Seller Financing Basics
Personal Lending Can Sell a House in Any Market
Obtaining a mortgage has never been tougher. Borrowers hoping to purchase a new home are being asked to come up with significantly higher downpayments, improve their credit scores, and/or buy properties in different areas. Sellers in this market can only watch as their pool of potential buyers gets cut down by mortgage financing woes. Sellers with equity in their homes do have some recourse; however, seller financing is making a huge comeback in this tough lending market.
Seller Financing Basics
Seller financing is when a seller offers to finance a portion of the buyer's cost of purchasing the seller’s property. Many times this takes the form of financing the buyer’s downpayment or the portion of the purchase price that the bank will not finance. When done properly seller financing can work well for the buyer and the seller. In this transaction the buyer gets the ability to purchase the property, usually at better financing rates than he/she could obtain from a mortgage lender, and the seller gets a long-term fixed return on their investment.
Typically seller financing has an interest rate about 2%-3% above current mortgage rates and has a five-year life span. Most of the time these deals are interest only or amortized over 30 years with a balloon payment (total principal repayment) at the end of the loan’s lifespan. The buyer typically pays off the seller financing by refinancing their home. Seller financing typically assumes values will have increased enough or that the purchaser will have enough equity in their home after this time period to refinance and pay off the seller’s original loan.
Seller Financing Watch Outs
As with any loan, sellers must ensure that their buyer is creditworthy. Seller financing always represents a second lien on the property. This means that the mortgage holder has the first right to the home in event of a foreclosure and that their mortgage must be paid in full before any other cash is paid out from the sell of the home. In the case of steep price declines this could leave the original seller with nothing if the buyer chooses to walk away from the home. Recently prices have dropped so quickly that many homeowners have higher mortgages than their home is currently worth. These homeowners have very little incentive to keep making payments because they have no vested equity in their home.
When approaching seller financing approach it like a lender. Understand the motivation behind the buyer’s purchase (investment property, residence, vacation home, etc.). Buyers using the property as their primary residence are less likely to leave if conditions worsen. Additionally, they will take better care of the property leaving more value in the home in the event of a foreclosure. Keep track of the buyer’s payment history and know the rights of lenders. As a second loan holder, sellers have the right to place liens on the buyers' personal property and the right to foreclose on the buyers' interest in the house. While most of the time these transactions go very smoothly, it is important to be prepared if a particular transaction goes sour
Seller financing can help sellers differentiate their offers from the many other properties in today’s crowded real estate market. Understanding and using seller financing properly can create a win-win situation for both the buyer and the seller.
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