Seller financing, also called “owner financing,” is simply the financing of a home by the seller instead of by a traditional lending institution. So, instead of going to a bank, a buyer provides the seller with needed information and the seller determines if they wish to make a loan to the seller. Once a financial document is drawn up, the buyer makes payments directly to the seller.
How Seller Financing Works
Unlike when a buyer goes to a bank, the terms set for seller financing can be determined between the buyer and seller, rather than banking regulations, as long as they keep state regulations in mind. Although the seller is not a bank, they will want certain things that a bank wants. For instance, most sellers want some kind of down payment. Down payments show that the buyer is invested in the property and are less likely to default on the loan if they have a sum of money involved in the property.
Once terms are set, the buyer and seller sign a promissory note. This explains the terms of the loan in detail. Then they record the mortgage or deed of trust, depending upon the state. Just as with a bank loan, the buyer pays back the loan over a specific period of years at a specific interest rate. And, just as with banker financing, the seller has the option to foreclose on a loan if the buyer doesn’t pay back the loan as directed.
Many times, seller financing is structured as a short-term solution. This allows the buyer to improve their financial situation enough to apply for a regular loan.
Types Of Seller Financing
There are many different ways to structure a seller-financed loan, however, most fall into one of five varieties.
- All-Inclusive: The all-inclusive mortgage or all-inclusive trust deed (AITD) is a loan that is most like what a bank offers. The seller carries the mortgage for the entire balance of the home loan. So, if the home sold for $150,000 and the buyer put $30,000 down, the seller would carry a promissory note for $120,000.
- Junior: A junior mortgage or second mortgage is one where a seller finances the difference between the 80% of the value of the home that the bank will lend and the amount needed. That means if a home is $200,000, a bank would only loan up to $160,000. However, a buyer may need to borrower $180,000. The seller would then offer a junior mortgage of $20,000 to make up the difference.
- Land Contract: A land contract gives the buyer shared ownership. The actual deed gets turned over when the seller makes the final payment.
- Lease Option: Similar to renting property, the seller agrees to lease the property to the buyer. The buyer pays an upfront fee and the seller then agrees to sell the property to the buyer at a specified time in the future. Depending upon the agreement, some of the lease payments may be used towards the purchase price of the home.
- Assumable Mortgage: In this case, the buyer takes the seller’s place on an existing mortgage. Some loans are assumable with a bank’s approval.
Why Do Sellers Opt To Finance?
There are many reasons that a seller might choose to offer financing when they put their home up for sale. Here are a few:
- The seller wants to sell the home “as-is”, but the banks are requiring certain repairs be made in order to finance the house.
- The interest rate they earn from carrying a mortgage is better than the rate they would earn on other similar low-risk investments.
- It is possible to sell the promissory note to an investor to receive a lump-sum payment.
- The seller receives tax breaks because they only have to report the income from the year rather than the whole price of the house.
- Monthly payments will help the seller’s cash flow.
- Seller financing helps the house stand out from other homes on the market to individuals that are seeking creative solutions to their home buying needs.
Why Would You Need Owner Financing?
Not everyone has exactly what the bank requires for getting a home mortgage. If you do not meet all the qualifications or do not have the needed down payment, then owner financing might be for you. The seller will be able to be more flexible with you than a bank can, especially with the new lending laws in place.
Additionally, seller financing can be tailored to fit your needs. Instead of the traditional loans, a seller can offer you a variety of options such as an interest only loan or a loan with a balloon payment in five years. You can also adjust your loan so that payments are due when it meets your needs. For instance, someone working in a 9-month contract could create a loan where payments are due only during the months of the year that the buyer is actually working.
Closing costs are also lower when dealing with a seller rather than a lending institution. Typically, a seller will not charge you points, origination fees, administration fees, or a variety of other fees traditionally charged by a bank.
Finally, closing can happen much faster on a seller-financed loan. This means that you can get into your new home much more quickly.
Don’t Go It Alone
If you do choose to use seller financing, make sure that you have some professional help. Both you and the seller will need a real estate attorney to help you craft a contract for the sale of the property, as well as the promissory note and other paperwork needed by your state. Since taxes on seller-financed deals are complicated, you should also consider hiring a financial adviser when tax time comes around.
