Banking Law

Pros and Cons of Seller Financing for the Home Seller

By Ilona Bray, J.D., University of Washington Law School

Seller financing is when a seller helps a buyer complete a real estate transaction by lending part of the money for it. Logistically speaking, this is accomplished by the seller taking a second loan note or even financing the entire purchase (assuming the seller owns the home free and clear).

In essence, the seller assumes the role of a banker and carries back the loan. As with a bank loan, the buyer makes a promise to pay, as evidenced by a written promissory note, and the real estate property serves as collateral for the loan (which can be sold if the buyer defaults through non-payment or some other failure to meet the loan terms).

Although relatively uncommon unless the local real estate market is quite cool or the house has no other viable offers, sellers become more willing to finance their home in situations where:

  • 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, or
  • the property is one that conventional lenders will refuse to finance.

Process for Arranging Seller Financing

If the seller is willing to take back a mortgage on the house, the buyer will need to sign 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 or otherwise defaults).

In return, the seller will ordinarily sign a deed transferring title (formal, documented ownership) of the property to the buyer. Because the buyer then holds the title, the buyer can sell the house or refinance, but must then either pay off the loan or keep making the agreed-upon payments to the seller.

If, however, the seller finances the entire purchase, he or she would keep title to the property for as long as it takes the buyer 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, and 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. Without preset provisions such as you would typically find in a mortgage from a traditional lender, a seller-financed loan can be as flexible as the parties involved would like. It is up to 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 should be 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.

Pros for the Home Seller

Here are some reasons a seller might want to offer, or at least be open to accepting, an arrangement whereby he or she finances part or all of the purchase.

  • Attract more interested buyers. Not every buyer will want seller financing, but for those who need an extra leg up in buying a home, this offer will make it very attractive indeed.
  • Higher sales price. A home seller who is offering financing to someone who might otherwise have had trouble qualifying 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 rest.
  • Elimination of repair, decorating, and staging costs. The property could be sold 'as is," eliminating the need for costly repairs that conventional lenders would require, along with other customary steps to make the house look its best for sale.
  • Saving on closing costs. Although the buyer normally pays most of the loan closing costs (for things like the loan origination fee and an appraisal), the fact that the buyer won't be on the hook for these leaves more money available for the rest of the transaction.

Cons for the Home Seller

Here are some downsides for sellers to consider before offering to, in essence, loan the buyer money with which to buy the home.

  • Monthly or regular need to keep track of payments. A home seller could end up feeling like a debt collector if the buyer is disorganized or worse. Some home sellers hire third parties to handle the payment collection, but of course this also costs money.
  • Possible need to foreclose. The buyer's financial situation could change for the worse. Or, the seller may not have gotten the buyer's full or accurate credit or employment picture initially. The seller would, upon the buyer's default, either need to negotiate a different arrangement or initiate the costly and often lengthy process of foreclosure.
  • Possible abandonment of the purchase. 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.
  • Need to pay off existing mortgage in full. Before turning around and financing it, a seller who is financing the entire purchase will need to pay off the existing mortgage. (In a "normal" sale, the seller uses the proceeds of the sale to pay off the existing bank loan.)
  • Time required to assess the creditworthiness of the buyer/borrower. You'll need to handle various tasks that a bank usually does, such as obtaining a credit report and financial information from the buyer and reviewing it for creditworthiness.
  • Fees. In order to arrange this deal, you may need to hire an attorney, pay an escrow company, pay recording fees, and more.
  • Tax obligation. Interest income on mortgage loan is taxable along with other income.

By way of protection from such downsides, a seller should run a full credit check on the borrower, require hazard insurance on the property, and include a due-on-sale clause (meaning that if the buyer resells the property, you'll be owed the entire balance of the loan amount immediately).

Before entering into a transaction with owner financing, you may want to consult a real estate lawyer and obtain competent legal advice with regard to the financing, disclosure, and repayment requirements that need to be met, and with documenting the deal.

Questions for Your Attorney

Here are some questions to ask a lawyer whom you are considering hiring to help with your seller financing deal.

  • 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 to offer as a home seller—a lease-purchase or seller financing?
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