Seller Financing: What It Is And How It Works
Seller financing is a solution that can keep your dream of becoming a homeowner within reach if you’re in the market for a new house but are having problems obtaining loan preapproval. Seller financing can be a great option to purchase a property and streamline the closing process, although not all sellers will be able or willing to do so.
Moreover, seller-financed homes can be complicated and require a written contract, so it’s essential to understand the process before moving forward. We’ll explain the principles of seller financing principles, how it can benefit buyers and sellers alike, and how a seller-financed deal is structured.
Seller Financing: What Is It?
Seller financing, also referred to as owner financing, enables purchasers to purchase a new home without relying a traditional bank loan. Instead, the owner (seller) finances the transaction, frequently with an interest rate higher than current mortgage rates, sometimes with a balloon payment due at least five years down the road.
By doing away with the requirement for a lender, an appraisal, and an inspection, this can make the process of buying and selling a home simpler.
The Process of Owner Financing
Owner financing is similar to a traditional mortgage in that a down payment is made and the balance is paid off over time. This non-traditional financing alternative often has a higher interest rate and may need to be repaid or converted into a conventional loan if it has a balloon date. Assuming the seller is willing and able to provide it, seller financing is usually quicker and simpler to obtain than a government-backed mortgage.
Additionally, even though the majority of owner financing involves some sort of credit or background check, it might enable otherwise underqualified buyers to buy a home. Owner financing doesn’t involve banks or other conventional lenders, and it also doesn’t require an inspection or appraisal unless the buyer wants one.
A monthly payment is provided to the owner-seller in accordance with an agreed-upon amortization schedule once a buyer and seller have reached an agreement on terms. The borrower might also have to make a sizable lump sum payment at the end of the loan term depending on that timetable.
The buyer has two options when the loan term is up: either they pay the balloon payment or they refinance their mortgage and use the money from the new loan to repay the sellers. Depending on how the owner financing was initially set up, either the seller will sign a Satisfaction of Mortgage confirming that the mortgage has been paid in full and relieving the lien on the property, or the buyer will receive title to the property for the first time.
Example: Owner Financing
Let’s take the example of a buyer who wants to buy a cute starter home but is unable to qualify with a bank because of being self employed. The borrower agrees to pay $100,000 for the house and put down $30,000, or 30% of the total cost.
The seller agrees to finance $70,000 at a rate of 7% amortized over 20 years with a 15 year term. The buyer makes payments of $543/month for principal and interest, not including property tax and insurance. After 15 years the buyer would need to pay the remainder of the loan of $27,408 at that time either with a refinanced loan or cash payment.
The buyer and seller sign a contract for deed that lays out those terms. After fifteen years of on-time monthly payments, the buyer makes the final balloon payment and the seller transfers the property deed on the home to the buyer.
Owner financing has both advantages and disadvantages.
Because it can make it simpler to finance the purchase of a house, owner financing is a popular choice for borrowers. Instead of accepting a single sum payment, sellers may choose owner financing to speed up the closing process and collect interest. However, there are some drawbacks that can discourage a buyer or a seller from agreeing to owner financing.
Benefits for Buyers
-allows homebuyers to finance homes when they may not qualify for traditional financing
-shortens the due diligence phase for faster closing for buyers and sellers
-eliminates the need for an appraisal, bank fees, and, if the buyer so chooses, an inspection, which lowers the cost of closing.
Benefits for Sellers
-enables owners to sell their properties in their current condition without having to comply with a lender’s evaluation standards
-presents a potential investment with higher returns than the majority of conventional investments
reduces the amount of due diligence required and gets rid of the lending procedure to speed up the selling process
-Still permits the sale of the promissory note to an investor in exchange for a cash payment.
Downsides for Buyers
-often has interest rates that are greater than those of a standard mortgage
-may require a balloon payment from the borrowers at the end of the loan term
-buyer’s creditworthiness may still prevent the seller from agreeing to owner financing
-depending on the underlying financing, a due-on-sale clause in seller’s mortgages may be triggered and require an early pay off the loan.
Downsides for Sellers
-exposes sellers to the danger of late payments, defaults, and, in some situations, the requirement to start the foreclosure process
-If the borrower defaults, the seller may be left with repairs and other implications of postponed maintenance
-federal requirements may restrict sellers from giving owner financing, limit balloon payments, and mandate that parties work with a mortgage loan originator.
Common Owner Financing Conditions
Owner financing agreements should be specified in writing, just like any other real estate contract, to make sure that both buyers and sellers are aware of their obligations. The owner financing agreement should include the following terms:
Price. Be sure the purchase amount for the property included in the seller financing documentation. This will make it easier for all parties to figure out the overall loan amount.
Down payment. The amount of the buyer’s down payment at closing should also be specified in an owner financing agreement. The amount of any earnest money deposit should also be mentioned in the contract.
Amount borrowed. To determine your loan amount, deduct the down payment, earnest money, and other upfront payments from the purchase price.
Interest rate. The interest rate of the loan should be specified in the owner financing agreement. Although it can be negotiated by the parties, seller financing rates are often higher than those on conventional government-backed mortgages.
Term of the loan and amortization schedule. The length of time a buyer has to repay the loan is known as the loan term. In other words, it’s how many monthly payments the buyer will make. The amortization schedule shows the monthly breakdown of the payment, amount going to interest, amount going to principal and remaining balance for each of the months during the life of the loan.
Monthly payment. The payment amount due each month, due date, definition of a late payment, and grace period (if any) should all be included in your owner financing conditions.
Details about balloon payments. Many seller financing agreements have terms that are substantially shorter yet are amortized over 20 or 30 years. As a result, there will be a balloon payment (or lump sum) due at the conclusion of the loan term. However, keep in mind that these might be constrained by federal legislation.
Taxes and insurance. Owner-financed buyers may be required to make payments to government and insurance companies directly, or they may be held in escrow to be paid by the seller. In either case, the owner financing agreement will specify who is in charge of making these payments.
Other additional terms. Because every real estate transaction is unique, be sure your owner financing agreement details everything that makes your transaction special. If subject property is a historic home, for instance, it may be stipulated that the purchasers must obtain written consent before removing or changing any of the home’s distinctive features.
Deal Structure
A written document that contains the details of the sale should always be used to commemorate an owner financing agreement between the buyer and seller. The ideal approach will depend on your particular needs and circumstances, but there are a few different methods to do this. Here are three primary ways a deal can be seller-financed:
1. Make use of a promissory note, mortgage, or trust deed
This model will be familiar to you if you are familiar with conventional mortgages. A promissory note that specifies terms such the loan amount, interest rate, and amortization schedule is signed by both the buyer and the seller. The buyer’s name appears on the title, the mortgage is filed with the local government, and the house serves as security or collateral for the loan.
2. Contract for deed
A contract for deed is when a buyer waits to get the deed to an owner-financed property until he makes the last loan payment. It is also referred to as an installment sale or land contract. Alternatively, the buyer acquires title if they pay the seller in full and/or refinances the debt with a different lender.
3. Lease contract with option to buy
In this option, also known as a lease option or a rent-to-own option, a seller rents a property to a buyer along with an option for the buyer to purchase it for a certain sum. After the lease term is up, the buyer has two options: he can either exercise his lease option and buy the property outright or give up the option. Rent paid throughout the lease period is credited against the purchase price if he decides to buy the property. This allows the tenant to ‘try before you buy’ with no obligation to purchase the property.
Is it right for you?
If you’re in the market for a new home but concerned with getting bank approval, owner financing may be the alternative that keeps homeownership within reach. It can be an excellent way to buy a property while also simplifying the entire process. If you would like to discuss it further, or would like to see what properties might be available, feel free to head to www.WyoSellerFinance.com to find more information.