Seller Financing 101 for home buyer, sellers and real estate investors

Seller financing can be highly advantageous to both buyers and sellers. If you want to get your house off the market, offering a seller-held mortgage can help you do so expeditiously. However, it’s essential to understand how seller financing works, its pros and cons, and how it will impact you before moving forward.

What Is Seller Financing?

Seller financing bypasses the traditional bank-owned mortgage, allowing the home seller to lend the buyer the money necessary to buy their property. The home seller takes on the bank’s role, deciding on the terms and conditions of the loan and using their discretion to approve potential buyers. 

In a seller-held mortgage, the buyer makes monthly payments directly to the seller instead of a bank or credit union. The seller sets the home’s down payment amount and sales price, and they’ll decide whether a buyer is credit-worthy or not. Since the seller doesn’t need to answer to corporate executives or shareholders, as financial institutions do, buyers may find they can negotiate more favorable mortgage terms.

Seller financing is sometimes referred to as a purchase money mortgage or owner financing, and you’ll often find the terms used interchangeably.

Types of Seller Financing

There are several different forms of seller financing agreements. The agreement used varies depending on the type of property and the buyer and seller’s financing objectives. Here are a few of the most typical seller-financed arrangements.

Assumable Mortgage

In an assumable mortgage, the buyer takes over the seller’s current mortgage. The buyer makes payments according to the terms of the original mortgage. An assumable mortgage is advantageous when the seller’s mortgage has a more favorable interest rate than the buyer can obtain.

Seller Held Mortgage

A holding mortgage occurs when the seller acts as the lender to the buyer. No outside financial institution is a party to the agreement. The seller agrees to lend the buyer money to purchase the property, and the buyer makes monthly payments following the contract. Once the buyer fully repays the loan, the seller transfers the property title to the buyer.

Lease Purchase

A lease purchase is similar to a rent-to-own contract. The buyer is a renter who makes monthly payments to the homeowner. However, the rental agreement provides an exclusive option that allows them to purchase the property at a specific price in the future. If the renter exercises the option, they can buy the property at the agreed-upon amount.

Land Contract

In a land contract, the buyer borrows money from a landowner to purchase a plot. The seller acts as the lender rather than an outside financial institution. Most land contracts include a balloon payment at the end of the repayment period, which the buyer must pay or refinance to own the land.

How Seller Financing Works

If you’re considering offering an owner-finance contract to a potential homebuyer, it’s crucial to understand the process to avoid possible mistakes that could prove costly. 

A seller-financed mortgage is between the owner and the buyer. Since no bank is involved, the seller assumes the risk of buyer default. Thus, the seller should ensure they are comfortable with the repercussions of default and can financially manage them should the worst happen. 

Establishing a thorough contract that both the seller and buyer understand is critical. Ensure the contract includes the loan interest rate, a repayment schedule, property details, and specific consequences if the buyer stops making payments. The buyer should sign a promissory note and mortgage contract guaranteeing they’ll make timely payments. A promissory note and signed mortgage contract allow the seller to foreclose on the property if the buyer doesn’t abide by the agreement.

Sellers worried about the risks of overseeing a mortgage can consider selling the note to a buyer. If they plan to do so, they must include the option in the mortgage contract. Selling a mortgage contract allows the seller to receive a lump-sum payment for other purposes, like buying another piece of property. The mortgage note purchaser will assume total responsibility for the mortgage, and they’ll connect with the homebuyer to arrange payment collections.

It’s a good idea to have a qualified attorney review a seller-financed mortgage contract, both for sellers and buyers. An attorney can identify potential issues and suggest corrections to avoid future confusion.

Pros and Cons of Seller Financing

Seller financing has advantages and disadvantages to be aware of.

Advantages for Sellers

Homeowners seeking to quickly get their homes off the market may find seller financing beneficial. People unable to qualify for traditional mortgages, such as those with bad or no credit, will take an interest in your property. You may be able to sell the home as-is without making any repairs or improvements.

Since the seller sets the terms of the agreement, you can maximize your sales price and save on closing costs. For example, sellers can ask for a higher sales price in exchange for accepting a buyer with a less-than-stellar credit history. They can also ask buyers to assume some or all of the closing costs, so the seller doesn’t need to come up with money out of their pocket. Buyers with few other alternatives will be more likely to accept the terms you set, even if they’re unfavorable to them.

Finally, sellers don’t need to assume long-term risk from a seller held mortgage. Instead, they can sell the mortgage note to a company willing to purchase it. The loan buyer will reward them with a lump-sum payment they can use for a down payment on a new home or some other purpose. Plus, the loan buyer will assume the future risk of the mortgage and all further collection activity.

Advantages for Buyers

Buyers with poor credit may find seller-financed mortgages to be the only homeownership alternative available until they can improve their credit history. Since the seller sets the loan terms, they can set their qualification criteria, which may be less stringent than a bank’s. 

Another advantage to buyers is flexibility. Buyers can ask the seller to exclude items that traditional mortgages usually require, such as private mortgage insurance (PMI) premiums. PMI costs are typical when the buyer doesn’t have enough money to make a 20% down payment on the home. They may significantly increase a buyer’s monthly mortgage payment.

Disadvantages for Buyers and Sellers

Seller financing does have its drawbacks that both buyers and sellers should understand.

The primary drawback to sellers is the risk. The seller assumes all the risks and rewards of the mortgage note. If the buyer defaults on the loan, it can impact the seller’s financial circumstances. 

Buyers also face potential disadvantages. If they’re looking for a seller-financed property because they can’t qualify for a traditional mortgage, the seller may charge a higher interest rate or sales price to cover the risk they’re assuming. Some sellers may require a more sizeable down payment, too.

Since seller-financed mortgages aren’t subject to as many regulations, buyers may lack some protections. Buyers should carefully evaluate a mortgage contract with their attorney before signing it to ensure they fully understand the terms.

Seller Financing: An Alternative to Traditional Mortgages

While seller financing isn’t for everyone, it does have significant advantages for both sellers and buyers. Buyers who can’t qualify for a traditional mortgage will appreciate the opportunity for homeownership, even if they must pay a higher interest rate or purchase price. Sellers who want to get their home off the market quickly will find seller financing a good option. 

Before finalizing a seller-financing agreement, make sure both buyers and sellers understand their responsibilities to one another. Both parties should seek help from an attorney to ensure they protect their interests in the contract.