Seller financing can score you a home sale faster, especially in a slow market, but you have to duck and dodge the obstacles that come with it.
If you’ve never heard of seller financing, you’re not alone. Fewer than 10% of home sales used seller financing in 2016.
Top 1% Florida real estate agent Dylan Snyder says he’s only had clients use seller financing a couple of times over his 16 years as a successful agent because, as he says, “all the stars have to be in line…it doesn’t always happen.”
What is Seller Financing?
People usually finance buying a house with a bank or other traditional lending institution. That’s where most folks send their mortgage payment every month.
With seller financing, you, the seller, lend the buyer credit for part or all of the purchase price, minus a down payment, and the buyer makes monthly payments to you. You are the lender!
You extend credit in a short-term loan, minus a down payment, for some or all of the price of the house. You and the buyer sign a promissory note, and the buyer pays you month to month, with interest.
For example, you might extend a thirty-year loan, like a bank would. But after five years, there is a balloon payment due of whatever you’re still owed. (After those five years, the buyer could refinance with another lender.)
Wait, back up a minute. I’m the bank? Why would I do that?
Seller financing isn’t the most common practice, but there are reasons to become the bank in your house sale:
- If there’s a tight credit market, only a small pool of potential buyers might be qualifying for a traditional loan. Your listing is not getting results, and time is passing.
- Maybe your house, although terrific, is not the super-updated gem of the area, and the competition is stiff. You want to even out the playing field.
- You could want to sell to a family member or to a friend’s son or daughter, someone who is not in a position to get traditional financing right at this time. But this person can afford a down payment and a monthly payment to you. Buyers just starting out in life, or just starting a new business, are sometimes in this position for a while.
- You don’t love the idea of paying taxes on the lump-sum profit from a house sale.
Being the lender has other positives that could make it a good idea for you:
- Not only can you increase your pool of potential buyers in a tight credit market, but in a buyers’ market, your house can stand out as a more attractive opportunity.
- Since you are the lender, you can set the price and create a situation where the buyer can manage it. You get the return on investment you want.
- You will earn more interest on this loan to the buyer than you would earn on the profits from a regular sale. We’re talking the 7-8% range here.
- Seller financing lets you sell a home “as is,” if it needs a little work done. Some buyers want a fixer-upper they can shower with TLC. (When they’re done paying you, they can finance the improved house with another lender.)
- If the buyer defaults, you keep all payments already made, and the house is still yours.
- You can sell the promissory note at any time if you decide you want the big payment.
- If you keep the promissory note, you have a monthly income from the buyer, which can be a delightful addition to retirement or give you a break from work.
How Seller Financing Works
There are a few different ways to set up seller financing:
- All-inclusive seller financing loan: you finance the entire cost of the house minus the down payment.
- Junior seller financing loan: you finance only part of the cost of your house, minus the down payment. It’s often the difference between the house price and what a traditional lender is willing to cover.
- Land Contract: both you and the buyer share ownership, called “equitable title,” until the final payment is made to you. The buyer lives in the house and covers maintenance, taxes, and insurance, but the deed is not fully transferred until the house fully paid for.
- Lease Option: you lease the home for a fee and promise to sell it to the lessee within a specified time. Some or all of the rental payments can go toward the purchase price.
- Assumable mortgage: the buyer takes your place on the existing mortgage you have with your own lender. Your lender has to approve, of course!
Seller financing comes with obstacles and serious risks, too.
The main obstacle for many sellers is that you have to own your home free and clear to offer this option. If you still have a mortgage, your lender has to approve seller financing, which is rare.
Say you do own your home. You do offer seller financing, and that home gets sold. Remember that you might now be the sole lender.
That’s fine, as long as the payments keep coming every month. But what if they stop? Where do you turn then? Nowhere. This job is yours, and yours alone, to handle.
Imagine that. Foreclosing is your problem, and you may spend in the tens of thousands of dollars on legal and other fees, plus spend the time it takes to supervise the foreclosure process.
In the meantime, you are no longer getting that payment every month you were counting on.
The maintenance, property taxes, insurance? It’s still your house. Yup, they’re all suddenly your problem again.
While you’re hacking your way through this jungle, the value of your house could be dropping…and dropping. How excited are you to start the selling process all over again from the beginning for a house that now appraises for less?
The Other Downsides of Seller Financing:
- If you are doing partial financing, along with a lending institution, and foreclosure happens, the bank gets paid in full first. You have to sit and wait for yours, and that could be a very long wait.
- Even if everything goes well, the taxes in a seller-financed purchase are extremely complicated, and you will need to hire a pro. For example, your eligibility to have part of the profit from a primary residence sale be tax-free may have changed. Ah, tax law.
- For your own protection, you absolutely need a loan application from the buyer, and it’s on you to get everything checked and vetted. Remember, you’re doing all the lender work here.
How You Can Minimize the Risks of Seller Financing
- Get a complete a loan application as thorough as a bank would use, and take the time to confirm every detail of the buyer’s financial situation. You can find basic applications online.
- The contract needs to state that the sale is subject to your approval of the application. You may need legal assistance to get these steps right.
- Make sure the loan is secured by the property: ensure the right to foreclose if necessary.
- You do not really want that house back, but at least you will get it.
- Aim for at least a 10% down payment. You are more secure with a buyer who has a serious financial investment in the house.
- Don’t let impatience tempt you to accept a buyer your instincts tell you is not a safe bet.
Still Think Seller Financing is For You? Here are Your Next Steps
If you’re not already working with a real estate agent and are ready to find one, there are agents who count seller financing as one of their specialties. There are many great ones available at Homelight.com, which recommends agents to meet your specific needs.
If you have an agent, make sure she knows you are ready to offer seller financing. A lot of online advice tells buyers to ask if it’s available.
Give your agent your terms for seller financing, the details of what you are able and willing to do to work with a buyer.
The listing needs to say “seller financing available,” “owner will carry,” “owc,” “flexible terms,” “motivated seller,” or “wrap” (for a mortgage “wrapped” around another).
If you see these terms in other listings in your area, you will have a much clearer sense of what the “competition” is up to, which may help you decide if the risks are worth choosing seller financing for yourself!