Seller Financing: How It Works in Home Sales
Seller financing — when the seller gives the buyer a mortgage — can help both home buyers and sellers. Need Professional Help? Talk to a Lawyer. Zip Code: Get Started By Broderick Perkins Share on Google Plus Share on Facebook 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.
Sellers willing to take on the role of financier represent only a small fraction of all sellers — typically less than 10%. That’s because the deal is not without legal, financial, and logistical hurdles. But by taking the right precautions and getting professional help, sellers can reduce the inherent risks.
The Mechanics of Seller Financing In seller financing, the seller takes on the role of the lender. Instead of giving cash to the buyer, the seller extends enough credit to the buyer for the purchase price of the home, minus any down payment. The buyer and seller sign a promissory note (which contains the terms of the loan). They record a mortgage (or “deed of trust” in some states) with the local public records authority. Then the buyer pays back the loan over time, typically with interest.
These loans are often short term — for example, amortized over 30 years but with a balloon payment due in five years. The theory is that, within a few years, the home will have gained enough in value or the buyers’ financial situation will have improved enough that they can refinance with a traditional lender.
From the seller’s standpoint, the short time period is also practical — sellers can’t count on having the same life expectancy as a mortgage lending institution, nor the patience to wait around for 30 years until the loan is paid off. In addition, sellers don’t want to be exposed to the risks of extending credit longer than necessary. A seller is in the best position to offer a seller financing deal when the home is free and clear of a mortgage — that is, when the seller’s own mortgage is paid off or can, at least, be paid off using the buyer’s down payment. If the seller still has a sizable mortgage on the property, the seller’s existing lender must agree to the transaction.
In a tight credit market, risk-averse lenders are rarely willing to take on that extra risk. 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. Getting Professional Help Both the buyer and seller will likely need an attorney or a real estate agent — perhaps both — or some other qualified professional experienced in seller financing and home transactions to write up the contract for the sale of the property, the promissory note, and any other necessary paperwork. In addition, reporting and paying taxes on a seller-financed deal can be complicated. The seller may need a financial or tax expert to provide advice and… Learn more click below