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Suppose that you have a house worth $500,000.00 that is gifted to you and this house is completely paid off. The people who want to purchase this house will need to go to the bank to get a loan so that they can pay me to sell them the house. Over time, the bank will make more money than the $500,000.00 they initially loaned out and I will have made the $500,000.00 in a lump sum payment.

My question here is why not "be the bank" in this scenario, and instead of having the interested buyers take the loan out from the bank they could instead pay you (more than the $500,000.00) over time. Arguably, you would make more money this way by acting as both the lender and the seller. If a proper contract was drawn up in the same vein that a bank would, it seems that you could hedge against the risk you take by collecting that income stream over time instead of accepting it all up front right away.

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    Leasing is an obvious option. Does convincing someone to rent a $500K home require more hocus-pocus than usual?
    – jpaugh
    May 18 '20 at 15:22
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    Obviously, in a perfect market the two options would yield the same profit, risks and hidden costs included. Now you may have insider knowledge (the house is rotten, but they'll only notice when it's too late; or you know the people who you rent it out to, and they are unusualy trustworthy, etc.) which gives you an advantage over the general market; then use it. May 18 '20 at 16:48
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    @jpaugh The question is concerned about the individual seller acting ‘as the bank’ in this question. But yes, leasing is an option. May 18 '20 at 16:51
  • If you're looking to make money on the property, why not lease it? The advantages are that you have a short defined timeframe and can sell at any point, quite possibly more cash flow from the lease than you would from acting as a mortgage provider, and you enjoy any property appreciation. The downsides are that you're responsible for the management of the property (unless you hire someone) and are responsible for taxes and any other association fees.
    – ryebread_g
    May 19 '20 at 14:06
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    In regards to "why not be the bank?" the answer is "Do you know how to act like a bank?" Are you able to properly vet a borrower's ability to pay off the house? Do you know how to foreclose on a property?
    – MonkeyZeus
    May 20 '20 at 14:04
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Risk. The bank will probably get more over time, as long as the borrower continues to make payments. If they don't, the bank may lose money (especially if they end up having to foreclose and can't sell the house for enough to cover the loan balance). If you act as the lender, you take on this risk.

You could just take the $500,000 up front from the sale and invest it, thereby earning more over time. Note that the returns and risks will vary depending on the type of investment, and won't necessarily match the lending scenario.

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    @LogicalBranch lower risk, lower returns
    – yoozer8
    May 18 '20 at 15:48
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    To be fair, investing in a high yield bond ETF would probably get you 5%-7% (reasonably). AFAIC, a 5%-7% return on $500k (+compounding) is a far better route than OP's suggestion. May 18 '20 at 15:50
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    This is called "carrying paper" where you the seller agree to hold the promissory note (carry the paper). It can be a win-win, but as was pointed out here, you're taking on a risk not present if you simply sell without carrying the paper.
    – C8H10N4O2
    May 18 '20 at 17:52
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    @LogicalBranch high yield ("junk") bonds are high risk, they behave more similar to equities than low risk bonds. HYG lost 22% top to bottom Feb-Mar this year, JNK lost 23%. JNK lost 39% in the 2008-2009 downturn. Not quite as bad as the S&P500, but a lot. Yes they came back (as did stocks) but these are nowhere near low risk investments, these are not something you can put money in and just expect 5-7% without capital risk. Government bonds are far more secure, but returns on those now are tiny, 0.14% on US 1yr, 0.7% on 10yr. Higher yield = higher risk, there is no way around that.
    – Ivan McA
    May 19 '20 at 8:56
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    An extension of this answer is that banks can afford to take on this risk because they spread it among many loans. They can afford to have X% of loans go sideways on them because they know they're making enough from the loans that work out to cover it. As a single seller carrying a single loan, your outcome is all or nothing.
    – IronSean
    May 19 '20 at 22:58
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This is known as a "vendor take back" mortgage. It's common with empty land and with vacation properties, which Canadian banks often prefer not to offer mortgages for, or to charge quite a bit more. It's also likely in those cases that the property is subject to capital gains (not being a primary residence) so taking the money a bit at a time can lower the tax rate it's exposed to. This article says investors like it for that reason.

It also says you usually only see it from "motivated sellers" -- in other words, most people would rather sell the property, get the money, and be done with it. Spending the next 25 years worrying if the person you lent money to is going to pay you back or not, and not knowing how to work the whole foreclosing machinery, is not worth the extra interest income for most people. Sell the house, settle with the tax people, and put the money in something that earns, if not as much as a mortgage, at least more than your savings account, possibly tax sheltered, and you have nothing to worry about. Or lend the money to someone who isn't living in your old house, and make profit from it on private loans with much shorter terms -- eg 5 years to a small business owner.

Here's another way to look at it: if you had inherited or otherwise received half a million in cash instead of a house, would your first instinct be to go find a complete stranger you could lend it to for 25 years, or would you choose a different investment vehicle for your windfall?

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  • Re investing, almost any investment will, over time, earn more than a mortgage.
    – jamesqf
    May 17 '20 at 16:42
  • a typical residential mortgage, yes. VTB are usually higher, partly because they need to be, so it might appeal to some sellers. May 17 '20 at 17:54
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    Your last sentence nails it. May 19 '20 at 19:10
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    @JaredSmith Reminds me of the old joke about marriage/divorce: "Find someone that hates you and give them your house - it will save a lot of time and effort."
    – richardb
    May 20 '20 at 16:56
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Letting a buyer hold the value and make payments is not a hedging of the value.

Over long periods of time, possible rising inflation could make the loan payments worthless. A financer, without hedging or long-term planning, should make loans with adjustable rates.

But then a buyer shouldn't accept a long-term adjustable rate loan unless they have hedging or long-term planning.

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Statistics. You are focusing on the expected value when the much more relevant issue is the variance. A bank doesn't make money by making one mortgage, it makes money by making thousands or millions of mortgages. The more mortgages you have, the lower the variance and the more certain you are that your observed result will be very close to the calculated expected value.

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    +1 A large lender could have dozens of outstanding mortgages default and barely feel the pain; if just one defaults in this scenario, you lose a lot (since you only have the one).
    – yoozer8
    May 18 '20 at 17:33
  • 2008 would like to have a word with you about variance and banks selling lots of mortgages. May 20 '20 at 11:48
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You're describing what's known as a land contract

Here's an article from Nolo Press detailing this type of financing, with some internal links for more info. It lists specific benefits and downsides for the buyer and seller. I'm not sure if it exists in Canada, but it's quite common in the US.

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  • In particular, I see land contracts being offered to people who are themselves rocky. This is done to maximize the chance of them missing payments and forfeiting the house later. May 20 '20 at 23:24
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It can definitely be advantageous to carry the loan, but one thing to keep in mind is that if interest rates fall in the future, your buyers may demand a rate adjustment or they will refinance the loan at the better rate. You'll get paid off in full if they refi, so that's not a problem. But if you were planning on a years of income and returns from the loan, it may end a lot sooner than you think. And then you'll still be faced with the issue of what to do with the lump sum.

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I'll go off the beaten path and say... no, you're probably not going to make more money with your scheme.

Why?

Well, you're comparing $500,000 now versus, say, $750,000 over 20 years. The problem is, you're comparing an immediate amount versus something that reflects compounding interest.

Right now, interest rates for mortgages are below 4%. Which means, if you find an investment that gets you a 4% return over those 20 years, you'll actually end up with more money if you take the $500,000 right now.

All the rest of the answers are focusing on a very important facet of the problem (the risk side of taking this position). I wanted to add the other facet: that it's quite possible that the theoretical downside you're trying to avoid... might not actually exist.

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You're thinking of it in absolute terms: Instead of the principal, you get the principal plus the interest, woo woo, more is better!

Actually more is not better, if a different "more" is better-er.

Treat the house as exchangeable for $500,000, and pretend that you are investing $500,000.

Where is the best place you can invest $500,000?

  • "Buy" this house and carry paper on it?
  • Buy competently in the stock market?
  • Buy Muni bonds (lower interest vastly lower volatility)?
  • Stay in cash?
  • Invest in a small business?
  • Micro-loans, Kiva, whatever?

Which of these corresponds with your long-term investment goals and general vision-of-life?

From this viewpoint, carrying paper on houses is probably a second-rate choice. Your bias toward this house in particular puts your investing strategy at further disadvantage: It's probably not the best choice of houses to carry paper on.

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