Seller Financing: Pros and Cons

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seller financingIf you absolutely must sell now and are not willing to slash your price, what do you do? What you need to do is stand out in a cluttered and crowded pool of homes for sale. One way to do that is to offer to finance the purchase. The current state of lending makes it difficult for many buyers to obtain acceptable traditional financing. They may not be able to document all of their income or may have some blemishes on their credit reports. I’m not suggesting that you offer financing to anyone with a pulse, but there are plenty of people who would otherwise be credit worthy but may have had a legitimate problem that keeps them from qualifying.

Obviously this is a strategy that works best if you own the property outright and don’t have a mortgage to pay off. If you have a mortgage you can still offer owner financing by wrapping a new loan around the existing one. But that’s a subject for another column, for now we’ll assume that you are selling a house that doesn’t have an existing mortgage.

Seller Financing: The PROs

The upside of offering to finance the purchase is that you can usually get a better price and a quicker sale. Car dealers figured out long ago that people are more likely to buy based on payment rather than the selling price. It is often the same way with a home, if the payment fits their budget they will buy. A buyer may balk at the price of the home in a traditional purchase but not think twice when looking at the payment alone. For some reason $599/month with $10,000 down sounds different than simply buying for $100,000 even though it is the same exact thing if you have a 30-year mortgage at 7%.

You may also benefit by treating it as an installment sale for tax purposes. This allows you to spread out any capital gains taxes that may be due. You do have the option of recognizing the entire gain in the year of the sale if that is more beneficial to you.

Seller Financing: The CONs

The biggest downside is pretty obvious, you don’t get your moely-houses-031ney up front. If you absolutely must sell you may have no choice. When you hold a mortgage you do have the option of selling it to a note buyer. You will have no trouble finding them either. As soon as the mortgage is recorded you will start getting letters offering to buy the mortgage from you. Of course, you will have to sell it at a discount. How big the discount is depends on the terms of the note, the loan-to-value, the credit worthiness of the person you sold the house to and the current conditions in the credit markets.

Another negative is having to deal with collecting payments, providing tax reports, verifying that property taxes have been paid and that the new owner has maintained property insurance that protects your interest. The easiest way to deal with that headache is to have a note servicing company deal with everything. Most title companies are able to recommend a servicing company to you.

Seller Financing: The Ugly

The real risk is that the buyer stops making payments at some point and you have to foreclose. You are subject to the same laws as any other lending institution. Each state is different but you will most likely need to hire an attorney to help you through the process. You will eventually get the house back and have to sell it all over again. You may have to deal with repairs and other issues before being able to sell.

While the risk of having to foreclose can’t be avoided, it can be minimized. You do that by carefully screening the buyer so that you are fully aware of any issues. You are probably dealing with someone who isn’t the most credit worthy or they would have just obtained a mortgage from a bank. The best way to reduce your risk is to get as much of a down payment as possible. The less money you receive up front the more likely you are to have problems.

Risk comes from not knowing what you’re doing. – Warren Buffett

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  1. Richard,

    Thanks for great article.

    In these unsettled financial times, as mortgages become more difficult to get, more people will have to use owner financing, so we need to let more people know about how to do it.


  2. Seller financing is also an excellent means for real estate investors to pick up additional properties in the current buyer’s market. Especially in light of tightened lending criteria that adversely affects the investor buyer, these opportunties can truly be gem-like when you find them!

  3. If buying a place with seller financing it is a good idea to have the seller frequently provide documentation that they are still paying the mortgage on their end. Otherwise you could end up paying the seller while they are not paying their mortgage, leading to foreclosure.

  4. A strong trend now and in 2010 (IMHO) is offering either:

    Seller Finance 1 – Long term lease options.
    Get the property in perfect shape, get 3% or $5K down, and offer 50% rent credit the 1st year only. Offer exercise price at new appraisal or average of 2 appraisals. You may not like offering properties at new appraisal (declining market), but it is fair for all parties. The Lease Option Buyer needs a real new appraisal value to get a loan.
    Seller Finance 2 – Free and Clear – Contract for Deed.
    People that hold paper and cashflows will win over the next 5 years better than flippers. A cash flow that can be utilized in many US states is an installment contract (CFD, AFD, ILC, etc). Texas is terrible, as are a few others. But I love them if the state laws allow repossession on installment sales.

    A tool for repossession is Deed in Lieu of Forecolosure. Ask your REIA Attorney if CFDs work.

    Selling to great income, terrible credit, 5% down, 95% financed for 40 years at 9.99% will create an affordable payment near rent in many RE Markets (say $100K – $250K middle class 4 B 2 B homes.)

    If you buy all cash with private IRA mortgages, then sell on lease option or CFD (free and clear), I believe it is a strong strategy for 2010 and beyond.

    Brian Gibbons

  5. Julia Sandoval

    Yesyerday i went to apply for a loan for a duplex. Credit scores were excellent but debt ratio was a little too high that is preventing the approval. The duplex has a lot of equity And it is from a family member that could give gift of equity. Seller financing may be the solution here but doe anyone know of other options?

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