Knowing seller financing is crucial when you are in the real estate business. You have to know the different kinds of financing methods that both buyers and sellers can make use of. With that knowledge, you can give the best advice to your clients on what would work for them and help you close the deal.
What is Seller Financing?
Also known as the owner financing or purchase-money mortgage, seller financing is a real estate agreement wherein the seller would shoulder the mortgage process rather than a bank or other financing institution. So, instead of securing a loan from a bank, the buyer would then settle the mortgage with the seller.
Why Consider Seller Financing?
A buyer who finds it challenging to secure a loan would find it enticing to sign off a mortgage with a seller. Why? Compared with banks, sellers don’t often require an appraisal and does not involve any closing costs. Plus, they are more flexible in terms of down payment amounts and often have a faster approval process, usually within a week.
For sellers, this option is highly preferred because it allows them to sell the property faster, especially during times when the real estate market is performing poorly, and there are lesser demands for homes. Additionally, sellers benefit from getting premium for offering to finance a property. In short, it is easier for them to negotiate their listing price in a buyer’s market.
The popularity of seller financing waxes and wanes, but they generally depend on the credit market. When banks are stricter, seller financing can be a way for most individuals to buy and sell a home. However, when the banks are more enthusiastic about lending money to home buyers, the seller financing market is down.
Advantages of Seller Financing
Owner financing, as mentioned, is an alternative to conventional financing. It is useful in times when securing a home mortgage is next to impossible. Since there is no bank involvement, both the buyers and sellers are responsible for drawing up their contract or promissory note, wherein they will settle payment schedules, interest rates, and liabilities on defaults. Because it is not a mortgage, there is no requirement for transferring the principal from the buyer to the seller but only a mutual agreement on the repayment.
Since it involves only two parties, owner financing is cheaper and quicker for sellers to dispose of the property. For instance, the closing costs are much lower since the transaction does not have to include origination fees and other charges that conventional lenders impose.
Disadvantages of Seller Financing
For buyers, they must expect that they will have to pay a higher interest rate compared to traditional mortgages from a lender. Typically, because most buyers who avail of owner financing have low credit scores. This higher interest rate is also the reason why most seller financing agreements are only short-term, lasting only about five years. The assumption is that most buyers prefer to pay off the financing by taking out a loan from a bank since they already have an improved credit score.
Buyers also need to shoulder other expenses, such as the title search, survey fees, and taxes. Sellers also have to take the risk of chasing buyers who default on their payments. Often, they would need to get a court order to reimburse the expenses. However, if the buyer files for bankruptcy, it might have an alienation clause, requiring the full repayment of the existing mortgage should the property sell. For this reason, both parties need to work together with a real estate lawyer to work on the details of the deal before finalizing it.
The Ins and Outs
Terms are not always better than a mortgage. Buyers must understand that they cannot get a better interest rate when they choose seller financing. At times, interest rates are higher than banks because sellers have to deal with financial risks.
Check if the seller is available to finance the sale. If the seller has direct ownership of the property, the financing is simple. However, if it has any existing mortgages, it can get complicated. Buyers have to make sure that it does not have a due on sale clause. This clause means that the seller cannot sell the property without paying off the mortgage. If the mortgage institution discovers that the property is being sold to another, they will mark the property as “sold,” and they have the right to demand full payment of the debt, and this permits the company to foreclose the property.
Seller financing can be short-term. Sellers can pass off the funding to someone else. However, this is often lower than the full value of the promissory note – about 65% to 90%.
Incorporate seller financing when selling the property. Seller financing is extremely rare, and not many buyers are aware of this option. You may want to include the phrase “seller financing available” to your property listing to make sure that the option is available for the buyers.
Ask help from tax experts. Seller financing can open tax complications. To make sure that you are not making any tax mistakes, consult an expert, and get advice.
- In seller financing, the buyers get the property from the seller, and they iron out the arrangements.
- Seller financing can be short-term and can be sold to another party.
- It also comes with risks for both buyers and sellers.
- Deals must always be in the presence of real estate lawyers and tax experts.