Seller Financing By Owner: What You Should Know
Jul 22, 2019 July 22, 2019
Seller financing, sometimes called owner financing or creative financing, is an option for buyers who may not be eligible for conventional mortgage financing from a financial institution. If you’re considering buying a home with seller financing, or if you are selling a home and want to finance the mortgage yourself, read on to learn more about how seller financing works.
What Is Seller Financing?
In seller financing, the seller assumes the function of the lender, in lieu of a bank or mortgage company. The seller essentially provides the buyer with a loan for the amount required to purchase the property, minus the amount of the down payment. The buyer and seller sign a promissory note that establishes the terms of the loan contract, and the buyer pays off the loan by making monthly payments to the seller.
What are Typical Loan Terms? How can I structure the Loan?
As with most financing agreements, the buyer will typically make a down payment, and a time period will be agreed upon for the repayment of the loan. When the seller is financing the sale of the property, the time period is usually shorter than the typical 30-year period provided by most banks. In most cases, the loan might be amortized over 30 years but will be paid off much earlier through a balloon clause, which establishes a point at which the entire outstanding balance must be paid in full.
Typically this happens after a 5, 10, or 15 year period, according to the agreement that the seller and buyer make, which can actually be a totally custom agreement. At that point, the buyer will most often refinance the balance of the loan with a traditional lender, at a better interest rate, having improved their credit score and earned some equity in the property.
The seller also has the option of selling the promissory note or loan contract to a lender or investor, who will then collect the buyer’s monthly payments.
While this may be an attractive option for the seller if they should suddenly desire a quick payoff, a promissory note will typically sell for only about 65% to 90% of its actual value, reducing the seller’s return on the sale of the property.
What is a Typical Down Payment on a Seller-Financed Home?
I find that sellers who would be willing to finance are looking for at least 25% of the property’s value as a down payment. Technically, as long as the buyer and seller agree, the down payment could be any amount. But most of the deals end up with a down payment of 30-50% of the property’s value.
Amortizing across the term of the loan or across a longer time-frame. What’s the difference?
When negotiating the loan terms, you can for example create a 5-year loan amortized over 5 years, which means that the monthly payments are set to pay the entire balance of the loan by the time you make the last payment in year 5.
Alternatively, another common agreement I have seen is a balloon loan, where you can have the loan amortized over any number of years. For example, you can set up the loan as a 5-year balloon loan with a 30-year amortization (this means the monthly loan payments are made is if you were to pay it over 30 years), which would cause a large balance to remain when you reach your last payment at the end of the 5th year of the loan. At that time you would be required to make a large balloon payment to pay off the full balance of the loan.
What Does a Seller Financing Contract Look Like?
Ideally, both parties should retain an attorney or real estate agent to compose and review the sales contract, promissory note, and all related documents that make up the loan contract. Hire professionals that are experienced with seller financed transactions and are local to your area if possible, because some regulations, such as those governing balloon payments, may vary by jurisdiction.
Promissory notes are simple documents that typically include:
- The amount of the principal debt
- Terms of repayment
- Interest rate
- Repayment schedule
- Details pertaining to balloon payment if applicable
- Late payment penalties
- Early payoff terms
- Transfer of mortgage and payoff terms in case the borrower sells the property
A mortgage document or deed of trust is also included to provide protection for the seller, placing a lien on the property and stipulating the course of action if the buyer/borrower should default on payments. This document must be filed in court and provides the basis for foreclosure if it should ever become necessary.
Seller Financing Interest Rates
There is no hard and fast rule for interest rates for owner financing, but it’s not uncommon for the interest rates to fall in the range of current market rates. That said, I would venture to guess that if you want to put a lower down payment or have a riskier credit profile the seller might want a higher interest rate, and the more you put down and cleaner your credit the lower you can take the interest rate. Also, if you are paying a premium in price for the property, the seller is likely to offer you more favorable financing terms, where as a typical lender won’t care or likely would not be happy to know you are paying a premium for the property.
Seller Financing vs Rent to Own
The primary difference between a regular seller financed sales contract and a rent-to-own contract is the point at which the property changes hands. In a regular sales contract with seller financing, the property is transferred to the buyer’s name immediately upon closing. In a rent-to-own arrangement, the property is transferred to the new owner at the end of an agreed-upon period of time or a specified number of payments.
Seller Financing vs Conventional Financing
While there are some disadvantages for the seller in financing the sale of their own property, such as not getting the full amount up front, having to administer the loan, and risking the possibility of having to foreclose, there are plenty of advantages as well.
The advantages to sellers include:
- getting more for the property, because buyers looking for seller financing sometimes are willing to pay a premium,
- creating an opportunity for a buyer to purchase your home who would otherwise not be able to purchase it
- and receiving a regular monthly income.
- Also, you can always foreclose and get the property back if the buyer defaults on payments.
- sell a property that might not otherwise be financeable (for example a property with known structural defects or a condo with bad financials)
- sale can happen a lot faster than a traditionally financed property, since you as seller are in control of the loan approval process
The advantages of owner financing for buyers include:
- a way to build credit
- a means to purchase a home you might not otherwise qualify for using traditional financing
- come up with loan terms a typical lender might not offer you
- much less paperwork to fill out and much faster loan approval
- lower closing costs
Where can I Search for Condos that Allow Seller Financing?
The best way to find seller-financed properties is by working with an experienced and knowledgeable realtor who has some insight as to the seller’s economic situation. A good realtor will know when a seller will likely be open to a creative financing negotiation. Basically, these are sellers who don't need the full payment for their property up front, and who would be interested in securing a monthly income source. Many sellers advertise seller financing as an option outright. Feel free to reach out to us at the contact info at the top of this page, and we will be happy to connect you to the right property that allows for seller financing.