Homebuyer’s Guide to Seller Financing

Seller financing is a creative lending technique that allows the home buyer to take out a mortgage from the home seller instead of, or in addition to, a traditional bank. Some homeowners use seller financing as an incentive to draw in potential buyers. With seller financing, buyers do not have to meet the traditional lending standards set by Fannie Mae and Freddie Mac. Instead, they only need to meet the qualifications set by the home seller. In many cases, the seller is willing to be flexible in regard to credit score, income, down payment, and other issues.

Types of Seller Financing

There are four main types of seller financing: private party mortgages, seller carry back mortgages, assumable mortgages, and wrap around mortgages.

If the seller owns the property free and clear, he may choose to be the sole lender (private party mortgage) by offering a first mortgage. In this case, the buyer takes out a single mortgage through the seller. His monthly payments go directly to the seller, without any bank involvement.

More common is the seller carry back mortgage. A buyer takes out a typical mortgage from a bank as well as a smaller mortgage from the seller. Generally, this second mortgage is used to make up for a buyer’s lack of down payment funds. For example: a buyer may borrow 80% of the home’s purchase price from the bank and 20% from the seller. The bank is the primary lender, but the seller holds a lien on the property until the second mortgage is paid off.

An assumable mortgage is any type of seller financing that involves the retention of the sellers original home loan. This can play out in different ways: the seller may charge the borrower monthly payments or the borrower may take full responsibility for the debt and pay the lender directly.

A fourth option is a wraparound mortgage (which also falls under the umbrella of assumable mortgages). In this instance, the seller maintains his own debt on the property after the sale. The buyer sends the seller monthly mortgage payments. The seller pays his own mortgage and pockets the additional money. For example: The seller owes $50,000 on a home and pays 5% in interest to his bank. He sells the home for $100,000 with a 7% interest rate. Each month the buyer sends a mortgage payment to the seller. The seller then pays his bank the amount owed and keeps the excess.

How to Qualify?

There are no universal requirements mandated for seller financing. Instead, each seller sets his own standards. Most people offer seller financing with the knowledge that it will appeal to buyers with poor credit or other financial problems. However, sellers may still want some type of assurance that they will be paid back. They may ask for credit reports, income documentation, or other information. Since these deals tend to be worked out face-to-face, buyers often have the chance to explain their situation and negotiate the loan terms.

Seller financing Benefits

Seller financing allows homebuyers to take out a mortgage without having to meet strict underwriting guidelines. Although the interest rates may be higher than those offered through traditional lenders, buyers save on fees such as closing costs and primary mortgage insurance (PMI). With seller financing, it may also be possible to arrange unusual deals such as cash back allowances. Many financial issues that hinder traditional loan applications can be worked out between buyers and sellers – almost everything is negotiable.

Seller financing has several benefits, particularly for buyers who don’t meet traditional lending qualifications. Here are some of the best features seller financing has to offer:

  • The ability to avoid traditional requirements. Homeowners usually know that people seeking seller financing won’t meet the standard bank requirements. Sellers are almost always willing to accept some weaknesses (poor credit, non-provable income, etc.) as long as they feel confident that the buyer will be reliable in making payments.
  • The opportunity to negotiate. With seller financing, you’re dealing with a person instead of a huge lending institution. It is often possible to negotiate the terms of the seller financed deal on issues such as length of loan and interest rate.
  • Fewer closing costs. Most people offering seller financing aren’t going to make up excessive closing costs as is common with banks. Take away the unnecessary fees and you could save hundreds.
  • Sooner closing. If you are getting complete seller financing with no bank involvement, it is often easier to push for a closer closing date.
  • No prepayment penalties. Unlike most banks, sellers are unlikely to require fees for early loan payment. This makes it easier for you to refinance or pay off your mortgage sooner than expected.

Sound too good to be true? Don’t get excited just yet. Be sure to take a look at the risks involved in choosing seller financing, outlined below.

Seller financing Drawbacks

On the downside, seller financed properties tend to sell for more than comparable properties. Buyers pay extra in principle and interest for the convenience of avoiding banks. If buyers do not request an appraisal or home inspection, they may find themselves paying too much for a property with problems. If the seller is unaware of title issues (other people who hold liens on the home), the buyer may not be able to hold a clear title even after he pays off the mortgage. In the case of wraparound mortgages, buyers must trust the seller to make monthly payments to the primary lender. If the seller doesn’t follow through, the buyer may lose his home through foreclosure.

Seller financing helps many buyers purchase their first homes. But, there are definitely some drawbacks to this method.

Here are some of the most important seller financing risks to consider:

  • Non-payment of original mortgage. If you take out a wraparound mortgage, the seller must continue making his own mortgage payments each month. If he stops paying the original lender, you may lose your property through foreclosure.
  • Original lender calls the loan due. Some sellers offer financing despite a “due-on-sale” clause in their original mortgage. In this case, if the bank finds out about the sale, it may choose to require full payment in just thirty days. Someone will have to come up with a significant amount of money in a very short time. If not, the house may be taken via foreclosure. Even if the bank chooses not to require payment, they may demand an increased interest rate or additional principle. The seller may want to pass those expenses on to you.
  • Undisclosed liens. If the property has liens that you are unaware of, you may end up being liable.
  • Ownership issues. The buyer’s name is generally put on the title when a seller-financed deal goes through. However, this is not always the case. If your name is not on the title of the property, you may have trouble proving your ownership.
  • Balloon payments. Some sellers require a massive balloon payment after just a few years. In such a case, you would need to find another way to finance the property or risk losing it.
  • Documentation trouble. If your seller-financed mortgage is not going through a loan servicer, you may have to rely on the seller to provide you with the necessary documents for proving homeownership. If he doesn’t take this task seriously, you may have trouble when filing taxes and completing other legal tasks.

If you’re worried about any of these issues, talk to a real estate attorney for a professional opinion on your situation.

Where to Find Seller Financing

Only a small percentage of homeowners are willing or able to offer seller financing. Here’s what to keep an eye out for:

  • Established Neighborhoods –Since the late 70’s, most mortgages have “due-on-sale” clauses that make it difficult for homeowners to offer seller financing. You may have a better chance of finding seller financing if you seek out homes in established neighborhoods where many residents have owned property for twenty or thirty years.
  • People with VA or FHA Loans – Mortgages offered by the Federal Housing Administration or Veterans Affairs must be assumable. Seek out sellers with these loans and you’ll be more likely to find financing.
  • Desperate Sellers – Struggling homeowners are more likely to enter into seller financing arrangements. You can help a homeowner get out of a difficult financial situation and he can help you purchase home. It’s a win-win.
  • For-Sale-By-Owner Signs – These signs show that sellers are willing to color outside of the lines. A for-sale-by-owner sign doesn’t mean that seller financing is available, but it does indicate that the homeowner may be more willing to negotiate.

Where can you find these seller financed deals?

Finding seller financed properties can be difficult. A real estate agent may be able to help you find homes with seller financing. However, many of these properties are being offered for-sale-by-owner and will not show up in MLS listings. Your best bet is to search in your desired neighborhood and through websites such as craigslist.com. In a buyer’s market, desperate sellers may be more willing to offer seller financing. Even if a home’s listing doesn’t mention financing options, it can’t hurt to ask the owner.

  • MLS Listings – Have your agent check the listing notes for buzzwords such as “owner will carry,” “seller financed,” “seller carry back,” “no banks.”
  • Craigslist.com – Run your own local searches for the preceding buzzwords. Be aware that scams are out there – you may have to sort through annoying ads to find the good stuff.
  • Specialized Real Estate Agents – Not just any agent will do. Try to find an agent who specializes in seller-financed deals and ask him to show you those properties exclusively.
  • Specialized Mortgage Brokers – A mortgage broker who deals with FHA and VA loans may be able to offer some ideas for seller financed opportunities in your area.
  • People You Know – Don’t forget this step. Asking friends and family members to share possible leads is one of the best ways to find a seller-financed deal.

Looking for a seller-financed deal will definitely limit the number of properties you can consider. But, with perseverance, most buyers are able to find seller financed homes that meet their needs.

How to Make an Offer on a Seller Financed Property

Seller financing is usually offered as a way to lure in potential buyers. Although the seller is willing to take a risk, he still wants to get a good deal and be sure that the buyer will pay back the loan reliably.

Here’s how to negotiate a seller-financed offer:

Consider Kitchen Table Deals

Realize that many seller financed deals are discussed informally, at least in the beginning. Since there are so many ways lending terms could be set, it’s a good idea to talk with the seller before making an offer. Is the seller willing to provide all or only partial financing? What range of interest is he expecting? Will this be a private loan or will you assume his original mortgage? Asking questions will help you know what the seller is able to do, and what simply will not work in an offer.

Show Off Your Strengths

Prove yourself worthy of seller financing (and a low-interest rate) by showing off your good points. You may be able to get a better deal by having a good credit score, proving reliable income, or bringing a large down payment.

Consult a Real Estate Attorney

Many buyers believe that a meeting with a real estate attorney is invaluable, especially when negotiating complicated seller financing agreements. Real estate agents don’t have the legal training necessary to give you the advice needed to make a competent decision. When writing an offer, run the final draft by your attorney. You’ll also want him to double-check any agreements you intend to sign.

Work with an Agent or Negotiate Directly

If the seller is open to casual upfront negotiation, you may want to work out a deal without sending a formal offer letter. Be sure to bring a list of the features you want (term, rate, etc.) and what you bring to the table (down payment, credit score, etc). Working together, you can write purchase agreement. Just be sure to check with your attorney before signing.

If you already have an agent, ask his advice. He may suggest that a formal offer letter is appropriate or he may want to negotiate directly. Whatever the case, be sure he is aware of the terms you will require before signing a seller-financed contract.