April 30, 2024
Ready to buy a home but don’t have the credit history to qualify for a bank loan? Ready to sell a home but want to add an incentive to make it more marketable? In either scenario, seller financing might offer an alternative option that would pay dividends.
Ready to buy a home but don’t have the credit history to qualify for a bank loan? Ready to sell a home but want to add an incentive to make it more marketable? In either scenario, seller financing might offer an alternative option that would pay dividends.
You’ve found the home of your dreams but you’re not yet able to qualify for a mortgage with a traditional lender or financial institution. The seller is, however, willing to help finance your purchase of the home until you can build your credit and qualify for a more traditional loan instrument. Is it too good to be true? Learn more about a seller-financed mortgage and determine whether it makes sense for your home purchase.
Seller financing is just what it sounds like: Instead of purchasing a home with bank financing, you pay your payments directly to the seller. Often, seller financing is a short-term loan of three to five years with a balloon payment at the end. This is because few sellers are willing to offer a 30-year amortization term like those that a financial institution would provide. The seller will want you to either pay off the loan within a few years or improve your credit to a level that would allow you to obtain a mortgage.
Seller financing has advantages for both buyer and seller. Here are some of the ways that seller financing can work for each party:
Seller financing can make the dream of homeownership easier to access for homebuyers who might not be ready to qualify for a mortgage through a financial institution. In addition, there is more flexibility in the payment terms since the seller and buyer can negotiate their own agreement.
For example, while traditional lenders charge private mortgage insurance (PMI) for mortgages with less than 20 percent equity, a seller may choose to forgo this requirement, helping the buyer to save thousands of dollars each year. In addition, a seller may be willing to finance with less money up front and a higher interest rate, or with a larger down payment as extra assurance for those whose credit history is weaker.
Sellers may save significantly on the closing costs associated with a seller-financed transaction. In addition, seller financing offers a value-added incentive that may help to get a property sold more quickly, especially in a strong buyers market.
At the same time, the seller is released from the obligation to pay many of the expenses associated with homeownership while earning significant income during the term of the seller-financed purchase. Seller financing can also be a good option for sellers who want to sell their home as-is and allow the buyer to make improvements and repairs over time.
While seller financing can be advantageous to both buyers and sellers, it carries risks as well.
One of the most important things to consider when buying with seller financing is whether the seller has the right to finance the property in this way. If the seller owns the home outright, they may be able to negotiate the transaction. However, if the seller does not have full title to the property or if they still owe money on their mortgage, they may be unable to enter into a contract with a buyer. If the seller has not paid off the mortgage, the buyer could be left in the lurch if the seller fails to make payments, leading to the foreclosure of the property.
Because seller financing is often offered to buyers who are unable to qualify for traditional financing, there is the possibility of fraud and dishonesty in the transaction. Often, a seller-financed transaction is not contingent on a home inspection and the homebuyer could take possession of the property and then find out that it is in significant disrepair.
In exchange for the convenience of seller financing, and because the transaction is not contingent on an appraisal, the buyer could end up paying too much for the property, either through an elevated home price or above-market interest rates. If you are a buyer considering a seller-financed home, you should still do your due diligence before entering into an agreement with the seller.
Should the buyer fail to make the agreed-upon payments, the seller could find themselves undertaking an expensive and time-consuming eviction process. Alternatively, the buyer could abandon the property, leaving the seller to undo the purchase agreement, make needed repairs, and find a new buyer for the property.
Depending on the increase in home value over the seller’s term of ownership, the seller may avoid or delay capital gains taxes to be paid upon the sale of the property. If you are a seller considering a seller-financed transaction, it is important to check with your accountant or tax advisor to determine whether seller financing would have a significant financial upside in your case.
While banks and financial institutions report to credit agencies, seller-financed loans may not show up on your credit report. That means that on-time payments will not help to improve your credit score the way they would with a commercial loan.
If, however, you default on the seller-financed agreement, that could end up affecting your credit score. This is especially likely if the seller pursues compensation through a court judgment or turns your account over to a debt collection company. This could not only end up impacting your credit history but also make it more difficult for you to obtain a rental in the future since there would be an eviction on your record.
Whether you’re on the buyer or seller side, you need to remember that seller financing is not your run-of-the-mill transaction. Both parties need to be protected throughout the process with the best legal and financial advice. Work with a real estate attorney and a well-qualified real estate agent or broker with experience navigating and negotiating alternative financing options, including seller financing. They’ll help ensure that this strategy works for both of you and helps you to accomplish your real estate goals.
