By: Bob Ballinger, Attorney at Law,

For the last several years individuals interested in owner (seller) financing and hard money lending have been restricted by a cap on the interest that they could charge by virtue of a low Arkansas usury rate. The Arkansas Constitution set the rate at 5% above the Federal Reserve Primary Credit Rate or 17%, which ever was less. For the last few years the Primary Credit Rate has been .5 and .75 percent, capping the usury at 5.5 and 5.75 percent. Federal preemption exempted banks from the obligation to comply with this rate restriction however private investors have been limited in what they could lawfully charge in interest.

This limit has restricted the profitability of owner financing and hard money lending as an instrument of successful investing. Typically individuals found that the risk was not worth the relatively low return. However, all of that may have changed with the passage of Issue 2 last fall which modified interest rates limits on individuals acting as private lenders. This limit is now restricted to an interest rate not exceeding 17 percent per annum, which is the existing limit for consumer debt under the Arkansas Constitution, and there is no longer a restriction that interest rates charged cannot be greater than five percent above the Federal Discount Rate. This includes an interest rate on a real estate transaction in which an individual finances the purchase.

Conventional financing offers the benefit of the inclusion of a lending professional who is able to walk a buyer through the process and allows the seller to realize the funds in cash at the closing. This cash allows the seller the option to reinvest the equity in other property if necessary and to avoid the potential hassles that can be associated with acting as a private lender. In short, there are real benefits to conventional financing, however not all individuals or properties qualify for conventional financing.
For the transactions that may not qualify for conventional financing, the option of owner financing of real estate becomes viable, and possibly even highly profitable. This is with the road block of the low capped rate removed. This is because there are many advantages to owner financing and hard money lending for both the buyer and seller. Sometimes the benefits are greater for one or the other, but in most cases it is a “win/win” for both parties.

Advantages

Seller:

Sellers want to obtain the most money for their property as possible, and a fast closing with little hassle. Many Sellers also want to pay as little taxes as possible on the gains incurred. In many cases, the seller can have most of his desires satisfied by owner financing sale rather than a traditional cash sale.

1. Highest Price. More often a seller can insist on and receive a higher price when offering flexible owner-finance terms. In many cases, the seller can receive more than the fair market value of the property by offering these “soft” terms. People are often willing to pay a premium for easy-qualifying financing.

2. Cash. Nearly every seller says they want all cash, but few need it. What the typical seller wants is the most net cash from the deal. Often, the seller has to pay closing costs, title insurance, broker fees, and the balance of the existing financing.

In addition, there may be capital gains tax due to the IRS. In many cases, owner financing the transaction (particularly a “wraparound”) will net the seller more future yield than any source from which the cash proceeds were reinvested.

3. Fast Closing. Typically nothing holds up a sale more than qualifying for financing. It can take months for a buyer to qualify and close a new loan to purchase property. Since most standard real estate contracts contain a financing contingency, a seller may end up back at square one if their buyer does not qualify.

Furthermore, if the house is not particularly nice or unique, it may take some time to even find an interested buyer. Since the seller is competing with all of the other houses for sale.

There are very few “assumable” loans and few sellers are offering “soft terms.” Thus, an owner financing and hard money lending makes a house unique. Furthermore, an owner financing and hard money lending transaction can be consummated in a matter of days, since there is no appraisal, underwriting, or other preconditions of closing involved.

4. Tax Savings. On an installment sale, the seller only pays gains to the extent they receive payments each year. This can be particularly advantageous if you have owned the property for several years.

As you can see, the installment sale provides many advantages to the seller of real property.

Buyer

Despite the possibility of an elevated purchase price and higher interest rate, there are many advantages to a buyer who engages in privately financed transaction.

1. Easy Qualification. The buyer, in many cases, prefers a privately financed transaction to conventional financing because it does not require traditional bank income and credit approval. The buyer may have poor credit because of a divorce or recent bankruptcy. He may be self-employed and cannot prove income. He may be new to his job and cannot meet strict lender guidelines.

As you can see, there are dozens of reasons why a buyer cannot (or will not) qualify for a conventional bank loan. The privately financed transaction becomes the perfect solution for him.

2. Credit Rating. An installment sale may give the buyer a chance to improve his credit rating by owning a home and making payments timely.

3. Low Loan Costs. One of the biggest benefits for the buyer is the ability to avoid much of the costs associated with conventional loans. Points, origination fees, underwriting charges, appraisal, credit reports, etc. charged by conventional lenders can amount to thousands of dollars at closing. The buyer may be free from much these expenses with owner financing and hard money lending.

4. Fast Closing. Often a buyer can close and move into a property within days, since there is no third party lender.

In summary, we should all appreciate the lenders who work hard to provide loan products for a variety of individuals with a verity of needs, however there are many individuals and transactions which cannot fit into any loan product available today. For those individuals and transactions, owner financing and hard money lending may be the key to unlock what otherwise would be a dead deal.