The Current State of Seller Financed Sales
Seller financing may just be the great untapped market in terms of win-win situations for a variety of reasons.
Interest rates are still relatively low, but credit is tightening a bit, making loan qualification more difficult for borderline buyers. The future is a bit uncertain, and interest rates are creeping up while demand seems to be leveling off.
Why should a buyer or a seller look to alternative financing because of this? In some cases, it can be good for both sides, and it can offer a way to simplify a transaction rather than adding additional layers of complication. It takes a good amount of consideration to determine if seller financing is a good move - buyers and sellers alike should speak with a financial professional to see how this would affect their current situation.
A History of Financing
While long-term mortgage financing is by far the most prevalent way to buy and sell real estate, it has never been the only way. Until the mid-20th Century, long-term mortgages were unheard of, even for commercial property. Cash ruled and, if terms were offered, it was usually for a short-term payout.
Farm property often changed hands by means of casual agreements to make payments out of successive harvests, sometimes with provision for a "balloon payment" after X number of years. The arrangement allowed newcomers and younger generations of farmers to build equity without having to save up for cash purchases of land.
A legal document known variously as a Contract for Deed or Land Contract, Lease-Option or Lease-Purchase Agreement, Equity Sharing, Junior Mortgages, and many other arrangements have been used for generations to transfer full or partial ownership from one owner to another. While they may have originated in the days of "handshake transactions," these alternative financing methods have a basis in tradition and law.
The greater risk is to the buyer; Inability to pay, whether payment is due to a commercial lender or to an individual owner, results in the loss of property through foreclosure proceedings. In most cases with owner-financing, the property reverts to the seller whether it is in the first year or later on in the contract. A buyer in default typically has no further claim on property, and any built up equity is abandoned and lost.
Possible Benefits to the Buyer of Seller Financing
- A quick road to closing
- Lower closing costs
- Flexible down payment
- Terms tailored to individual situations
Possible Benefits for the Seller in Offering Seller Financing
- Higher than market rate interest
- The ability to "unload" existing debt and eliminate the ongoing carrying costs and responsibilities of home ownership (if, however, there is an existing mortgage that will not be retired, approval for the transaction from that lender is likely necessary)
- The opportunity for a quick sale
- In case of default, property reverts to the seller. This might be considered good or bad, depending on individual circumstances.
Judging the Market
In a hot real estate market, the ideal situation for most sellers is an easy sale to a pre-qualified buyer with impeccable credit, at full price and with minimal days on market. But the ideal is far from the norm sometimes. Even in a "Seller's Market," there may be advantages to offering the option of seller financing.
First, because terms are flexible, the seller can help a prospective buyer who might be highly motivated and credit-worthy, but short on cash. Such a buyer might jump at the chance to own a home with less than 20 percent down, no mortgage insurance and a speedy move-in. It may be an ideal match for a seller who does not require cash to purchase another home, and who might appreciate the monthly income for a period of years. There are often specific tax advantages available to such sellers.
Likewise in a slower market, or for property that is not heavily sought after, seller financing can pave the way to a sale that might not have happened otherwise. At the very least, it may be a way to spark interest or to initiate a conversation.
There is no single formula. Seller financing, however, is one way to match motivated sellers with motivated buyers. Each side has certain advantages, and both bet that the other side will concede some points. The give and take may sometimes generate wins all around.
There are some pitfalls to avoid. While the requirements for loan origination and fees for such things as points, insurance, and appraisal are generally waived for seller financing, any agreement is still a legally binding document, and should be prepared by an attorney familiar with pertinent real estate practices. In addition, both buyer and seller should be aware of the legal and tax ramifications, and must thoroughly understand their individual rights during the term of the contract.
It is generally advisable to agree to the shortest reasonable time frame; and to stipulate what actions, if any, are available to adjust the contract terms. For example, if a 10-year payout is agreed to, can the buyer opt to refinance and pay the balance early? On the seller's end, does a buyer have recourse if the seller chooses to "sell the contract" to a third-party financier who alters the terms?
Doing Your Research
Because seller financing is rare in today's market, most people are not thoroughly knowledgeable concerning the ins and outs of non-traditional financing.
This is absolutely a case of needing to know what you might be getting into, and it pays to seek help prior to offering or seeking a seller-financed deal. Remember that the property or home should almost always secure the loan, and sellers are wise to ask for the same sort of extensive application information that a traditional lender would request.
Know that there are many resources available, whether you are buying or selling, to make the path easier. And then consider all available options.