How Does Seller Financing Work?
A seller financing agreement — also known as an owner financed mortgage — occurs when a home seller lends a homebuyer the money needed to purchase the seller’s property. In this guide, we’ll show you how the process works, explain the benefits, and answer commonly asked questions about the topic.
Once you have a handle on the information below, you’ll be in a much better position to decide whether seller financing is a good option for your plans of selling your home.
How the Process Works
In a seller financing transaction, the property seller finances the sale of its own real estate, taking the place of traditional lenders such as banks and credit unions. Instead of making monthly mortgage payments to a professional lender, the buyer makes payments to the seller.
After both parties approve the transaction regarding the loan interest rate, repayment schedule, and consequences for defaulting on the loan, the buyer signs a promissory note to assume responsibility for repaying the loan and signs a mortgage contract, or a deed of trust. These financial vehicles allow the seller to foreclose on the property if the buyer fails to pay.
Sellers can also protect their financial interests by selling the mortgage note to a loan buyer, but only if the seller includes this option in the contract. In selling the mortgage note, the buyer can receive a large, lump sum payment, with no strings attached. The loan buyer that purchases the mortgage then assumes full responsibility for ensuring the repayment of the loan.
Seller Financing Benefits
An owner financed mortgage involves two essential parties: the buyer and the seller. Consequently, understanding its benefits begins with separating the advantages that it offers buyers from advantages that apply to sellers.
Benefits for Buyers
For many homebuyers, an owner financed mortgage has three primary benefits that aren’t found as often in a traditional home loan that a professional lender offers.
First, the transaction benefits buyers who have poor credit. Because the seller provides the loan instead of a traditional lender, the loan is based on the seller’s financial situation and not the stringent standards of a lender that has revenue goals to meet and — in the case of corporate lenders that sell stock — shareholders to please. A poor credit score can disqualify you from getting a bank loan, but it doesn’t automatically prevent you from receiving seller financing.
Second, the transaction benefits buyers by making it faster to obtain a loan. Receiving loan approval from a professional lender can take several weeks — even for people in a good financial position. Conversely, a loan from the seller can be obtained in as little as a few days. Many professional lenders consistently have a large volume of loan applications to process, but the seller has only a single loan to consider. This speeds up the approval process.
Third, the transaction benefits buyers because the down payment on the property is flexible in relation to the seller’s financial situation. According to MortgageCalculator.org, “The benchmark figure for a down payment is 20 percent of the home’s price.” With seller financing, there isn’t a pre-established down payment amount. Seller and buyer work together to decide the payment.
Benefits for Sellers
An owner financed mortgage also has three primary benefits for property sellers, especially when it comes to selling real estate quickly and with as few potential glitches as possible.
For sellers, the transaction can make it easier to find property buyers. Because the seller decides the terms of the loan, it has the option of selling to buyers who don’t qualify for loans from traditional lenders, in addition to those who do qualify for third party lending options.
The longer a property sits on the market, the less attractive it can become to prospective buyers, who may assume that something is “wrong” with the property.
Additionally, the transaction benefits sellers because it helps them receive their initial asking price, or a price in the same vicinity. Because buyers who use seller financing are seldom in a position to receive a loan from a professional lender, they have less financial flexibility in the home buying process. Therefore, they’re motivated to accept the seller’s asking price. When the seller is essentially the only financing option, buyers are highly motivated to accept the terms.
Lastly, the transaction helps sellers receive money they need for a down payment on a future property. The seller can choose to save the buyer’s monthly payments to put toward a down payment, or sell the loan to a loan buyer, and receive a lump sum payment that allows the down payment to be paid in full in a short period of time.
Commonly Asked Questions
Buyers and sellers who consider using seller financing for the first time often have basic questions about the details of the transaction that they need answered before they proceed with the sale process. Below are six of the most commonly asked questions we hear.
Do sellers have the option of canceling a loan?
The seller can pull out of the loan before the contract is signed and the loan becomes active. However, after the terms of the loan are signed off on, the seller is legally bound by the terms of the financial agreement. The buyer has legal recourse if the loan is unfairly canceled.
Does the transaction prevent refinancing?
The buyer can typically refinance the real estate any time, just as they could do if they received a loan from a bank. As long as the buyer stays current on payments to the seller or a loan buyer to which the loan was sold, the buyer can pursue refinancing however it chooses.
Can sellers charge unusually high interest?
Because they aren’t bound by industry regulations for home loans or necessarily influenced by the fair market value of real estate, private sellers often charge higher loan interest rates than you receive from professional lenders. With that said, the increase usually isn’t exorbitant. If it was, the seller would have a much harder time attracting buyers who can close the sale.
Do loan terms change if the loan is sold?
The loan terms you agree to remain in place for the length of the loan agreement. If you have a 15-year loan that’s immediately sold to a loan buyer, your terms shouldn’t change for 15 years. However, if you have what amounts to a 5-year adjustable-rate mortgage (ARM), your loan terms could change once the adjustable-rate clause kicks in after the five-year window.
Can sellers change terms on an active loan?
The seller can change loan terms to the extent that the loan contract permits. For example, a seller could include an escalation clause that allows the interest rate to increase by a certain percentage annually to offset inflation. This is why it’s important for buyers to examine the terms of an owner financed mortgage just as they would the terms of a traditional mortgage.
Why is seller financing considered uncommon?
An owner financed mortgage is more uncommon than a traditional mortgage for three main reasons: sellers can be wary of offering loans to buyers who don’t qualify for third party financing, buyers can be wary of working with a private individual who doesn’t have professional loan experience, and many buyers and sellers simply aren’t familiar with the owner financed mortgage model.
However, seller financing is not exactly uncommon, either. Each year, thousands of homeowners in the U.S. sell their property using an owner financed mortgage.
Seller financing may be uncommon compared to traditional lender financing, but it offers buyers and sellers important financial options that traditional mortgages don’t. Ultimately, an owner financed mortgage offer buyers the benefits of making it easier to find prospective buyers, helping them receive an offer in close proximity to the initial asking price, and helping them receive the money they need for a down payment on a future property quickly.
At the same time, an owner financed mortgage offers buyers the benefits of helping them buy a residence despite having poor credit, helping expedite the process of obtaining a loan, and offering flexibility when it comes to establishing a down payment amount and other loan terms.
Whether you’re a property owner who is considering using seller financing, you should sit down with a professional loan advisor to explore whether the option is truly in your best financial interest. At Amerinote Xchange, we can help you evaluate whether an owner financed mortgage is indeed a good option, please call us today at (800) 698-3650, or use our contact form. We look forward to helping you fulfill your plans for selling your residence.