4 Steps To Minimize The Risk Of Seller Finance
Government has offered a lot of housing programs to help people get bank financing. But for those who do not qualify for these housing programs, it becomes very difficult to qualify for a bank loan.
For those who can’t seem to get bank financing, there are other financing alternatives such as a seller finance agreement. Perhaps, one of the most common investment gurus in the topic is Rick Otton, who has been known for setting up investment workshops in the UK at least once a year. Many of his former associates have also held their own seminars – which is a testament on the growing popularity of seller financing.
However, a seller finance agreement has its risks. If you are seriously looking into this type of deal, here are four precautions I recommend you take.
Step 1: Double Check Your Buyer’s Creditworthiness
While there are some applications you can use to check if your buyer has a good credit history, still, nothing beats using your intuition and independent assessment on the person and his credentials.
Don’t just focus the buyer’s record for the past 18 months. Try to implement these 3 strategies as additional safeguards:
- Look into their property investment plan and compare them with industry projections to see if they are realistic and attainable.
- Check the lease contracts (if the buyer is a property investor) and examine if it contains enough stipulations to ensure that he doesn’t allow fly by night renters.
- Make sure the proper documents are in place and complies with proper requirements.
Step 2: Disclose All Existing Arrangements Attached With The Property
It’s not common practice for the buyer or investor to tell the seller what’s going on with the property after the agreement has been made. However, in a tough market, it’s important for sellers in a seller finance agreement to find out the status of the property’s lessees. It’s practical because when the lessees or renters fail to pay their monthly rents there’s no way for the buyer to pay his obligations to the seller.
To prevent this from happening, funders may:
- Introduce themselves to the lessees, even if the lease agreement is still existing between the renters and the buyer/investor.
- Require a guaranty or guaranties from the buyer/investor.
- Insist on receiving timely financial statements, certifications and other reports on the buyer/investor and the end-user lessee to spot potential for defaults or advance recognition of a need to restructure the agreement.
Step 3: Look for Strong Buyer/Investor and Lessee Management
Why is it important to check if the buyer exercises good management over the property? The answer’s simple: the market has gone haywire in the past few years so it’s crucial that the buyer/investor offer a strong management of the property and its lessees.
There are 5Cs used to measure a buyer’s creditworthiness, but some people also apply them to test the strength of an investor’s management skill:
- Character- this may well be the most important of the 5, since this measures the buyer’s willingness to complete the payments on the house;
- Cash Flow- the actual capacity of the property to pay its debts;
- Capital- the real tangible net worth as support for repayment;
- Collateral- the value of the buyer’s other assets and is it enough to make up for unpaid debts; and
- Conditions- aka economic environment, is there a price correction or the property prices rising at the moment?
Step 4: Mitigate Potential Fraud Risks
Tough economies force some people do some acts, such as fraud, which may be beneficial in the short-term for themselves, but not exactly for other parties. Fraud can be minimised by hiring third parties to conduct audits, and sellers could also monitor a buyers bank transactions.
I admit that even if a seller has exhausted every possible way to protect himself from begin defrauded by a buyer, the efforts I recommended may not be enough to stop a truly criminal mind. But, still, you owe it to yourself to install a first line of defense, so that the potential for fraud may be crossed off on the list of challenges you may encounter in property investment.