Real Estate

The instrument to make all this happen can be one of many things, though I prefer the land contract of sale. It only grants “equitable” title to the buyer until a specifically defined event becomes reality. At that point full title is granted. In this scenario I wouldn’t grant full title ’til the note was paid off completely.

This is just one way for the investor selling a loan-encumbered property who wants or feels they must …read more