Prospective homebuyers can run into a number of financing problems when they try to buy their future home.
A buyer’s financial situation may not fit neatly within their bank’s requirements for mortgage approval. An unpredictable salary, a lack of pay stubs or W-2 forms, or a less-than-exemplary credit score can be major obstacles. In these situations, a seller financed mortgage can be the best option for quickly closing the sale.
- A seller-financed mortgage is a loan given to a real estate buyer by the seller, and works in a similar way to a conventional mortgage.
- Seller-financed mortgages are fairly uncommon because many real estate professionals are unfamiliar with them, giving real estate buyers and sellers the impression that they are secondary options.
- Seller-financed mortgages can speed up the process of a home sale, make it easier for a buyer to get financing, and allow buyers and sellers to customize the loan in ways third-party lenders don’t typically allow.
What is a seller-financed mortgage?
At its simplest, a seller financed mortgage is a transaction in which the seller of a property provides financing to the buyer, allowing the latter to skip the detailed, time-consuming process of receiving a loan from a traditional lender. This factor is especially important because many buyers that use seller financing — also known as “contract financing” — lack the financial profile to receive loans from a bank, a credit union, or a private loan company.
The seller can retain the loan for its duration or sell the loan to a mortgage investor. The latter option is often preferred because the buyer pays the seller a large, lump sum that makes it easy to pay sizable debts, buy a new property, or fund investments. Even if the loan is sold to an investor, the buyer’s payments are based the original contract. This is why it’s important for buyers to have a seller-financed mortgage specialist review the stipulations of the contract.
How does a seller-financed mortgage work?
In seller-financed mortgages, the buyer of a property receives a loan from the seller. The parties form a loan agreement whose characteristics are similar to a traditional mortgage. Buyer and seller agree on an interest rate, repayment schedule, and penalties for defaulting, creating a loan agreement that financially benefits both parties.
Next, the buyer signs a promissory note to assume responsibility for repaying the loan, and proceeds to sign a mortgage contract, or a deed of trust. These agreements allow the seller to foreclose on the property if the buyer fails to keep up with monthly payments.
In many cases, seller-financed mortgages are short-term agreements, with balloon payments due at the end of the contract. This is why it’s important for home shoppers to consult a seller financing mortgage specialist to assess whether the transaction is a good option based on their current financial situation, as well as their foreseeable financial needs near the end of the loan.
Why is a seller-financed mortgage uncommon?
You almost never see seller financed mortgages advertised on TV, radio, or in newspapers. In the absence of using a professional mortgage advisor, many buyers and sellers initially learn about the transaction through internet research. There are also three additional factors that make seller financed mortgages uncommon compared to other types of mortgages.
- Many sellers follow the traditional route, and try to receive a loan from their financial institution because they’re familiar with the institution’s lending practices and product and service offerings. Only after failing to qualify for financing through a traditional lender do many prospective buyers explore seller-financed mortgages.
- Many investors — and even some seasoned real estate professionals — lack insight into seller-financed mortgages and how they operate, much less the mortgages’ financial benefits for buyers and sellers. This lack of information can give buyers and sellers the impression that they won’t receive much professional help with the loan process.
- A seller-financed mortgage doesn’t necessarily operate within parameters set by the housing market. For example, the seller can charge a higher than normal interest rate, and may also write special considerations in the loan agreement, such as an escalation clause that permits the interest rate to increase by a small percentage annually to offset inflation. Sellers seeking traditional terms can balk at these specialized terms.
For homebuyers who are accustomed to the characteristics of traditional home loans, seller-financed mortgages can seem like obscure, secondary options to conventional loans. In reality, seller financing is a perfectly legitimate option for buyers who would pay more through other lending options. For buyers who aren’t perfectly positioned to buy a new home, seller financing should be the first option of choice, not a secondary one.
Aside from these aspects, seller-financed mortgages are also uncommon due to a perceived lack of trust. Sellers can be hesitant to offer loans to buyers with low credit scores, or buyers can be wary of dealing with a private individual who doesn’t have professional home loan experience.
Why do sellers offer a seller-financed mortgage?
After sitting down with a seller financed mortgage specialist, sellers walk away with a much better understanding of the transaction and what it entails. They see that, unlike traditional home loan options, seller-financed mortgages offer the following three benefits to sellers.
- Buyers are often found quickly due to the financial flexibility of the loan’s terms. Consequently, the cost of holding the sale property until it sells if often reduced. Many sellers have lost the property they were selling due to the financial strain of paying two mortgages simultaneously: one on the sale property and one on a new residence.
- Using a seller financed mortgage helps eliminate this situation by putting sellers in the position to receive equity from the property sale quickly, and then use the funds just as quickly to secure ownership over the new residence they purchase.
- Seller financed mortgages can be highly competitive in local markets. They’re commonly based on local, fair market real estate prices and the degree of competition in the marketspace. In addition to receiving a “fair shake” on the price of real estate, the buyer’s options for down payment, interest rate, and penalties can be quite flexible. Lowering the financial barriers to buying property naturally helps property sell faster.
- Buyers with poor credit are typically motivated to pay the seller’s asking price. This is mainly because the buyer has few, if any, additional financing options. There’s naturally an element of risk in selling to buyers who have poor credit, but difficulties with satisfying the loan agreement on the buyer’s end can be avoided by selling the loan to a loan buyer that assumes full responsibility for collecting the debt after the sale.
Additional reasons why sellers offer seller financed mortgages, include: To acquire funds for a down payment on a different residence (this is sometimes done by selling real estate notes to a loan buyer), pay off debts, and use monthly payments on the loan to fund financial investments that promise to improve the fiscal situation of the property seller in the long run.
How does a seller financed mortgage help buyers?
The primary way a seller financed mortgage benefits buyers is by giving them a viable financing option, when receiving a loan from a traditional lender is out of the question. But this isn’t the only bright spot. Seller financed mortgages also offer sellers the following benefits.
- Because the seller is typically motivated to sell his or her real estate expeditiously, the seller has the option to reduce closing costs — and tweak the contract in other ways — to help the buyer acquire the real estate. In turn, the seller often receives sale money in a shorter period of time than would be possible if a third party lender evaluated buyer qualifications for loan approval.
- The closing process is more efficient because it involves only two decision makers: buyer and seller. A financial advisor may be involved on both ends of the transaction, but the advisor doesn’t control the aspects of the loan. Eliminating the middleman of a third party lender lets buyers and sellers agree on terms in a more timely manner. Ultimately, this can help the sale close faster that it would otherwise.
- Because the seller has full autonomy when drawing up the sales contract, the seller can set a down payment amount that allows a greater number of buyers to compete for the property. Applicants for a seller-financed mortgage often have less than stellar credit and a low degree of liquidity. Consequently, any financial advantages that the seller can offer prospective buyers only increases the range of potential buyers
There is more than one way to facilitate property sales through financing. However, when a prospective buyer lacks the qualifications to receive loans from traditional lenders, and the seller is committed to liquidating the real estate quickly by attracting a large number of interested applicants, a seller-financed mortgage may be the optimal solution, despite being less popular than commonplace lending options available from conventional financial institutions.
To learn more about the seller-financed mortgage process and how we can assist you with the transaction, call us today at (800) 698-3650, or use our contact form. We look forward to helping you sell a property on the most profitable terms through a seller-financed mortgage.