According to Pew Research, approximately one in five homebuyers shy away from conventional mortgages when buying a home.
The reasons for this may include shortfalls in low-value mortgages, land ownership issues, and wanting to buy a property that’s ineligible for a mortgage. Alternative financing options include land contracts, lease purchase agreements, personal property loans, and seller financing.
That means, as a seller, you can increase your pool of potential buyers if you’re willing and able to agree to a seller-financed mortgage.
Keep reading to find out more about this option, how it works, and all the pros and cons that go with it.
What Is Seller Financing?
Unless you decide to sell your home to a cash buyer, most home sales follow a familiar, time-consuming, and costly process. This includes finding a realtor, finding a buyer, waiting for them to secure funds, and closing the deal.
Most buyers finance their home purchase via a traditional lender, which means they must apply for a mortgage with their chosen institution.
If they don’t have the required credit score, employment history, and income to meet the lender’s requirements, this can stall the sale, or even cause it to fall through. Sometimes lenders require a home inspection before they’ll grant a mortgage, resulting in further costs and complications for the buyer and seller.
Once buyers have secured a mortgage, the buyer and seller pay the relevant costs associated with the sale and the seller receives their money.
Seller-financing is an alternative to conventional mortgages, where the seller finances the deal. This means the seller extends credit to the buyer for all or part of the cost of the home.
The buyer pays a down payment and pays the loan in monthly payments to the seller instead of a bank or other lender. Like a mortgage, seller finance includes interest rates over a certain time frame, a set of agreed-upon terms, and a certain time frame.
The Legalities Associated with Seller Financed Homes
Seller financing isn’t an option if you want to avoid trouble with your mortgage. A mortgage on your property adds complications, as most mortgages have a ‘due on sale’ clause that prevents sellers from selling their homes without paying off the mortgage.
Federal laws, like the Dodd-Frank ACT and the SAFE Act, define seller financiers as mortgage originators. This means the seller must ensure the buyer has the means to pay back the loan and hold a mortgage broker’s license.
Some exceptions in the law exclude you from these requirements if you are:
- A natural person, or acting on behalf of a trust or estate
- Only provide finance to one person per 12-month period
- Did not build the house
- Willing to use a balloon payment due within no less than five years
- Preferably, offer a fixed rate
Á final regulation states the loan may not end up in negative amortization once it’s repaid.
There is also a ” Three property exception” applying to sales of three or fewer properties over twelve months. In these cases, the seller must own the properties, amortize the loan, check if the buyer can afford to pay the loan and exclude balloon payments.
Federal laws may change, so it’s important to speak to a property lawyer about current federal and state laws applicable to seller financing.
Types of Seller Finance
As the seller, you choose the type of repayment plan you’d like to offer the lender. There are three common types of seller-finance options, namely:
This contract provides an “equitable title” which is a sort of temporary shared ownership. With this arrangement, the buyer only gets the deed once they’ve made all the payments.
This option resembles a regular rental agreement in that the seller leases the property to the buyer. Both parties agree to a future time and price when the buyer can afford to buy the property outright.
The seller deducts all or some of the rental payments from the purchase price.
Some lenders will only cover 80% of the mortgage nowadays. In these cases, the seller can finance the difference.
However, some banks won’t agree to these terms as they feel there is too much financial risk involved for the buyer.
All-inclusive mortgage or (AITD)
This is one of the most common seller financing options. In these cases, the seller carries the promissory note and the mortgage for the home’s price, minus the down payment.
This agreement allows the buyer and seller to switch places regarding the home’s existing mortgage. Usually, you’ll need the lander’s permission if you want to sell your home this way.
FHA, VA, and ARM loans are assumable only if the applicable bank approves.
Benefits of Seller Financing
The pros and cons of seller financing vary depending on the terms of the arrangement.
Both the seller and buyer can save on the costs associated with home sales, such as closing costs and real estate agent’s commission.
They also avoid the time delays and uncertainties involved with mortgage applications. Both parties can negotiate a contract that suits their budget and time frame.
Costly and time-consuming home inspections are optional with seller financing arrangements, which makes it easier to sell a home as-is if necessary.
With seller finance, the seller increases their potential to sell their home quickly by including buyers that might not qualify for a traditional mortgage. This is particularly beneficial as the U.S. real estate market starts to cool.
When you take the costs associated with traditional sales into account, sellers may ultimately enjoy a higher price for their homes when they go this route. If the buyer defaults on payments, you get to keep the money paid to date, plus you still have your house.
Buyers can also sell the promissory note to an investor if they receive a lump sum payment immediately.
What Are the Risks Associated With Seller Financing?
Most of the risks associated with seller financing impact the buyer rather than the seller. For instance, the seller could conceal important information from them that affects the sale.
The seller may not reveal that the title of the home isn’t transferred to them yet due to unforeseen circumstances. The property could face foreclosure if the seller has an undisclosed mortgage in place.
If the buyer doesn’t have enough funds to pay for a property inspection or appraisal beforehand, they may end up paying an inflated price for the home.
If the seller doesn’t do due diligence determining whether the buyer can afford the installments, or investigate their credit record, they could end up having to foreclose on the home.
It may take up to 12 months to finalize the foreclosure process.
As a seller financer, there are a few ways to reduce the risks associated with this type of home sale. These are:
Insist on a Loan Application
Don’t enter into an agreement with a buyer unless they complete a detailed loan application form. Once they’ve done that, verify all the information provided, and run a credit check.
Vet their claims regarding assets, finances, references, and employment as well as any other information provided.
Specify Loan Approval in the Contract
The written sales contract includes all specifics relating to the sale. This includes the loan amount, interest rate, and term. Make sure these terms are contingent on the seller’s approval of the buyer’s financial circumstances.
Use the Home to Secure the Loan
Make sure you use the property as security for the loan. In these cases, the seller can foreclose if the buyer defaults on the contract.
The seller should get a professional property appraiser to confirm its value equals or exceeds the purchase price.
Get a Down Payment
Traditional lenders require a down payment to cushion them against the risk of losing the investment. This financial commitment gives the buyer a stake in the property and makes it more difficult to walk away from the deal at the first sign of money problems.
It’s best to ask for at least 10% of the property price as a down payment. Otherwise, foreclosure could leave the seller with a home that won’t cover the costs associated with re-selling it.
Some of the above tips can reduce the risks for buyers, too. For instance, a credit check might reveal a potential for future financial distress, and a home evaluation ensures they get a fair deal.
Get Help Selling Your Home
Seller financing might suit you if you’ve inherited a home, need to move an elderly parent out of their home quickly, or want to sell a home as-is.
If you’re considering this option when selling your home, be sure to work with a property expert or legal advisor throughout your seller financing journey to ensure it benefits both you and the buyer. It’s the best way to avoid any risks associated with these arrangements.
Selling a property can cause confusion and stress for homeowners. Get in touch for all the guidance you need regarding selling your home quickly and stress-free.