Seller financing is when a seller helps to finance a real estate transaction. This is accomplished by taking a second loan note or even financing the entire purchase if the seller owns the home free and clear. In essence, the seller assumes the role of a banker and carries back the loan. Either way, the buyer makes a promise to pay, evidenced by a promissory note, and the property serves as collateral for the loan. Usually sellers do this when a buyer has difficulty qualifying for a conventional loan or meeting the purchase price.
If the seller takes back a mortgage on the house, the buyer signs both a promissory note (promising to repay the loan) and either a mortgage or a deed of trust (allowing the seller to foreclose if the buyer fails to pay). In return, the seller signs a deed transferring title to the buyer. Because the buyer holds the title, the buyer can sell the house or refinance but must keep making the agreed-upon payments to the seller.
If the seller finances the entire purchase then the seller keeps the title to the property for as long as it takes you to pay off the loan. The contract between the buyer and seller is known by various names, including contract for deed, contract of sale, land sale contract or installment sales contract.
How the loan is to be repaid and other loan terms are usually negotiated between the buyer and seller. So there can be numerous variations on the way these loans are structured. Because there are no preset provisions as you would typically find in a mortgage from a traditional lender, a seller-financed loan can be as flexible as the parties involved. It is up them to determine and agree on terms like interest rate, payment amount, late charge stipulations (if any), due dates, length of loan, down payment and so forth.
After the terms are worked out, a formal agreement as to the price, loan amount, interest rate and terms is signed by the buyer and the seller. An escrow account should be opened with a title company or a real estate attorney should be hired to handle the paperwork.
Seller financing is an alternative worth considering when:
- The seller does not want to receive cash
- The buyer has no cash for a down payment sufficient to qualify for conventional financing
- The buyer is otherwise unqualified for conventional financing
- The property is one that conventional lenders will not finance
Pros for the Seller:
- Higher sales price - because the seller is offering owner financing, the seller may be in a position to command full list price or higher
- Tax breaks - the seller might pay less in taxes on an installment sale, reporting only the income received in each calendar year
- Monthly income - payments from a buyer increase the seller's monthly cash flow, resulting in spendable income
- Higher interest rate - owner financing can carry a higher rate of interest than a seller might receive in a money market account or other low-risk types of investments
- Shorter listing term - owner financing attracts a different set of buyers. If a property is not selling under conventional methods, offering owner financing is one way to stand out from the sea of inventory and move a hard-to-sell property that otherwise might not sell
- Eliminate repair costs - the property could be sold 'as is," eliminating the need for costly repairs that conventional lenders would require:
- Substantial savings in closing costs
- Attract a larger number of interested buyers
Cons for Seller:
- Possible foreclosure - sellers may not get the buyer's full credit or employment picture, which could make foreclosure more likely and the seller will need to initiate the costly process of foreclosure if the borrower stops making monthly payments
- Possible abandonment - the seller could agree to a small down payment from the buyer to assist in the sale, only to have the buyer abandon the property because of the minimal investment that was at stake
- Pay off existing mortgage - the seller has to pay off their existing mortgage before they can sell if the owner is financing the entire purchase
- Takes time to assess the creditworthiness of borrower
- Interest income on mortgage loan is taxable
A seller should run a full credit check on the borrower, require hazard insurance on the property and include a due-on-sale clause. Before entering into a transaction with owner financing, you may want to consult a real estate lawyer and obtain competent legal advice because there are financing, disclosure and repayment-term requirements that need to be met.
Questions for Your Attorney
- Have you previously represented clients who are offering seller financing?
- How much do you charge for your services?
- Will the buyers pay all of your fees?
- Can you represent everyone, or do the buyers need their own attorney?
- Should we get an appraisal?
- What's more beneficial for me as a seller—a lease-purchase or seller financing?