What is Seller Financing
What is Seller Financing
Seller financing is just what it sounds like: instead of the buyer getting a loan from the bank, the person selling the house lends the buyer the money for the purchase.
Seller financing can be a useful tool in a tight credit market. It allows sellers to move a home faster and get a sizable return on the investment. And buyers may benefit from less stringent qualifying and down payment requirements, more flexible rates, and better loan terms on a home that otherwise might be out of reach.
Types of Seller Financing Arrangements
Here's a quick look at some of the most common types of seller financing.
All-inclusive mortgage. In an all-inclusive mortgage or all-inclusive trust deed (AITD), the seller carries the promissory note and mortgage for the entire balance of the home price, less any down payment.
Junior mortgage. In today's market, lenders are reluctant to finance more than 80% of a home's value. Sellers can potentially extend credit to buyers to make up the difference: The seller can carry a second or "junior" mortgage for the balance of the purchase price, less any down payment. In this case, the seller immediately gets the proceeds from the first mortgage from the buyer's first mortgage lender. However, the seller's risk in carrying a second mortgage is that he or she accepts a lower priority should the borrower default. In a foreclosure or repossession, the seller's second, or junior, mortgage is paid only after the first mortgage lender is paid off and only if there are sufficient proceeds from the sale. Also, the bank may not agree to make a loan to someone carrying so much debt.
Land contract. Land contracts don't pass title to the buyer, but give the buyer "equitable title," a temporarily shared ownership. The buyer makes payments to the seller and, after the final payment, the buyer gets the deed.
Lease option. The seller leases the property to the buyer for a contracted term, like an ordinary rental -- except that the seller also agrees, in return for an upfront fee, to sell the property to the buyer within some specified time in the future, at agreed-upon terms (possibly including price). Some or all of the rental payments can be credited against the purchase price. Numerous variations exist on lease options.
Assumable mortgage. Assumable mortgages allow the buyer to take the seller's place on the existing mortgage. Some FHA and VA loans, as well as conventional adjustable mortgage rate (ARM) loans, are assumable -- with the bank's approval.
Pros and Cons of Seller Financing
Pros for buyers:
- Seller financing lets people who might not be able to secure a mortgage buy a home. A seller might OK you even if a bank or other traditional lender turned you down.
- The closing process is faster and cheaper.
- The down payment can be whatever amount you and the seller agree upon.
Cons for buyers:
- The interest you pay might be high.
- Just because the seller is not a bank doesn't mean he or she won't run a credit check on you. You could be turned down if you're a credit risk.
- You need to ensure you can pay the balloon payment.
Pros for sellers:
- If you're having trouble selling, offering seller financing makes your home stand out, potentially getting it sold faster. Simply add the words "seller financing available" to the listing to let people know.
- You may be able to sell the house "as is," instead of making costly repairs that might be required by traditional lenders.
- You could get a better interest rate than you could get from other investments.
- If the buyer stops making payments, you get the house back and can keep the down payment — plus any money that was paid.
- You can sell the promissory note (usually at a discounted amount) right away to an investor, if desired. That would give you a lump-sum payment.
Cons for sellers:
- You typically need to own the home free and clear. If you still hold a mortgage, you must get approval from your lender before going forward with the deal.
- The buyer could stop making payments at any time. "Most of the time, when buyers default on the loan, they feel bad and just walk away," says real estate professional Barb Getty of Indianapolis. But if the buyer doesn't leave, you need to go through the foreclosure process. "I had to do this once, and it took three months and $700 in fees," she explains.
- You might "incur repair costs, depending on how the buyer cared for the property," if you need to take back the house, says Cindy Welu, a real estate professional from Minneapolis/St. Paul.
- Taxes could be complicated.
Bottom Line
There's more than one way to buy or sell a house. Just because your financial situation is a little more complicated than traditional lenders prefer doesn't mean you can't buy. And just because banks aren't approving borrowers easily doesn't mean you can't sell your house quickly — and for what it's worth. Seller financing might be just the solution you've been looking for.