What is Seller Financing?
Seller financing is a type of arrangement between a homebuyer and seller where the buyer purchases the property in installments—usually including principal and interest—until the property is paid off in full.
Unlike a traditional mortgage, however, seller financing is often short-term in nature. The transaction is usually completed in, say, five years, with a balloon payment at the end.
Why should a seller be willing to enter into such an arrangement with a buyer, you may ask?
Well, seller financing is what you could call a symbiotic type of relationship.
Let’s break it down.
Benefits that Come with Seller Financing
Seller financing can be beneficial for a seller when closing a deal on the home proves challenging because borrowers are having trouble securing loans to buy the house. Credit can, and does, get tight sometimes, and during such periods, selling a home becomes a bit more daunting.
Also known as owner financing, seller financing can benefit the seller in these other ways as well:
- Ability to sell an unmarketable property
- Steady flow of income
- Spreading out taxes
- Enjoying higher interest rates
- Eliminating the middleman
To the buyer, it is a perfect way to circumvent conventional financing, which they may choose to do should they be unable to obtain financing because they do not meet the usual criteria.
Other benefits of seller financing to the buyer include:
- Flexible financing
- Lower down payment
- Lower closing costs
- Faster close
How Buyers can Obtain Seller Financing
Seller financing is not a one-size-fits-all solution—there are several options available to the buyer and seller.
A “Subject to” Purchase
Buying “subject to” is a transaction that involves purchasing the property subject to the seller’s existing mortgage.
Usually in this case, you, the buyer, do not qualify for the existing loan, so you agree with the seller, allowing them to give you a quitclaim deed or grant in exchange for some type of consideration. If you fail to make your monthly payments, it is the seller who will be owing money to the lender—not you.
Many lenders don’t advocate for this kind of arrangement since a buyer needs to formally qualify for the mortgage in the first place. But it is hard for the lender to foreclose on the new property owner since most are content just receiving the monthly payments.
The possibility of foreclosure is always there, though, and to be on the safe side, it is advisable to obtain a clear title insurance policy from a national title insurance company.
AITD (All Inclusive Trust Deed)
Also known as an all-inclusive mortgage, this type of seller financing is a “wrap” of an underlying mortgage.
A wrap is basically the creation of a new mortgage big enough to pay on the existing loan (wrap around), including any additional equity in the property.
This larger payment is usually made to the seller, thus entrusting them to pay the underlying loan. If the seller fails to pay their underlying mortgage, the buyer can be on the hook.
This seller financing approach involves leasing the property from the seller while retaining the option to buy at a later date—but without the actual obligation.
This affords the buyer control over the property and selling price until they can secure outside financing.
However, this option also calls for extra caution on the side of the buyer, lest the seller fails to make their monthly payments while the lease option is still in force.
Second Lien Position
A seller carries a second mortgage lien (aka junior lien) behind the bank to make a small or no-money-down deal.
The buyer, for his part, is required to make two sets of payments each month: the senior bank lien holder pockets the first, while the second is made to the private seller.
In the event the buyer only pays the first holder, the seller has the ability to foreclose and repay the larger lien holder. But for this, the seller will need to have sufficient funds or equity.
A land installment contract can be as complicated as it is risky for the buyer. It involves setting up a contract for the buyer whereby they are required to make agreed-upon payments for a stipulated period (five to 10 years being the most common).
Just as in a lease arrangement, a land contract affords the buyer control of the property (and price) until the buyer can arrange other financing.
But it happens to carry a great amount of risk: the property buyer only carries equitable interest in the property—the seller retains custody of the legal, titled interest.
Should the buyer happen to default on even a single payment, the contract can be terminated and the seller assumes absolute control of the property without the need to foreclose.
Before you decide to try either of these seller financing options, seek legal, accounting, and financial opinions from your local advisers. The outcome of the deal could hinge upon that.