Selling a House Upfront Or Collecting An Income Over Time?
Suppose that you have a house worth 0,000.00 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 0,000.00 they initially loaned out and I will have made the 0,000.00 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 0,000.00) 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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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.
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 0,000 now versus, say, 0,000 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 0,000 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.
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.
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 0,000 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.
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.
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?
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.
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 0,000, and pretend that you are investing 0,000.
Where is the best place you can invest 0,000?
"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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