Qualifying for a home mortgage can be a challenging task. That’s because some lending institutions have stringent requirements and quickly weed out loan applicants with too much debt or a low credit rating. If you are a seller whose house is not selling or a buyer having issues with traditional lender requirements, then seller financing is a viable option. Seller financing is also popular in places where the local real estate setting is a buyer’s market. In this article, we are going to look at how seller financing works, types of owner financing, and pros and cons to make an informed decision when purchasing a home.
UNDERSTANDING SELLER FINANCING
Seller financing, also known as owner financing, refers to a situation where a property owner offers financing to a home buyer. In other words, rather than getting a mortgage with commercial lenders, the buyer borrows the money from the homeowner. A buyer can fully finance the purchase using this way or, combining the loan from the homeowner with another one from a lending institution. Payments are usually made to the home seller over a certain period with a stipulated interest rate and specified terms.
HOW DOES SELLER FINANCING WORK?
Seller financing is a situation where a part of the house purchase of a potential homebuyer gets financed by the owner selling the home. The seller becomes the lender of the homebuyer, allowing him or her to set the loan terms. Owner financing is a secondary route outside the normal buying options, such as taking out a home mortgage or paying cash.
For instance, if you only qualify for a small mortgage and you want to try seller financing, then you can try convincing the homeowner to finance the remaining amount for you. The seller can also afford to lend the homebuyer enough money for the entire cost of the home. Regardless of the chosen way, the homebuyer is responsible for repaying whatever they borrow with interest every month. In this kind of arrangement, the home seller will need the homebuyer to sign a promissory note containing all the details about the loan. This will also include the interest rate, terms, and schedule for making the payments.
TYPES OF SELLER/OWNER FINANCING ARRANGEMENTS
Buyers and sellers are free to discuss and negotiate the terms and conditions of seller financing, according to the state-specific moneylending laws and the other local regulations. Here is a breakdown of some of the popular types of owner financing.
1. JUNIOR MORTGAGES
Nowadays, lending institutions are reluctant to finance over 80 percent of the value of a home. Home sellers can extend credit to the homebuyers to make up for the difference. In this case, the seller of the home can carry a junior or second mortgage for the remaining balance of the home purchase cost, less the down payment. Therefore, the seller receives the proceeds from the initial mortgage immediately from the first mortgage lender of the homebuyer.
2. ALL-INCLUSIVE MORTGAGES
In an all-inclusive trust deed or all-inclusive mortgage, the home’s seller holds the promissory note and the mortgage for the full balance of the property price, less the down payment paid.
3. ASSUMABLE MORTGAGES
An assumable mortgage allows the homebuyer to take the place of the seller on an existing mortgage. Some traditional adjustable mortgage-rate loans (ARM), VA loans, and FHA loans are easily assumable with the lender’s approval.
4. LAND CONTRACTS
In a land contract, the seller does not pass the title to the home buyer. Instead, the buyer gets an equitable title, which is a temporarily shared property ownership. The homebuyer makes payments to the owner and gets the deed after making the final payment.
5. LEASE OPTION
In this form of owner financing, the seller of the home leases it to the prospective buyer for a contracted period, just like a standard rental. However, the seller should agree, in return for an agreed-upon upfront fee to sell the home to the buyer within a specified period in the future. All or some of the rental payments could get credited against the buying price.
PROS OF OWNER/SELLER FINANCING
BENEFITS FOR BUYERS
Seller financing can be useful to homebuyers in various ways. Some of them include:
LITTLE OR NO QUALIFICATIONS
The interpretations of the seller when it comes to the qualification of the buyer are usually more flexible and less stringent than those enforced by traditional lending institutions.
FLEXIBILITY OF DOWN PAYMENTS
Down payments are usually negotiable, which means that if a seller wants a higher down payment than the homebuyer can afford, then the seller can allow the buyer to make some regular lump sum payments towards the down payment.
Unlike the traditional loans, buyers and sellers can select from a wide array of loan repayment routes, such as fixed-rate amortization, interest-only, less-than-interest, balloon payments, or a combination of two or more of these.
FAST CLOSING AND POSSESSION
Since the sellers and buyers are not waiting for a lending institution to process the mortgage financing, a buyer can close fast and get the possession of the home sooner than a traditional loan transaction.
LOW CLOSING COSTS
In seller financing, there are no discounts or loan points and no administration fees, processing fees, origination fees, or any other miscellaneous fees that conventional lenders charge. Therefore, a buyer can save a lot of money on the closing costs.
BENEFITS FOR SELLERS
The seller can also benefit a lot from owner financing. Some of the common advantages include:
The payments the sellers get from homebuyers increase their monthly cash flow, which results in a good spendable income.
HIGH SALES PRICE
The seller is in a position to command a complete list price or even higher because he or she is providing the financing.
The seller-financed loan may come with a higher interest rate that a home seller can get in money market accounts or other types of low-risk investments.
Seller financing allows the seller to pay less taxes on installment sales, where they only report the income received in every calendar year.
Seller financing is one of the best ways to attract a different set of homebuyers, especially when you want to move a hard-to-sell residential property.
CONS OF OWNER/SELLER FINANCING
DRAWBACKS FOR BUYERS
LESS ORGANIZED PROCESSING OF MONTHLY PAYMENTS
It isn’t easy to make automatic payments with owner financing, and you might not loan balance updates and monthly payment statements.
ASSUMING SELLER RISKS
If a home seller has some liens or any other claim from creditors that the homebuyer does not know about, then a buyer might inherit some of these obligations when you become the new owner.
DRAWBACKS FOR SELLERS
RISKY INCOME STREAM
In seller financing, the seller cannot know fully if a buyer will pay the agreed amount over time. The buyer can lose their job or even pass away.
LESS CASH WHEN CLOSING
The home seller is trading their lump sum for monthly payments, which means they’ll have less cash at hand during closing.
LONG AND COMPLICATED PROCESS OF FORECLOSURE
If the homebuyer fails to pay in the long run, both seller and the buyer will be facing a long and expensive foreclosure process.
Seller financing can give a seller a steady flow of income and make the path to homeownership much easier. However, the arrangement has its drawbacks too. If you decide to take the owner financing route, it is good to look for a real estate lawyer to check whether the seller financing contract covers all the legal bases. If you have more seller financing or real estate financing questions, then we can help.