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2010-06-04 14:08:03
Video - Seller Financing 101

The recent real estate market has posed new challenges to both buyers and sellers. 

  • Buyers have found the pendulum has swung to the other extreme with lending institutions now extremely strict with their lending requirements.  Thus many buyers want to buy a home but are finding it very difficult to obtain a mortgage loan.
  • Sellers have found that the price they want to sell their home at is not enough of a 'bargain' to attract buyers.  Thus many sellers want to sell their home but can't find a buyer for the price they need.

A great solution for both of these situations is SELLER FINANCING! Sellers broaden their home's market by attracting more buyers and buyers can find the home of their dreams!

Seller financing is not new. It was very common in the early 80s when interest rates were in the teens.  At that time, savvy sellers who offered seller financing sold sell their home when many sellers could not.  How?  They attracted buyers by offering a lower interest rate than what buyers could get from a lending institution.  The same is true today.  Savvy sellers who offer seller financing make their home stand out in this market and from their competition by making their home available to more buyers. 

The key is understanding how seller financing works and finding an experienced real estate agent.

Please watch this 4 minute video and read more below to learn about seller financing.

With traditional third-party financing, a lending institution makes a loan to the buyer for the purchase price of a home and takes back a security interest in the same home. The security interest comes in the form of a mortgage or deed of trust, which allows the lender to foreclose on the home to recover its loan money in the event of a default. The buyer gives the seller the entire purchase price and the seller leaves the picture. The buyer then must make mortgage payments to the lender until the loan is paid off and the buyer owns the house free and clear.

Seller financing works a bit differently. In this situation, the seller does not receive a lump sum of cash and remains involved in a financial relationship with the buyer until the entire purchase price is paid. With seller financing, the seller agrees to transfer title to the house in exchange for a note and a security interest in the house. The note is paid off just like a mortgage, but it is paid to the seller instead of a bank. Also, just like with traditional financing, the seller's security interest gives him the power to foreclose on the house in the event of default. Often, when a seller finances the purchase of a home, the loan note provides for a balloon payment after a period of years. A balloon payment is basically a lump sum payment of the amount still owed to the seller. When the balloon payment is due, the buyer usually pays it or refinances with a traditional third party lender who pays it.

Purchasing a house under a lease to own contract is also a form of seller financing. Lease to own works just as it sounds. Rather than buy the house right off the bat, the buyer rents the home for a period of time or until some other purchase trigger occurs. At that point, the buyer has the option to purchase home. If she chooses to do so, then all the rent payments she has made count towards the purchase price of the house. If not, she walks away from the house, just as if she were a renter. Typically, the buyer has first right of refusal in the event another person offers to purchase the house.

With seller financing, the seller has to wait a period of years to get the full purchase price of the house and bears the risk of default in the meanwhile. Additionally, the payments for seller financing are usually lower than those on a traditional mortgage. So, why would a seller be interested in a deal like this? The same reason a bank would be: interest. Charging interest allows the seller to get more than his asking price or make up for a very low purchase price through interest. In a seller's market, the seller gets to squeeze even more money out of the buyer; in a buyer's market, the seller gets to sell her house and possibly get close to her original asking price anyhow. Also, because of the balloon payment, the seller usually gets out quickly - after five to 10 years, so she really isn't bearing the same risk as a third-party lender.

What are the benefits of seller financing?

Some of the major advantages include a substantial savings in closing costs for both buyer and seller. The parties can also negotiate the interest rate and the repayment schedule, as well as other conditions of the loan. The buyer can request special conditions of the purchase, such as the inclusion of household appliances or even vehicles. Also, the borrower does not have to qualify with a loan underwriter and, unless negotiated, there are no PMI insurance premiums.

On the seller’s side, he or she could receive a higher yield on their investment by receiving their equity with interest. The seller could also possibly negotiate a higher interest rate than could be received on other types of investments. A higher selling price could also be obtained as compensation for assisting the buyer with financing. The property could be sold “as is”, thus eliminating the need for costly repairs that conventional lenders would require. The seller could screen the buyer for creditworthiness and the ability to pay, and could also require the buyer to purchase a PMI policy to protect the seller against default. The seller could also choose which security document (mortgage, deed of trust, land sales document, etc.) to best secure his or her interest until the loan is paid.

Are there any disadvantages? Of course there are. For one, the buyer could pay the loan in full but still not receive title due to other encumbrances not divulged by or unknown to the seller. The buyer could make payments faithfully, but the seller might not make payments on any senior financing that may be in place, thus subjecting the property to foreclosure. Also, the buyer may not have the protection of a home inspection, mortgage insurance, or an appraisal to ensure that he or she is not paying too much for the property. (Of course, all of these options can be negotiated into the transaction.)

In short, a seller-financed sale can be good, as long as it is good for both parties. The concerns of buyer and seller must be addressed during negotiations. But with a “meeting of the minds”, it can certainly be a win-win situation for all concerned.

Benefits

  • Substantial savings in closing costs for both buyer and seller
  • Negotiated interest rate, repayment schedule, and other conditions of the loan
  • Buyer can request special conditions for the purchase (such as inclusion of household appliances)
  • Borrower does not have to qualify with a loan underwriter
  • There are no PMI insurance premiums (unless negotiated)
  • Seller could receive a higher yield on their investment by receiving their equity with interest
  • Seller could negotiate higher interest rate
  • Seller could negotiate a higher selling price
  • Property could be sold 'as-is' (thus, there will be non need for repairs)
  • Seller could choose which security documents (mortgage, deed of trust, land sales document, etc.) to best secure his/her interest until the loan is paid

Drawbacks

  • Buyer could pay the loan in full but still not receive title due to other encumbrances not divulged by or unknown to the seller
  • Buyer could make payments faithfully, but the seller might not make payments on any senior financing that may be in place, thus subjecting the property to foreclosure
  • Buyer may not have the protection of a home inspection, mortgage insurance, or an appraisal to ensure that he/she is not paying too much for the property
  • Seller may not get the buyer’s full credit or employment picture, which could make foreclosure more likely
  • Depending upon the security instrument that was used, foreclosure could take up to a year
  • 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
 
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