A seller-financed real estate deal is a financial arrangement where the seller accepts the installments directly from the buyer rather than the buyer getting a bank loan. It is a useful tool as it gives the buyer easier repayment terms with easier qualification compared to a traditional mortgage while providing sellers with monthly income.
When it comes to financing or a real estate deal, most of the transactions follow a general process. The seller will look for a suitable buyer who has got the required income, good employment history, and credit score to qualify for a mortgage, and a lending institute to take care of the financing.
But what happens when there is no traditional financing? This is where the importance of seller financing comes. As the term goes, the person who is selling finances the purchase, rather than the bank providing a mortgage to the buyer.
How does a seller-financed deal work?
A seller-financed real estate deal is also known as owner financing is a tool used to purchase real estate where you make arrangements to pay the owner in installments, consisting of the interest and principal, till you have paid the purchase amount.
Whereas in case of a traditional mortgage, you get the money from the bank as a loan to pay for the property.
It allows a seller to move a home faster and get a good return on the investment. And buyers benefit from the flexible rates and better loan terms on a home, which might otherwise seem out of reach.
The seller takes the role of the lender. And instead of providing cash, the seller extends the credit to the buyer for purchasing the home, minus any down payment.
A promissory note is signed between the buyer and the seller which contains all the terms of the loan. A record of the mortgage also known as the deed of trust is kept with the local public records authority. Then the buyer pays back the amount as per the agreement.
These types of loans are usually for short terms. The reason behind the short duration is that the home will have gained in value over time and also the buyer’s financial situation will have improved enough that they can consider refinancing with a traditional lender.
This is also practical from the seller’s perspective, as a seller do not need to wait for the same life expectancy as in case of mortgage lending institution. Nor they have the patience to wait around 30 years for the loan to be paid off. It also helps in avoiding the risks of getting exposed to extended credits.
Seller financing can be used by anyone for different types of properties starting from a single-home family to an apartment building to empty lands.
It is known by different names:
- Seller financing
- Owner financing
- Owner carried financing
- Owner carryback
- Owner will carry
All these terms have the same meaning.
What are the different arrangements available for seller financing?
Let’s go through some of the most common types of seller financing:
• All-inclusive mortgage:
In case of the all-inclusive and all-inclusive trust deed, the seller takes the promissory note and mortgage for the entire balance on the home price, less any down payment.
• Junior mortgage:
Lenders usually prefer to keep the finance less than 80% of a home’s value. The sellers can extend the credit to buyers to level up the difference.
There is an option for the seller to carry a second or junior mortgage which helps them to balance the purchase price, less any down payment. In this scenario, the seller gets the proceeds from the first mortgage from the buyer’s first mortgage lender.
However, the only drawback with the junior mortgage is the seller may have to accept a lower priority in case the of borrowers default.
The seller’s second mortgage is paid once the first mortgage is cleared. But there should be sufficient proceeds from the sale.
• Land contract:
In case of land contracts, the buyer does not get the title but receives “equitable title” along with temporary shared ownership. The buyer gets the deed only after settling the final payments with the seller.
• Lease option:
In the lease option, the buyer gets property in lease from the seller for a contracted term. But the condition is that the seller should also agree for an upfront fee to sell the property to the buyer within a specified time in the future based on the mutual agreement. There are numerous variations on lease options.
• Assumable mortgage:
In this FHA, VA loans or even conventional adjustable mortgage rate loans are assumable with the bank’s approval. The buyers can take place of the seller on the existing mortgage.
Pros and Cons of seller financing:
Let’s look into what pros and cons do seller financing has to provide:
Benefits for buyers:
Seller financing is beneficial for buyers in many ways:
- It is an attractive alternative to a standard mortgage loan.
- It does not carry the usual down payment of 20%.
- Unlike traditional banking, homebuyers might also pay lesser fees and lesser closing cost.
- Poor credit can make it difficult to get a mortgage from traditional banks, but with this, you get to bypass the stringent approval requirements.
Benefits for sellers:
- Can use the loan as an extra source of income.
- Can sell the promissory note for the loan for a lump sum payment.
- In case of full financing, the seller gets the chance to retain the property’s title until full repayment of the loan. And if the buyers fail to keep up with the bills, the seller can reclaim the home.
- One of the major headaches when it comes to reselling a house is the renovation and preparing for the market. But with seller financing, you get to sell the home as-is.
- Completes the selling process in a very short period.
This is beneficial both for the seller and buyers as the buyers need not wait for the approval from a traditional lender.
Along with pros, there are certain drawbacks which need to be taken care of:
Drawbacks of buyers:
- With a shorter loan period, there are chances for the buyer to get stuck in a balloon payment at the end of the mortgage term.
- Homebuyers may pay less upfront but may end up overpaying, if the financing comes with a higher interest rate.
Drawbacks of sellers:
- In case of default from the buyer’s end, the seller might have to face foreclosure.
- Mortgages come with clauses and require the payments to be done within a certain period.
- In extreme case scenarios, sellers might get forced to utilize outside mortgage services.
How to reduce the seller’s risk?
It is highly recommendable to get the help of professionals like an attorney, real estate agent or some other experienced professionals for seller financing to write up the contract, the promissory note, and any other related paper works.
Often sellers become reluctant to underwrite a mortgage for the fear of default from the buyer’s end. In such situations, the seller can take the help of financial or tax expert for advice and assistance.
Here are some of the steps that the sellers should consider taking to reduce the risk of default during a seller-financed deal:
The seller should make sure that the buyers give a detailed loan application form which is duly filled and make it a point to thoroughly verify all the information provided by the buyer. It includes a complete credit check, vetting employment, financial claims, references, asset, and related documents along with any available background information.
Seller approval of the buyer’s finances:
The written sales contract which contains the terms along with the loan amount and interest rate should be made contingent upon the seller’s approval on the buyer’s financial ability.
Getting the loan secured by the home:
The loan should be secured against the property which can cover up in case of buyers default. The property should be properly appraised so that the value is equal to or higher than the purchased price.
Although a seller-financed deal does not ask for a down payment, the seller may collect at least 10 % of the purchase price. It will not give the buyer a stake in the property but also makes them less likely to walk away at the time of financial trouble. Or else in case of a soft and falling market, foreclosures may leave the sellers with homes that cannot be sold to cover the total cost.
When it comes to financing, any seller-financed deal does become a helpful option in challenging the markets. However there are certain risks factors both for the buyers and the seller, and it is wise to take help from experienced professionals who can help to mitigate those and run the process smoothly. They can help in deciding on the particular agreement which best suits both for the buyer and seller and the circumstances of the sale.
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