I own a home in Colorado where I always planned on retiring, but now I am not moving back. I bought it for $200,000 and it was, at the height of the market, estimated at $620,000. It has been a rental since 2004 when I was deployed, then transferred.
The couple renting it are interested in buying, given that prices are falling. Could I be the lender? How would that work? Also, would my capital-gains taxes on the sale be based on the entire sale price? And how would a mortgage payment be taxed?
I wouldn’t want a loan to last 30 or even 20 years, but 10 years of steady interest payments around 7% seems like a pretty good deal to me.
‘The Big Move’ is a MarketWatch column looking at the ins and outs of real estate, from navigating the search for a new home to applying for a mortgage.
Do you have a question about buying or selling a home? Do you want to know where your next move should be? Email Aarthi Swaminathan at TheBigMove@marketwatch.com.
It’s nice of you to offer to sell your home to your tenants. It shows a mark of a good landlord-tenant relationship, and since you’ve known them for nearly two decades, the arrangement discussed likely came out of a good place.
For the buyer, there are several pros: they don’t have a minimum down payment, there are fewer regulations, and it can provide an avenue for homeownership for people without a high credit score.
And for the seller? You could save on closing costs, and could arrange for the buyer to pay the property tax, and homeowners insurance and other costs of upkeep. There may be a “balloon payment” due at the end of the process.
With such huge financial transactions, however, it’s not advisable to overlook the reasons why a traditional mortgage route would be preferable.
Having them take out a mortgage will a) allow you to have more financial freedom by having access to the cash up front versus being paid over a decade, which may be useful in multiple scenarios, and more importantly, b) protect you in the event that your tenants miss payments, or worse, completely stop them, and c) enable these tenants to refinance at a lower rate if they do decide to lock into an interest rate at close to 7% or 8%.
Arrangements such as the one you’re describing are regarded as “seller financing” or “owner financing” where the homeowner — not the bank or the mortgage company — is the lender and the buyer pays you monthly.
Related: Some home sellers are offering to pay their buyers’ mortgages. What’s the catch with ‘seller financing’?
Advantages of cash upfront
More commonly seen in investor deals, such a deal could make sense if you were not in immediate need of the cash, and have the appetite to take on the risk of your buyers defaulting on the payments.
Some other questions to think about in the meantime: What else could you do with the money if you decided to sell your property the traditional way? Could you invest it elsewhere and ensure your retirement funds grow? Can you use that significant chunk of cash to fund some other dream?
You may think you know your tenants well, but what if an emergency arises and they stop their payments? You would need to foreclose on the property, or pursue other legal means. Do you have the stomach to deal with all of that? A mortgage lender has the resources to deal with forbearance and delinquency.
Seek professional advice
If you go this route, consult a real-estate attorney to make sure the deal is rock-solid — from running a credit check on your tenants to checking their income, job security, and professional and personal references. Like a traditional lender, it would obviously be wise to hold onto the property’s title until the tenants pay off the loan.
After calculating and paying capital-gains tax on the sale, you will need to pay tax on your annual net income after depreciation, maintenance and other costs, said Nick Aiola, owner and CEO of Aiola CPA.
It may feel like the right thing to do for your longtime tenants, but ultimately is this the right thing for you? If they break your trust and stop paying you, you’ll be left high and dry. For that reason, formalize the transaction, legally, rather than offering seller financing.
Related: Here’s how much money you need to buy a $400,000 home with 8% mortgage rates
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Other columns by Aarthi Swaminathan:
I listed my home 3 weeks ago, but have no offers. I want to cut the price. My agent says no. Who’s right?
‘It makes me sad’: I want to move into my grandparents’ former home, but my uncle refuses to hand over the keys. What can I do?
‘It just seems wasteful’: I bought a 3,000-square-foot house at a 3% interest rate. It’s too big. Do I sell?