The Psychology of the Seller Financing Lender

Share This:

Episode Summary

Listen on iTunes
Listen on Spotify
Watch on YouTube

As real estate investors, we often talk about the differences between the different types of loans we can get to buy our properties. But one thing we don’t often do is look beyond the loans themselves, and consider the lenders of those loans and their psychology.  There are huge differences in the psychology between seller financing lenders and other types of traditional or private money lenders.  In this episode, Jeff breaks down three key differences in the psychological dynamics of seller financing lenders and other types of lenders, and discusses how to navigate those psychological differences for the best possible borrower outcome.

Episode Transcript

Well, there’s multiple ways to get financing for our acquisitions. And if you’re listening to this show, you probably are very well aware that I’m a big fan advocate for and practitioner of buying properties with seller financing. And as we think about the different types of financing options we have, we kind of want to compare and contrast and understand them. And in this episode, I want to talk with you about a few points of the psychological differences between a seller making you a loan and a lender, who is going to write you a check making you a loan. So let’s cue up the theme; we’re gonna jump right in.

Welcome to Racking Up Rentals, a show about how regular people, those of us without huge war chest of capital or insider connections, can build lasting wealth acquiring a portfolio of buy and hold real estate. But we don’t just go mainstream looking at what’s on the market and asking banks for loans, nor are we posting We Buy Houses signs are just looking for “motivated sellers” to make lowball offers to. You see, we are people-oriented deal makers, we sit down directly with sellers to work out win-win deals without agents or any other obstacles, and buy properties nobody else even knows are for sale. I’m Jeff from the Thoughtful Real Estate Entrepreneur. If you’re the kind of real estate investor who wants long term wealth, not get rich quick gimmicks or pictures of yourself holding fat checks on social media, this show is for you. Join me and quietly become the wealthiest person on your block. Now let’s go rack up a rental portfolio.

Hey, thank you for joining me for another episode of racking up rentals. Show Notes for this episode can be found at thoughtfulre.com/e181. Please do us a big favor by hitting that subscribe button, hitting that follow button in your podcast app; it really helps fellow thoughtful real estate entrepreneurs to find this show and of course, makes sure you don’t miss anything coming up either. Onward with today’s episode.

You know, I find myself having lots of conversations with people about different types of loans and the attributes and virtues of different types of loans. And of course, I’m a staunch defender of seller financing loans. And we’ve even had podcast episodes on this exact show where we’ve talked about why seller financing loans are better. Well, recently I was having a conversation with somebody about debt service coverage ratio loans. And debt service coverage ratio loans are tools that underwrite properties for financing based on the income stream primarily of the property and the value of the property to but the big picture idea there is that it’s more about the property than it is about the borrower. And a lot of investors really like that because that means that they don’t have to be quite as concerned about constantly managing the right debt to income ratio, and things like that, that are so critical for getting conventional loans through lenders, backed by Fannie Mae and Freddie Mac and organizations like that. And a debt service coverage ratio loan is definitely a very, very good tool.

But the point that I was making to this person is that there is still underwriting though that has to be done. And that puts limits on how much a borrower can borrow. That’s really the whole idea of debt service coverage ratios. It says, Well, we have to have limits in some ways. So let’s make this program about limits based on how much cash flow there is and how it covers the mortgage payments that this loan would be. And while that’s still a good tool, absolutely, there’s no debating that. It’s still limits. You know, it reminds me of when I was in high school. And the first time I went out to a nice golf course that had carts, and you know, driving the carts as a high school student was really exciting, you know, you kind of get it going as fast as you possibly could. And then we kind of go over a hill and start going down and you’d actually feel the golf cart. It’s like it was applying brakes, even though I wasn’t applying brakes, I turned to the person next to me, I was like, well, that’s a weird feeling. What’s that all about? And they said, Oh, yeah, it’s a governor, the governor is going to govern your speed, it’s going to make sure you don’t go too fast. And a debt service coverage ratio is maybe a more liberal or workable or favorable type of governor. And then other types of loans we might be able to get through bank lenders, but it’s still a governor. And I kind of liked the idea of not needing to necessarily have a governor in my lending life or my borrowing life from the side of the table. And so I started thinking about this topic, and that’s why I wanted to make this episode for you.

So let me just point out three kind of categories of ways that a lender psychology is very different when the lender is the seller versus the lender being somebody who’s going to write a check cheque to you out of liquid cash to be secured by your real estate. Okay, so here’s the first category of difference in psychology for all humans, and organizations made of humans, parting with existing liquid cash feels very, very different than receiving future cash on a schedule. So in other words, let’s just say we’re talking about a $500,000 loan could come from the seller, or it could be a $500,000 loan from a lender, it could be a private lender, a person, a small, hard money business in your town or a big bank. But if it’s a private lender in your town, or a big bank, the point is they have a big reservoir of cash available, and they’re going to write you a check out of their liquid cash, they’re going to take something they already have, and they’re going to give it to you. Whereas a seller on the other hand, they actually don’t have their loan funds in hand, their loan funds are illiquid, at this point, they are their equity. And so to make an agreement for someone to pay you out on your equity on a schedule, psychologically, feels very different than looking at your checking account and saying, I’ve got a million dollars there am I really going to give half of it to this potential borrower, like the psychology of giving something somebody that’s already feels like you have it in hand. And in many cases, literally, you have it in hand already, and handing it to somebody else feels far riskier. But when you are the seller, and you’re not literally writing somebody’s check, you’re basically just saying, you can pay me for my equity over time. That is a very different psychological feel, it’s easier to stomach the idea of receiving your equity as payments over time than it is to stomach the idea oftentimes of writing a check out of your liquid cash, it feels very different to write a check.

You know, one of the general psychological principles of humans is that we value things in the present much more than we value things in the future. That’s why someone says, Hey, four months from now, do you want to go do this weekend trip? And you say, sure, but then as the four months approaches, you start feeling like you regretted signing up for that? Well, it’s because we’ve, we value our future time less than we value our current time. But as the future time, you know, that weekend that you committed yourself to starts to become the present time, that’s when we start to regret it. So the same thing is happening with money, as well. So when a person who is a lender is considering writing a check, they have a very different perspective on things like risk, very different perspective on timelines have a very different respect perspective on what their requirements are for returns to make the risk feel worthwhile.

To wrap up this first point, I feel like one of the most important things is simply a lender is looking at what they have. And they’re thinking about giving you some of it. Whereas a seller financing lender is actually thinking about what you’re going to give them, right, so a normal lender, someone who’s going to write you a check. They’re looking at their resources, and they’re saying, Here’s what I’m giving you, what am I comfortable giving to you. Whereas the seller, on the other hand, says I already have my equity, it’s just not liquid. And so the seller is asking the question, what are you giving me? The seller is asking the question, What am I getting in terms of a down payment? What am I getting in terms of an interest rate, et cetera. So the normal lender, the standard lender, who’s writing a check feels like they’re partying with something, and they’re focused on what they’re giving you. Whereas the seller financing lender is focused on what you are giving them. So that’s one major psychological difference between the two types of lenders.

Let’s talk about a second one. Let’s talk about worst case scenario thinking. Now, what’s really interesting is that both a traditional lender who has written you a check to be secured by your property and a seller financing lender, they both have the same form of security, if we’re talking about an promissory note and trust deed scenario, because that’s what I do and what I teach other people to do. A traditional sale where, you know, the buyer becomes the owner and the lender has a deed of trust that’s recorded with the county as a security instrument, promising to pay back the loan and pledging this property as collateral to secure that promise. But The thinking that comes about worst case scenarios in my observation has been very different. When I’m talking to private lenders versus seller financing lenders, they both have the same kind of protections and for foreclosure rights and things like that, but they think about it differently. In my experience, a seller is more focused on the risk of hassle with, quote, getting a property back, the seller is more thinking about not necessarily losing money, but they’re, they’re thinking about, if the buyer and thus the borrower doesn’t perform that now they’re going to have a project on their hands in the sense that they’re going to get the property back, and they’re gonna have to go through a legal process to make that happen, and they’re gonna have to start over. And they tend to be thinking more about that, necessarily, then the financial loss.

However, the normal lender, the lender who is the private money lender, or the bank, who’s just going to write you a check out of their liquid proceeds, they’re thinking much more about the loss of not getting their money back. They’re thinking about protecting their risk so that they can be made whole. And it’s just really interesting, because like I said, both types of lenders have the same protections available to them. But they tend to come at this thought process of worst case scenario, from different angles. And that creates a different way for you to negotiate with each of them, because we’re trying to understand the mindset of the party we’re dealing with. But the mindset of those two different parties, the seller, financing lender, or the traditional lender who’s going to lend you money out of their liquid cash and write you a check is actually very, very different.

And the third and final category is about decision making process. Now, every human’s decision making process on anything is multifactorial, they’re going to consider multiple different things. But in this particular case, it’s been my experience that sellers, are very multifactorial in their decision making. Whereas outside lenders who are just going to write you a check, are maybe a little bit more straightforward and streamlined in their decision making process. So let’s talk about sellers, a seller is making their decision about whether they want to be involved in the financing of the property and be the beneficiary of a promissory note, based on several different factors, not just one.

For example, they are certainly thinking about their return in relation to other things they could do with their capital. So if you say, I proposed that this promissory note bears an interest rate of four and a half percent per year, the seller is certainly going to be thinking about four and a half percent in relation to what they consider their other options to be. But that’s only one of the things they’re thinking about. Simultaneously, they’re also thinking about how this structure of financing the property for the buyer could actually also really help with the deferral of capital gains tax and the softening of the overall pain associated with paying that tax, especially all at once. So even those two things right there, start to really play off each other. And you’ll find that some sellers, care less about capital gains and care more about the interest rate. Other sellers maybe even in the exact same position, care far more about capital gains tax and thus the interest rate is of very little importance to them, because they are just much more interested in making sure the structure doesn’t involve next April them writing a giant check for the capital gains tax bill associated with the sale of this property. So those are two quick examples.

A seller is also thinking about risk; they’re sizing you up. In a recent episode, I talked about how seller financing loans are auditioned for and normal loans are applied for well, the seller is sizing you up and trying to assess the risk associated with doing business with you. That’s another decision. And there also for sellers some challenges associated with receiving cash, and that could be a major decision for them. Some sellers are in a position where they don’t necessarily need all the cash. And if they were to receive it, they wouldn’t know exactly what to do with it anyway. In fact, it might feel even burdensome to them to have to figure out how to deploy this capital. There are some sellers who kind of just want to put it in a bank but at the same time they’re seeing news stories that that say that people at certain banks that are not going well and are going out of business, their deposits above $250,000 were at risk, and they might not be getting some of that money back, they might be seeing risk that way. There are certainly risks associated with cash balances with older folks who are trying to qualify for certain programs like Medicare, or Medicaid, I’m not an expert on the details of this. But there are certainly requirements for qualification to some of these types of programs that that the participant doesn’t have too much liquid cash available. So sometimes receiving a bunch of liquid cash could actually disqualify them from a program that they might really want to be a part of.

So the point is, a seller is considering lots and lots of different things simultaneously, as they are making their decision about whether they want to be involved in the financing. But a lender who is writing you a check out of their existing liquid cash, returns, they are thinking kind of about two things, or maybe it’s even two aspects of the same thing. You maybe you’ve heard people say return of capital and return on capital, because again, they’re thinking about making sure that they’re protecting against losses, making sure that they’re deploying their resources in a way that’s going to generate the best possible return for them. And so that lender is looking at the risk of a certain borrower and the return of a certain borrower, or of a certain type of loan. And so that decision making process is also very, very different; the lender is going to think of it much more logically, whereas the seller financing lender very well may think of it logically, but also somewhat emotionally because their emotions are tied up with things like paying a giant capital gains tax bill, maybe they just don’t believe in the principle of capital gains tax, maybe they don’t agree with the current administration, who would be receiving the funds, if they paid that capital gains tax things along those lines.

So we’ve just covered three different categories of the differences in psychology between the lenders who are seller, financing lenders, and lenders who are going to write you a check out of their liquid proceeds for you to borrow and secure with your real estate. And to me, here’s the point. All of these are tools in your toolbox. And I hope that you have a level of familiarity comfort mastery with all of them. But when I think about the psychological dynamics, around seller financing in the sellers, who are evaluating their options for seller financing, I feel like we have more possibility to negotiate more unique, less rigid, more mutually advantageous types of lending arrangements with sellers, then we do with people who are outside lenders who are going to write a check, I think when we’re working with a seller who is using both their head and their heart and their emotions to navigate their decision when they’re considering lots of different aspects of everything, when they’re looking at risk differently, and they’re thinking a lot about, if they’re comfortable with you as the borrower. I think that that gives us a great opportunity to become excellent tailors to really, really get to know these people, what matters to them, what they’re thinking about what their concerns are, what things they’re not concerned about and to completely custom, completely custom no out of the box, one size fits all loan ideas, but to really in a customized manner, tailor something that really, really works for them, while also really, really working for you. And that’s the kind of conversation as a thoughtful real estate entrepreneur, I would much rather have than the lender conversation that says, Here are our programs. Here’s how you qualify here are the limits, take it or leave it without any real negotiation, and certainly without us having any input on how to tailor this to work best for everybody.

That is it for today’s episode of Racking Up Rentals. So again, show notes can be found at thoughtfulre.com/e181. Please do us a big ol’ favor by hitting that follow or subscribe button in your podcast app and rate and review the show; I see every single one of those and I’m so grateful for every one of them and it tremendously helps. Thank you for rating and reviewing the show.

Did you know, too, that we have a Facebook group for Thoughtful Real Estate Entrepreneurs? It’s called called Rental Portfolio Wealth Builders and we’d love to have you join us over there; just go to to group.thoughtfulre.com and the magic of the internet will take you right to that page in Facebook. Thank you so much for being here today and for joining me. I will see you in the next episode. Until then, this is Jeff from the Thoughtful Real Estate Entrepreneur signing off.

Thanks for listening to Racking Up Rentals where we build long term wealth by being win-win dealmakers. Remember: solve the person to unlock the deal and solve the financing to unlock the profits.

Leave a Reply

Your email address will not be published. Required fields are marked *