Seller Finance

What is Seller Financing?

Also known as Owner Finance, Vendor Finance and Seller Carryback. It’s a form of lending in which the owner/seller takes on the role of the lender (becomes the ‘bank’). Instead of giving cash to the buyer to pay for the property in full, the seller agrees to receive payment in monthly installments from the buyer. The concept of seller financing of real estate is well known in the United States.

When Is It Used?

Buyers will seek Seller Finance if they don’t qualify for traditional financing due to factors such as being unemployed, being self-employed, no savings, bad credit rating, previous bankruptcy or foreclosure, or economic factors that tighten lending guidelines.

Sellers can be desperate to sell for any number of reasons. Perhaps they can’t afford to make the monthly loan repayments but don’t want to walk away and leave their house to the bank. Or an owner might be tired of being a landlord and will consider an offer using Seller Finance if approached by an investor.                                                                                         

How It Works?

Under a Seller Finance arrangement, the buyer and seller negotiate terms for a property and the seller agrees to finance the purchase. Terms will usually include the amount of a down deposit to secure the property; the interest rate; a schedule of monthly installments; the length of the agreement; whether a balloon payment is involved; and consequences if the buyer defaults on payments.

An example. Buyer will pay the full asking price with 5% down payment, seller financing in place for the remainder at 6% interest, amortized over a period of 25 years with a five year balloon payment. Buyer to refinance (with financial institution) before the five years. 

What Paperwork is Involved?

Whilst some sellers are content to fully manage the transaction and the paperwork themselves, it is advisable to use an attorney to ensure nothing is left to chance. This is when a title search should be undertaken to establish ownership of the property and that the owner can sell the property and release the title in due course.

The legal instrument used to facilitate a seller finance arrangement is a promissory note.

Promissory Note In this note the buyer promises to pay a certain amount of money under specific terms. It includes all of the terms negotiated by the parties involved. It is like a loan agreement and obligates the buyer to repay the loan. The seller/owner will usually keep the property title until all repayments have been made to protect against default.

 Mortgage Instrument or Deed of Trust

They create a lien on the property, which allows the vendor to foreclose on the property in the event the buyer stops paying. It's structured like a note and mortgage, but instead of the buyer receiving a deed and being placed on title, the seller remains on title until the debt is repaid in full.

Why use Seller Finance?

In most cases, only a small deposit (down payment) is required, instead of a typical 20% with a bank loan. Being able to put in less cash upfront has got to be great for first home buyers and for investors.

Not having to deal with a third party (only the buyer and seller involved) keeps costs down at closing. The buyer doesn’t need to deal with rigorous bank qualification rules, nor credit scores and credit reports and avoids paying for mortgage insurance through a bank. Sometimes, a buyer may not even bother with a building and pest report. And if the paperwork is handled by the seller and the buyer (no attorney involved), both parties make a saving. However, it is highly recommended that for any paperwork, an attorney should be used to ensure all parties are protected.

Pros and Cons of using Seller Finance

For buyers, there are number of advantages and disadvantages before considering vendor financing.

Pros for Buyers

  • Alternative for buyers who can’t get financing:  Obviously, it’s a funding option for buyers who are not able to secure a traditional mortgage.
  • Faster closing:  No waiting for the bank loan officer, underwriter, and legal department to process and approve AN application.
  • Cheaper closing:  No bank fees or appraisal costs.
  • Flexible down payment:  No bank or government required minimums.

Cons for Buyers

  • Higher interest:  The interest you pay will likely be higher than you would pay though a bank.
  • Due-on-sale clause:  If the seller has a mortgage on the property, then their bank or lender can demand immediate payment of the debt in full if the house is sold (to you). That’s because most mortgages have due-on-sale clauses – and if the lender isn’t paid, then the bank can foreclose. To avoid this risk, make sure that the seller owns the house free and clear or that the seller’s lender agrees to owner financing.
  • Balloon payments:  With many owner-financing arrangements, a large balloon payment becomes due after five or 10 years. If you can’t secure financing by then, you could lose all the money you’ve paid so far – plus the house.

Finding Potential Sellers

  • Real estate investor clubs. You’ll find these in many towns and cities. They meet regularly to network and discuss property investing opportunities.
  • Real estate agents. Agents and brokers in your area might know about unpublicized deals in your area. Or they might know a motivated seller who would be willing to offer owner financing.
  • Search FSBO listings. Find ‘For Sale By Owner’ (FSBO) listings in your area. If a property interests you, reach out to the seller and ask if owner financing is an option. Or, you can also do an Internet search for “owner-financed homes near me” to find local businesses that connect buyers and sellers.
  • Search rental listings. Likewise, if you see a house for rent that you like, ask the owner if they’re interested in selling with financing.

Conclusion

Using Seller Finance can be an absolute game-changer for the first-time investors, first home buyers and even the very experienced investor. It’s quite easy to understand and, as long as the buyer and the seller are aware of the risks and benefits inherent in any property deal, it should be a win-win for both parties.

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