Sellers sometimes agree to finance all or part of a home's purchase price. When this occurs, a seller assumes the role of a lender and should thoroughly evaluate the creditworthiness of a buyer before agreeing to finance the purchase.
Evaluate Buyer's Financial Condition
The seller will need to know if the buyer is able and likely to repay the loan. The seller should ask for and examine documents that any other lender would look at such as:
- Get a credit report and review the buyer's credit history to see if the buyer has a record of late payments, bankruptcies or outstanding obligations
- Ask for and review copies of bank statements or other financial documents
- Verify employment and any other sources of income the buyer will rely on to make their loan payments
- Require personal financial statements to determine if the buyer has adequate income or assets to support the loan
- Ask for references from prior lenders
- Ask for recommendation letters from landlords
- If the buyer is applying for additional financing from a mortgage lender, review a copy of the loan application.
Minimizing Risk of Default
The seller should require a large down payment because the more money a buyer has invested in a home, the less likely the buyer will be to default on the loan. The seller should also make sure they have adequate collateral. The property serves as security for the loan and if the buyer defaults, the seller needs to know that the home is likely to sell for an amount sufficient to cover outstanding debts. Therefore, the seller should confirm that the appraised value of the property is equal to or higher than the purchase price. In addition, the seller should include the following in the contract:
- Impose a penalty if payments are late
- Require proof of homeowner's insurance covering fire and other perils
- Give the seller a right to do annual inspections
- Give the seller periodic access to credit reports
Require PMI Insurance
The seller may want to require the buyer to purchase private mortgage insurance (PMI) to protect against default on the mortgage.
Contract Contingent on Buyer's Financial Qualifications
In addition to the inclusion of all of the terms of the loan in the purchase contract, the seller may want to include a contingency clause that makes the contract contingent or conditional on the seller's examination and approval of the buyer's financial qualifications. Then, if they are not to the seller's specified satisfaction, the seller may legally walk away from the deal without penalty.
Establish Financial Claim
The seller should record the mortgage in the public records to establish the priority of the seller's lien (financial claim) on the property.