There are more ways to buy and sell a home than conventional means – qualifying for a loan from a lender, making a down payment, and closing the transaction with no further contact between the principal parties. Instead, the buyer and seller can agree to a private arrangement for their mutual benefit.
Seller financing, also known as owner financing, simply means that the buyer and seller agree to let the seller take the place of a lender for a brief time, typically between two and five years. There are no set terms as the parties can agree to their own terms without having to follow government guidelines for lending qualifications, but after the agreed-upon term ends, the buyer is supposed to apply for a conventional loan which will repay the seller in full.
Circumstances vary for which seller financing is a good option. For the seller, it’s best that they either
own the home outright, or that they owe very little on their mortgage, so the seller can use the buyer’s down-payment to pay off the remaining balance. If the seller has a larger mortgage, they have to get permission from the lender to seller-finance; most lenders are unlikely to approve a seller-financing deal because of increased risk.
Less than
10% of home sales are completed with seller financing, but it’s an ideal solution for homebuyers and sellers who know each other well, such as family members or friends. It’s also useful in a tight credit market in which many homebuyers have difficulty affording a loan, or because of personal credit issues. In that case, seller financing can help the homebuyer build or repair their credit through timely payments, allowing them to qualify for a more favorable conventional or government-guaranteed loan after the seller-financing term ends.
In addition to the freedom to negotiate terms, homebuyers can save money by avoiding paying for a bank appraisal and the closing costs of a conventional mortgage, as well as the need to purchase private mortgage insurance because they have less than a 20% down-payment. Sellers can attract more homebuyers with seller-financing, save on their own closing costs, and close the transaction faster than traditional homebuying methods.
The seller who offers to finance the buyer may be doing so out of the goodness of their hearts, but there also has to be benefits to make the effort and attendant risks worth it. The biggest benefit to the seller is being able to charge interest. They may require a low down-payment and then charge a higher rate of interest than a conventional lender. Sellers may also charge a higher purchase price for the home than market value because of the length of time they’re obligated and in case the buyer defaults. However, if the home is foreclosed, the seller likely gets to keep all the interest and principal payments and regains total ownership of the home with the ability to seller-finance all over again.
To lower risk, the seller can require a detailed loan application, but it’s incumbent upon them to verify the buyer’s information. This includes running a credit check and background check on the buyer, confirming the buyer’s employment, and contacting references personally. The sales contract should specify the loan amount, interest rate, and term and be contingent upon approving the buyer’s finances and receiving a down-payment to protect the seller should the housing market decline. The loan should be secured by the home, so the seller can foreclose for non-payment.
Since there are fewer legal protections for payment defaults or foreclosure, it’s advisable for each party to have a real estate attorney advise them and to draft the terms of the transaction. The seller is also responsible for managing the transfer of the property’s title, while the buyer is responsible for ordering a title search. The seller also has to service the loan – collecting payments and initiating foreclosure for unpaid bills.
How is a seller-financing agreement structured? According to
Nolo.com, the seller doesn’t give cash to the buyer to buy the home, but instead extends the credit for the purchase price of the home, less any down-payment the buyer makes. The homebuyer and seller sign a promissory note containing the loan terms, and record the mortgage, or deed of trust with the local property taxing authority. Many times, the terms include maintenance stipulations making the buyer responsible for repairs and upkeep so the home doesn’t deteriorate in value. While the selling price of the home may be market value or a little higher, the loan is structured as a 30-year loan so payments will be affordable for the buyer. But at the end of two to five years, or the term of the seller-financing, a balloon payment is due – the . To make the balloon payment, the buyer goes to a traditional lender to get a loan to buy the seller out completely.
As mentioned earlier, there are more ways to buy and sell a home with seller-financing. The most common types of seller financing are:
The all-inclusive mortgage. This is an all-inclusive trust deed in which the seller carries the promissory note for the entire home price, less any down-payment from the buyer.
The junior mortgage. In this scenario, the buyer gets a traditional loan for 80% of the home’s value, but the seller carries a junior mortgage for the other 20%. The seller is given the proceeds from the traditional mortgage, but as the second mortgage lender, the seller is at more risk in the event of the buyer’s default.
The land contract. A land contract doesn’t give title to the property to the buyer, but it does give “equitable title,” a form of temporary shared ownership. As long as the buyer makes all payments to the seller, they will get the deed to the property with the last payment.
The lease option. Also known as “rent-to-buy,” the
seller leases the property to the buyer for an agreed-upon term, with partial or all payments being credited toward the purchase price of the home.
The assumable mortgage. With the lender’s permission, the buyer can assume the seller’s mortgage using the same terms.
Homebuyers should also do their due diligence. Before they begin the homebuying process, buyers should obtain copies of their credit reports and credit scores. They should talk to a lender to learn what a traditional mortgage would cost and how much home they can be approved to buy. They should compare current mortgage interest rates in their area. Last, but not least, they should hire their own real estate attorney and real estate sales agent to help them navigate the homebuying process.
