Seller Financing
A Tool to Give Sellers an Advantage in a Down Real Estate Market
Seller financing has been a tool used to make properties more attractive on the commercial side of the real estate business. It works for residential sellers as well.
As the real estate market begins to dip, sellers will need to find more creative ways to sell their home. One of the major problems in today’s real estate market is the lack of financing vehicles available to buyers. Buyers with good to average credit find it harder and harder to get approved for the amount of money they would like at an interest rate that they feel comfortable with. Seller financing provides an easy bridge to close a buyer’s financing gap.
Basics of Seller Financing
Before offering seller financing, sellers need to be sure they completely understand their obligations. Most of the time seller financing requires no direct cash outlay from the seller. Sellers simply substitute a portion of their equity interest in exchange for a promissory note from the buyer of the property.
The promissory note acts like a second position or second lien loan. Essentially, this puts the seller in the same position as a home equity lender or second mortgage lender. In event of foreclosure, the primary lender must first be made whole from the proceeds of a forced sale, and then second lien holders split what is left. In up markets this is not a problem because most houses sell for enough to cover both positions.
However, down markets elevate the risk to second lien holders. While the risk of foreclosure is not high (less than 1% on average), accounting for the additional risk is important. Seller financing typically carries a rate of 1-2% above the current mortgage rate. Additionally, sellers often opt for some balloon payment structure. For example, a seller might allow monthly payments to be made for five years, and then require the balance of the loan be paid in full at the end of that period.
Pros and Cons of Seller Financing
Seller financing has become quite common place in commercial real estate transactions. On the residential real estate side, seller financing has been restricted to the upper end of the market, but all sellers have the opportunity to gain a marketing advantage by offering seller financing.
The transaction acts very much like purchasing a bond. With interest rates currently around 6.5% for mortgages, sellers could get away with 7-9% rates. Even as interest rates rise, this is a great return to have on a yearly basis. These rates provide more than fair rates for buyers, who cannot afford a full down payment or who are looking to avoid PMI by gaining a 20% equity stake.
Ensuring all parties understand the transaction continues to be the biggest challenge. Seller financing benefits both parties, but some agents and buyers may not be comfortable handling these kinds of transactions. Having a knowledgeable realtor and mortgage broker will alleviate much of this problem. Additionally, walking through the transaction step by step with all interested parties, or simply their agents, present helps everyone wrap their minds around different alternatives.
Buyer default is also a small possibility. This can be minimized with a simple credit check or by following standard mortgage guidelines. In many situations a mortgage broker will handle this portion of the transaction for the seller, including any paperwork or contractual requirements.
In down markets sellers need to use every tool available to sell their home quickly. Quicker sales tend to be more profitable and provide less headaches then chasing a down markets. Seller financing can give sellers the advantage they need to overcome a key purchasing hurdle, opening their property up to more potential buyers.
