Seller Financing

By Kevin Dougherty | June 4, 2020
Staging Your Home

Background
Seller Financing, Seller Carry-Back Financing, Seller Participation, Owner Financing, Bond-For-Title… all terms for the same thing. It’s a loan provided by the seller of a property to the purchaser of that property. Most consumers have little or no experience in this type of financing and surprisingly, most real estate agents don’t know any thing about it either. Of course, a mortgage broker will not have a product like this either because it takes them out of the process. So what is this mysterious type of financing all about and why would anyone participate in it?

Since the recent “mortgage crisis” of 2007-2010, the lenders have made qualifying for a loan much more difficult. As a result, there are lots of very good buyers out there that have a hard time getting their desired loan for a variety of reason. Since the seller decides if they are comfortable making the loan or not, the buyer does not have this same challenge.

How it works
It’ s considered Seller Financing when the seller of a property offers the buyer a loan rather than the buyer obtaining one from a bank or other lending institution. Usually, the buyer will offer some amount of down payment and the seller will provide credit for the remainder of the purchase. Both parties then execute a Promissory Note (a promise from the buyer to the seller to repay the loan under well-defined terms and conditions). Those terms will include the;

  • Interest Rate
  • Repayment Schedule and
  • Consequences of Default
    • (In some cases the owner keeps the title to the property until the loan is paid in full. This is called a Land Contract)

Frequently, Seller Financing is short term (1-5 years) until the buyer can refinance the property into a more traditional institutional loan. The loan is often amortized over a traditional 30-year period with a large Balloon Payment due at the end of the loan term.

Pros and Cons to the buyer
Pros: There are several reasons a buyer might want to consider Seller Financing instead of a more traditional institutional loan;

  • The biggest reason is usually because a buyer can not get a loan for one reason or another
    • The buyer might be self-employed and really good and writing of your expenses which in turn reduces your taxable income but also makes it appear you don’t make as much money that a bank would want to see.
    • The buyer may have a strong balance sheet but a weaker income statement, again allowing you to put a larger down payment down and giving a seller a strong sense of security but your DTI (Debt : Income Ratio) might be below what you need to qualify.
    • The buyer may be cash-rich but income-poor.
  • The buyer might be able to buy a house that you would otherwise not be able to.
  • You might be able to close the transaction quicker and for less money if you didn’t have to pay for bank fees or appraisal costs.
  • There is no strict or formal loan-qualification process.

Cons: Don’t be fooled though. There are cons to this idea for the buyer as well;

  • You might have to pay a higher interest rate than a bank might charge.
  • You still need the seller to approve and cooperate with this type of financing and most sellers are uneducated in this area and as a result fearful of the unknown (even if there are very safe ways to structure the loan to give the seller a high level of comfort and security).
  • You might only be able to negotiate this type of loan for a shorter period of time (1-5 years). At the end of that term you would have a balloon payment and have to pay the loan off to the seller (usually through a refinance).
  • If the seller already has debt on the property, there may be a due-on-sale clause where the seller’s bank demands full payment if they are made aware of the sale between you and the seller.
    • This is why Seller Financing is usually used only on properties that are owned free and clear by the seller.

Pros and Cons to the seller
Pros: There are a several reasons why a seller might want to participate in this type of financing;

  • The seller may want to sell the property but not need the proceeds right away.
  • It can often help sell a home fast by opening up the purchase to more prospective buyers.
  • It could return a better interest rate than you would otherwise earn elsewhere.
  • There could be tax benefits. It could help to minimize or defer capital gains tax if your sale is going to create a tax liability.
  • It can usually be done cheaper without big bank fees or appraisal costs
  • A seller could sell the Promissory Note to an investor is they decided to cash-out.

Cons: There is risk in any real estate transaction of course. If you are a seller considering Seller Financing, there are a few things to think about as well.

  • Buyer Default: The buyer could stop making payments at any time. If this happens and they don’t just walk away, you could end up going through the foreclosure process.
    • To mitigate the risk of the buyer defaulting, the seller does have the option of retaining title to the property under a Land Contract so, in case of a buyer default, the seller can just evict the buyer instead of having to go through the foreclosure process.
  • They if you do have to take back the property via foreclosure, you may get stuck with the repair and maintenance costs depending on how well they buyer took care of the property.
  • Dodd-Frank Act: Under the Dodd-Frank Wall Street Reform and Consumer Protection Act new rules were applied to owner financing. Balloon payments may not be an option and you might have to involve a mortgage loan originator depending on the number of properties you owner-finance each year

Holding Title

Qualifying

Legality

There are several other details that both parties need to work out but these are the high-level points of consideration for all buyers and sellers thinking about participating in Seller Financing. If you’re unfamiliar with Seller Financing but think you’re in a position